I had a banker report they have been using this approach to early withdrawal...
We increased our prepayment penalties several years ago. Basically, the fee is the term minus 6 months. So a 4 year term will have a penalty of 3.5 years worth of interest., 5 year maturity would be 4.5 years of interest. It is very easy to figure and it has slowed the amount of CD's that were being asked for early withdrawals.
Does anyone else do this or something else that is unconventional?
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Neil Stanley
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Original Message:
Sent: 06-22-2021 14:11
From: Neil Stanley
Subject: How Many Financial Institutions Use Compensating Penalties?
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Neil Stanley
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We increased our prepayment penalties several years ago. Basically, the fee is the term minus 6 months. So a 4 year term will have a penalty of 3.5 years worth of interest., 5 year maturity would be 4.5 years of interest. It is very easy to figure and it has slowed the amount of CD's that were being asked for early withdrawals.
Does anyone else do this or something else that is unconventional?
------------------------------
Neil Stanley
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-------------------------------------------
Original Message:
Sent: 06-22-2021 14:11
From: Neil Stanley
Subject: How Many Financial Institutions Use Compensating Penalties?
With the potential for rising rates sometime in the future, I am curious about how many financial institutions have adopted Compensating Penalties. Here is a sample in the disclosures from a bank that currently has a portfolio of $7 billion of time deposits:
Early Withdrawal Penalty – We calculate the early withdrawal penalty on a 365-day basis as follows:
Early Withdrawal Penalty – We calculate the early withdrawal penalty on a 365-day basis as follows:
- For maturity terms of 7–31 days, the greatest of 1) all interest earned on the amount withdrawn; 2) 7 days' interest on the amount withdrawn; or 3) the amount of interest that could have been earned on the amount withdrawn for one-half the term
- For maturity terms of 32 to 91 days, the greater of 1) 31 days' simple interest at the rate being paid on the amount withdrawn; or 2) the compensating penalty
- For maturity terms of 92 days to one year, the greater of 1) 91 days' simple interest at the rate being paid on the amount withdrawn; or 2) the compensating penalty
- For maturity terms of more than one year, the greater of 1) 181 days' simple interest at the rate being paid on the amount withdrawn; or 2) the compensating penalty
Compensating Penalty – We calculate the compensating penalty on a 365-day basis as follows:
1) We subtract the interest rate being paid on your original Time Deposit account from the rate we would pay on a new Time Deposit account in the amount of your original Time Deposit account with a term equal to the number of days remaining in the term.
2) Using that interest rate difference, we calculate the amount of simple interest that could have been earned on the amount withdrawn for the number of days remaining in the current term of the original time deposit.
Example: A $2,000 time deposit established for 36 months at 4% is withdrawn after 12 months. To calculate the compensating penalty, we first determine the rate for a new $2,000, 24-month Time Deposit (the remaining term of the time deposit). If this rate were 7%, we would calculate a penalty equal to 24 months' simple interest on $2,000 at 3% (the rate difference of 7% minus 4%). The compensating penalty is $120. The early withdrawal penalty would be 181 days' simple interest on $2,000 at 4%, or $39.67. In this example, the $120 compensating penalty is greater and would be assessed.
What comes to mind as you think about what this bank is doing to reduce their interest rate risk in the face of a future rising rate environment? Has your ALCO modeled the risk of time deposit attrition and repricing as rates rise?
1) We subtract the interest rate being paid on your original Time Deposit account from the rate we would pay on a new Time Deposit account in the amount of your original Time Deposit account with a term equal to the number of days remaining in the term.
2) Using that interest rate difference, we calculate the amount of simple interest that could have been earned on the amount withdrawn for the number of days remaining in the current term of the original time deposit.
Example: A $2,000 time deposit established for 36 months at 4% is withdrawn after 12 months. To calculate the compensating penalty, we first determine the rate for a new $2,000, 24-month Time Deposit (the remaining term of the time deposit). If this rate were 7%, we would calculate a penalty equal to 24 months' simple interest on $2,000 at 3% (the rate difference of 7% minus 4%). The compensating penalty is $120. The early withdrawal penalty would be 181 days' simple interest on $2,000 at 4%, or $39.67. In this example, the $120 compensating penalty is greater and would be assessed.
What comes to mind as you think about what this bank is doing to reduce their interest rate risk in the face of a future rising rate environment? Has your ALCO modeled the risk of time deposit attrition and repricing as rates rise?
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Neil Stanley
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