Why the Banks Are Screwing You

NEW YORK ( TheStreet) -- Investors who have been putting aside cash to invest in certificates of deposit should realize they're not benefiting from the recent surge in longer-term Treasury yields that have pushed the 10-year note to its highest level since 2011.

While the yield on the 10-year Treasury note has surged to 2.6% from a May 9 yield of 1.812%, the national average rate for a 5-year certificate of deposit remains virtually unchanged at 0.8%, according to RateWatch, TheStreet's banking data and analytics service.

What gives?

Myriad factors influence the lack of better rates in CDs, and investors can look to the Federal Reserve and banks for answers.

A look at the recent earnings of Wells Fargo ( WFC) is a good primer for how Fed policy is driving banks' decisions in offering yields to savers.

Put simply, banks flush with new deposits such as Wells Fargo aren't likely to offer savers a better rate of return on CDs unless they are forced to. Right now, surging inflows of deposits and the bank's below-average CD rates indicate Wells Fargo doesn't need to increase yields. Banks that sit on a comfortable amount of deposits have less incentive to attract more depositors through higher CD rates.

In fact, Wells Fargo over the past two quarters has seen its earnings suffer from new deposits. Wells Fargo earns a spread in what it pays to depositors and what the bank earns through its various lending businesses. That spread, called net interest margin, has fallen to record lows in 2013 as higher-yielding loans granted prior to the Fed's easing policies run off Wells Fargo's balance sheet.

Low rates offered on CDs and a recent rise in the yields of bonds, mortgages and Treasuries that Wells Fargo characteristically holds on its balance sheet are a saving grace for the bank's profit margins that it likely won't soon choose to cede.

"When you look at how much quicker to react mortgage rates have been to CD rates, you have to conclude that banks are protecting themselves and protecting their profit margins," said Richard Barrington, senior financial analyst at MoneyRates.com.

Fed Chairman Ben Bernanke's recent comments have moved mortgage and Treasury yields sharply higher; however, they remain well below historical averages given the central bank's maintenance of $85 billion a month in purchases of mortgage-backed securities and longer-term Treasuries and its maintenance of the federal funds rate at between 0% and 0.25%.

Bernanke's words indicate the Fed may begin tapering its bond buying as early as the fourth quarter of 2013 and it may even stick to its target of raising the fed funds rate by mid-2015, after extending low-rate policies for years. It's no surprise the yield on 5-year and 10-year Treasury notes have recently posted historic gains.

"I think what you're seeing is that's a comment on when the market actually expects rates to change, because the 10-year obviously includes another five years, but if rates kind of sit where they are for another couple years, that eats up a big chunk of the 5 year CD ," said Brad McMillan, chief investment officer for Commonwealth Financial.

"The front end rate -- the Fed is not going to hike the federal funds rate -- is pegged to the short term rate and that's why the short-term securities are more closely related to those federal funds rates," said Justin Tabellione, a senior portfolio manager at LGIMA. "So they're not selling off nearly as much as the securities further out the curve."

In a sense, the lagging rise in CD rates shows just how much work Bernanke will leave unfinished if he decides not to seek in 2014 re-appointment to head the central bank.

In the wake of the financial crisis that triggered hundreds of billions of dollars in bailouts, the nation's largest banks have seen steady inflows of deposits from savers who are confident that these institutions remain "too big to fail" in a time of crisis. After leading unprecedented bank bailouts, Bernanke made it a priority to end such guarantees; however, many market participants still believe that the nation's largest and most complex banks would have government and central bank aid if a crisis of 2008 proportions occurred again.

"Too big to fail" impacts CD rates because the large, systematically important banks gaining deposits have little incentive to raise rates. For healthy banks such as Wells Fargo, inflows of deposits at any rate also indicate a continued flight to safety among consumers.

In recent quarters, for instance, Wells Fargo management pinned some deposit inflows on the struggles of European and emerging-market banks.

A sudden jolt in June to Wall Street's expectations of how the Fed may withdraw from its extraordinary support to financial assets has impacted mortgage rates and Treasury yields. Speculation among traders has shifted to when, not if, the Fed will taper its monetary stimulus and raise short-term interest rates.

It's important for investors to remember that a heavy number of participants actively trade Treasuries each day on the open market, while individual banks decide where to set CD rates.

"CDs are not like a traded security, and so the banks are a little insulated from the market," said MoneyRates.com's Barrington. "CD rates do not move up and down every day."

Finally, banks use CDs to support lending practices. With the Fed purchasing $40 billion a month in mortgage-backed securities and $45 billion a month in agency-issued longer-term Treasuries, the central bank acts as one of the banking industry's biggest clients. With the Fed giving the most cash to banks these institutions simply have less of a need to attract new depositors with more competitive CD rates.

The spread continues to widen between the 10-year Treasury note and the national average rate on 5-year CDs, and it's important for investors to understand the divergence if they're looking to put their cash to work.

-- Written by Joe Deaux and Antoine Gara in New York.

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