Rescuers of Thrifts Link Rates to Market Conditions

Q: My husband and I had three separate savings accounts at Columbia Savings & Loan. Each paid a rather handsome interest rate. However, now that American Savings Bank has taken over Columbia, the interest rates on these accounts have dropped considerably. We expected some decline, but we are confused as to how the new rates were derived because each of our accounts now has a rate different from the others. Can you explain the rhyme and reason to this--if any? --M.T.A.

A: Let’s start by explaining what is going on with your savings accounts. To entice healthy thrift institutions to take over ailing savings and loans, the federal government’s Resolution Trust Corp. allows them to adjust the interest rates on all the depositor accounts they assume to reflect current market conditions. Why? Often the ailing institutions were paying interest far above prevailing rates to attract new deposits, trapping themselves in a vicious circle of having to attract even more new money in order to meet their obligations to existing depositors.

In an effort to break that cycle, the RTC allows thrifts taking over ailing thrifts to bring depositor interest rates back in line with prevailing market conditions. In fact, the RTC allows the thrifts to pay as little as the prevailing passbook rate for their assumed deposits. In American’s case this would be 5%.

American Savings says it has calculated the new rates it is offering Columbia Savings depositors according to a complex formula based largely on the size of the account and its maturity date. Larger accounts with longer maturity dates earn more than smaller accounts that mature sooner. That is why each of your accounts has a different interest rate.

When you saw your letter from American Savings you were no doubt hit with reverse sticker shock. The very highest rate currently offered by American Savings is 7.25%, while some Columbia Savings’ accounts drew more than 13%. This is an unfortunate time for depositors to have their savings accounts pegged to market interest rates. Rates haven’t been this low in years! So not only are you hit with an assumption adjustment there is also the double whammy of being forced to accept currently depressed market rates.

American Savings executives say they recognize the potential problem and are allowing Columbia depositors, who had a total of $1.15 billion in Columbia Savings, to withdraw their money with no penalty at any time up to the maturity of their account. The new rates became effective Saturday, and unless you moved your account, you are already earning the lower interest. You will continue to earn this rate until you either move your account or it matures.

By the way, in case you are wondering, you are not allowed to deduct the interest you would have earned if your account had not been assumed as an investment loss. We’ve been asked this question before and had to tell readers that you can’t deduct something you never had.

Should Depositor Switch to B of A Now?

Q: I am a longtime customer of Security Pacific National Bank. I have never been satisfied with the bank’s attitude toward its customers and am looking forward to the pending merger with the Bank of America. Given that the merger is imminent, I wonder whether I should transfer my account to B of A now? I am really looking forward to having a new bank handle my account. --C.H.

A: Hold on! Don’t let your emotions get out of hand here. There is absolutely no reason to make the switch on your own.

For starters, you have no absolute guarantee that Bank of America’s purchase of Security Pacific will go through as planned. Although the chances are great that the deal will be consummated early next year, it can still fall apart. Assume nothing; even the best of deals can go awry at the last minute.

On a more practical note, switching your accounts now will more than likely cost you money. Depending on the type of account you open, you may incur charges for new checks, monthly checking services as well as credit card membership. However, if you wait and let Security Pacific and the B of A handle the transfer of accounts, you will pay nothing for your new B of A checks and credit cards. The banks say they hope to make the transfer of accounts as invisible and painless to their customers as possible and will send you information about the conversion as the deal comes closer to consummation.

Although Security Pacific has not notified its customers of the pending merger by mail, it has material briefly explaining what the deal means to its depositors and borrowers at each of its branch offices. The bank also encourages customers to take additional questions to branch officials.

Compounding Adds to Account’s Earnings

Q: Please explain how banks can advertise an annual interest rate of 6.3% and then say that it has an annual yield of 6.5%. --B.Y.

A: Actually, this apparent mathematical magic is the result of compounding. In this case, the bank is computing interest on a daily basis, which means that it adds one day’s interest to the account before calculating the next day’s.

Let’s say you had $1,000 in an account paying 6.3% interest compounded daily. Your initial daily interest would be about 17.3 cents. Those pennies would then be added to your account, and the following day’s interest would be calculated on the basis of a balance of $1,000.173. This computation is performed daily, and at the end of one year, your account would earn you $65, instead of the $63 you would have gotten without daily compounding.