How Often Do Callable CDs Get Called?

Certificates of Deposit (CDs) are a savings tool offering a fixed interest rate for a specific period, generally considered a low-risk option. A “callable” CD introduces an additional element: the issuing financial institution has the right to terminate the CD early under certain conditions. This article clarifies what callable CDs entail, the reasons behind an issuer calling a CD, and the implications for investors.

Basics of Callable Certificates of Deposit

A Callable Certificate of Deposit is a time deposit where the issuing bank or financial institution retains the option, but not the obligation, to redeem the CD before its stated maturity date. This feature differentiates it from a traditional, non-callable CD, where the investor maintains control over the investment term until maturity. The call provision is a specific term disclosed to the investor when the CD is purchased, outlining the conditions under which the issuer may exercise this right.

Investors typically accept this call feature in exchange for a potentially higher interest rate compared to a traditional CD of similar maturity. While investors in traditional CDs face penalties for early withdrawal, the early redemption of a callable CD is solely at the discretion of the issuing institution.

Reasons an Issuer Calls a CD

The primary motivation for a financial institution to call a CD is to reduce its interest expense. This decision is driven by a significant decline in prevailing market interest rates since the CD was originally issued. When current market rates fall below the fixed interest rate the bank is paying on an existing callable CD, it becomes financially advantageous for the bank to redeem the CD.

By calling the CD, the bank repays the principal and any accrued interest to the investor. The institution can then re-issue new CDs or borrow funds at the lower current market rates. This strategy allows the bank to optimize its funding costs and align its liabilities with the prevailing interest rate environment.

Factors Influencing Call Likelihood

The probability of a callable CD being redeemed is influenced by several factors, with market interest rates being the most significant. A sustained period of falling interest rates substantially increases the likelihood that an issuer will call a CD. Conversely, if interest rates remain stable or increase after the CD’s issuance, the incentive for the bank to call the CD diminishes, making early redemption less probable.

Many callable CDs include an initial “call protection period” during which the CD cannot be called by the issuer. This period typically ranges from six months to a year, providing a guaranteed timeframe for the investor. Once this protection period ends, the CD enters its callable date, and the issuer gains the right to call the CD, often at regular intervals, such as every six months.

The spread between the CD’s original interest rate and current market rates also plays a role; a larger positive difference provides a stronger financial incentive for the bank to exercise its call option. Beyond interest rate movements, an issuer’s specific funding needs and overall liquidity strategy can also influence the decision to call a CD. These internal factors, combined with the external interest rate environment, determine when and if a callable CD is redeemed prior to its maturity.

What Happens When a CD Is Called

When a financial institution decides to call a CD, it will typically notify the investor in writing before the call date. Upon the call, the investor receives their original principal investment along with all interest accrued up to the call date.

Investors generally have a short window, often around 10 to 30 days, to decide how to handle the returned funds. They can choose to take the principal and accrued interest, or they may have the option to roll over the funds into a new CD, though this new CD will likely be at the prevailing, potentially lower, interest rates.

The primary disadvantage for investors in a callable CD is reinvestment risk. If the CD is called during a period of declining interest rates, the investor is then forced to reinvest their principal at a lower rate, which can impact their expected future earnings. When a CD is called by the bank, the investor does not incur any early withdrawal penalties, as the decision to terminate the CD originates from the issuing institution, not the investor.