Hybrid CD investment - Your thoughts

[disneysteve]

I'm curious what folks think about this investment. If it FDIC insured but has some creative/unusual terms. I'm not sure exactly what they call them but I've heard about these in the past. Forget whether or not they are appropriate for a particular person or situation. Just comment on the actual deal itself.

15-year CD, FDIC insured
$10,000 minimum investment
First year pays a fixed 6% interest
After that, the rate adjusts quarterly.
It pays 1.1 x 6 - 6-month LIBOR rate.
So currently, the 6-month LIBOR is 0.75 so it would be 1.1x6-0.75=5.85%
The deal is also tied to the S&P 500 index. If the S&P drops below 1,095, the CD stops earning interest for every day that it stays under that level. It is checked daily so as soon as the index rises over 1,095 the interest resumes.

So right now, the LIBOR is at 0.75 and has been pretty steady since rates have been low for some time and are expected to stay low for the next couple of years. After that, nobody knows. The S&P is hovering just under 1,400 so it would have to fall about 20% for the interest to stop. Even if the LIBOR quadruples to 3.5%, the CD would still be paying 3.6%. Of course, you have to consider that if rates quadruple, regular CDs would be paying a lot more than they are today also. So you could end up with this CD underperforming prevailing rates but most likely not in the next couple of years during which time this would be way outperforming existing CDs. Would that balance it out over time?

It is pretty bizarre but an interesting concept. So what does everyone think?

[Slug]

Interesting. What's the early withdrawal penalty? Who's offering it?

[kork13]

Interesting. What's the early withdrawal penalty? Who's offering it?

My thoughts exactly... How bad is the hit for early withdrawal? Honestly, it's an interesting idea. Mostly, because it bases return on 3 totally separate sources...the base rate, LIBOR rate, and S&P 500. Of course the 15-yr duration is a little off-putting, but I think for the right person and strategy (probably best for a retiree), it could be a great deal.

[disneysteve]

What's the early withdrawal penalty?

Good question. I don't know but will try to find out.

[humandraydel]

Sounds like a bad deal to me. I estimated the average LIBOR rate since 1989 and it's around 5%. I think it's very likely that it will get back to 5% and be 5-6% average over the next 15 years, which would make your CD pay little to nothing. Of course, as others have pointed out, if the withdraw penalty isn't bad, then it might be worth it. But I suspect with a "deal" like this, the withdraw penalty will be severe.

[kv968]

Call me a pessimist, but I'd be very wary of something like this. I'd definitely make sure to go over the fine print VERY carefully. My main thing would be who's the issuer and what's the early withdrawal penalty?

I'm not saying it's not legit, but as they say, "if it's too good to be true..." and you don't get extra rewards without extra risk.

Just a couple of things from the SEC's website you might want to look at:

• The SEC filed a complaint against individuals who raised more than $3.9 million from at least 50 investors by selling CDs that did not exist. The fraudsters lured investors, many of whom were seniors, with promises of above market rates on FDIC-insured CDs purportedly issued by an entity called the "Liberty Certificate of Deposit Trust Fund." Rather than purchasing the CDs as agreed, the perpetrators used the invested money to make payments to prior investors and for their own personal uses. [See SEC v. Reinhard et al., Civil Action No. 06-997-CMR (E.D. Pa.)].

• The SEC and the Florida Office of Financial Regulation filed an Emergency action and secured injunctions and asset freezes against financial services firm AmeriFirst Funding and its principals for defrauding investors of approximately $55 million in a fraudulent offer and sale of so-called Secured Debt Obligations (SDOs). AmeriFirst sales agents lured older investors and those saving for retirement, with advertisements for relatively high-yielding FDIC-insured certificates of deposit, then convinced the investors to purchase the SDOs instead. Defendants falsely asserted that the investment had little or no risk because accounts were guaranteed by a commercial bank, protected by many layers of insurance coverage and fully secured by collateral. [See SEC v. Amerifirst Funding, Inc., et al. Civil Action No. 3:07-CV-1188-D (N.D. Tex.); State of Florida vs. AmeriFirst Funding Inc. et al.].

[disneysteve]

Call me a pessimist, but I'd be very wary of something like this. I'd definitely make sure to go over the fine print VERY carefully. My main thing would be who's the issuer and what's the early withdrawal penalty?

I'm not saying it's not legit, but as they say, "if it's too good to be true..." and you don't get extra rewards without extra risk.

I appreciate the warning. In this case, at least, this product is being sold by a major national brokerage firm. It wasn't some unsolicited e-mail or cold call on the phone so I'm thinking it is legit as stated, which doesn't mean it is not without risk of course. Obviously, the potetial downside risk is significant. If rates shoot up or the S&P crashes, this account could stop earning interest entirely. If that were to happen 5 years from now, you'd be stuck with 10 years of 0% interest. The CD could be sold on the market but who would want it? By the way, the CD is also callable but I'm not sure of the timing for that.

[kv968]

I appreciate the warning. In this case, at least, this product is being sold by a major national brokerage firm. It wasn't some unsolicited e-mail or cold call on the phone so I'm thinking it is legit as stated, which doesn't mean it is not without risk of course. Obviously, the potetial downside risk is significant. If rates shoot up or the S&P crashes, this account could stop earning interest entirely. If that were to happen 5 years from now, you'd be stuck with 10 years of 0% interest. The CD could be sold on the market but who would want it? By the way, the CD is also callable but I'm not sure of the timing for that.

I figured it would be callable, but when would they call it? The only variable that would cause them to pay more would be the 6-month LIBOR rate. With that currently being 0.75, how much lower could it go that they'd call it?

One of my finance professors mentioned something about his father buying into a similar product and how he wished he'd talked to him first. I'll have to ask him about what it was exactly and see what he thought of it. I'm not sure if it was a variable CD or the terms involved but the numbers he mentioned look similiar. I'll check it out.

[disneysteve]

I figured it would be callable, but when would they call it? The only variable that would cause them to pay more would be the 6-month LIBOR rate. With that currently being 0.75, how much lower could it go that they'd call it?

Seems to me the issuer is counting on rates going up which would make the interest rate on the CD lower. If rates stay low for an extended period, they're stuck continuing to pay nearly 6% interest. I could see them calling it to avoid having to do that for too long.

[kv968]

Here's also a little bit of info from the FDIC website on brokered CD's:

FDIC

[kv968]

Seems to me the issuer is counting on rates going up which would make the interest rate on the CD lower. If rates stay low for an extended period, they're stuck continuing to pay nearly 6% interest. I could see them calling it to avoid having to do that for too long.

I'm sure they are counting on rates going up. Heck, I can guarantee you they will within the next 15 years. I would just think that they'd have called them, or not even issued the CD, with rates being so low now. Maybe like you said though, they'll do it for awhile but if they stay this low for too long, then they'll call it.

[bjl584]

Wouldn't be too bad if the penalty for early withdrawl isn't too steep. Take your 6% and get out.

You would have to hit bear market for the CD to stop paying, which happened last fall. Will it happen again? Maybe. If Europe implodes or is Israel strikes Iran.

I'd probably rather tie my money up into something with a little less going on.

Maybe CHI. Good as long as rates stay low.

Or something like BHY.

Or a nat gas trust like ECT or ERF.