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Callable CDs and other Callable Government Agency Securities
Agencies of the United States Government and banks have
recently issued a growing number of securities with many different callable structures. A
callable note, bond or CD is one that may be redeemed at par prior to its original stated
maturity at the option of the issuer.
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Why do these premier issuers want to issue callable debt?
Callable securities provide the issuer with greater
flexibility in managing their balance sheet. Once an initial non-callable period has
passed, the issuer can call the debt according to the terms of the particular
security’s call provision. This means that if interest rates decline, the issuer can
replace the securities with less expensive liabilities.
What are the benefits of Callable CDs?
Callable CDs are insured up to $100,000 per depositor
through the Federal Deposit Insurance Corporation (FDIC) and may be redeemed early at the
full principal value in the event of the death or adjudication of incompetency of the
owner. Callable CDs are available in minimum denominations of $10,000 and increments of
$1,000 thereafter.
Who invests in Callable Certificates of Deposit?
Due to the yield, recognized credit quality, and the
variety of maturities available, callable CDs appeal to many different investor groups.
Buyers of callable securities include individuals, pension funds, insurance companies,
commercial banks, credit unions, savings banks and other financial institutions.
Why are the interest rates and APYs so much higher
than traditional fixed rate Certificates of Deposit?
The investor has in effect, sold the right to call the CD
prior to maturity to the issuer. This call feature has considerable value. Thus, the
financial institution pays the investor a higher interest rate than he would receive
purchasing a non-callable CD in exchange for receiving this right to call the issue.
What causes a Callable CD to be called?
A callable CD may be called when the issuer determines that
it is cheaper to issue a new security than it is to pay the interest payments on the
outstanding security. There is no simple way to predict precisely when a call will occur.
However, when interest rates decline, the probability of the investment being called
increases significantly.
Is all or part of the principal called?
As a general rule, callable CDs are called only when there
is an economic reason to do so. As a result the issue will be called in its entirety or
not at all. Some issues have a provision allowing for a partial call of the issue
outstanding, but there is no great likelihood that a partial call would ever occur.
*The Annual Percentage Yield (APY) represents the interest
earned through each year-end call period based on simple interest calculations.
Is there a secondary market?
An active secondary market exists for callable CDs. It
should be recognized, however, that the relatively small deal size of the issues and their
unique characteristics place limitations on the potential liquidity of the product.
Accordingly, if these investments are sold in the secondary market prior to maturity or
call date, they may be worth less than their original cost.
What are Callable Multi-Step Certificates of
Deposit?
Multi-Step Certificates of Deposit are a special type of
callable CD. The interest rate paid on a callable Multi-Step CD increases over time on a
predetermined schedule. As the name suggests, Multi-Step CDs have a series of increasing
coupons that will be paid to the investor over the life of the CD. In all cases,
Multi-Steps have a period of time during which they are non-callable. At the end of that
non-callable period, usually one or two years from issue date, the CDs may be called at
par, or the financial institution must pay a higher coupon to the investor. The CDs are
usually callable on each subsequent interest payment date.
Investment Considerations
From the investor’s perspective, callable and
Multi-Step CDs offer attractive yields relative to comparable treasuries or other
non-callable securities. They are, however, best suited for "buy and hold"
investors as there is little likelihood that the securities will ever trade at a
significant premium over their redemption value.
Preferred Securities Group, Inc.
5301 N. Federal Highway, Suite 150
Boca Raton, Florida 33487
1-800-909-9150
Tel. (561) 998-2170
Fax (561) 998-2177
Email: info@preferredsecurities.com
Member N.A.S.D., S.I.P.C.
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