On December 24, 2014, the FDIC released its latest statements on what they consider to be “brokered deposits.”  In Guidance on Identifying, Accepting, and Reporting Brokered Deposits Frequently Asked Questions (the “FAQs”), the FDIC outlined their current views on what they will deem to be brokered deposits, formally stating positions that have been developing over the last few years but which had not previously been stated in writing.  For many FDIC-insured depository institutions (collectively, “banks”), the FAQs might have little or no impact.  For others, the impact could be significant.

Banks that have a large portfolio of brokered deposits know that they do, but these FAQs could expand the number of brokered deposits held by such banks.  It therefore is important to review the FAQs carefully to ensure that your call reports are accurate.  As discussed below, your volume of brokered deposits could even impact your FDIC insurance assessments.

There also may be those banks that believe they do not have any brokered deposits, except perhaps the reciprocal deposits obtained through CDARs, the Certificate of Deposit Registry Service.  This belief might not be accurate, and might be based on interpretations of the “primary purpose” exception that the FDIC does not share.  We recommend that every bank reconsider their brokered deposit holdings in light of the FAQs.

This article discusses the possible implications of having brokered deposits and the FDIC’s interpretation of what is or is not a brokered deposit as reflected in past FDIC Interpretive Letters and the FAQs.

The Brokered Deposit Rules and Consequences

Under Section 29 of the Federal Deposit Insurance Act (12 U.S.C. § 1831f) and its implementing regulation at 12 C.F.R. § 337.6, a “brokered deposit” is any deposit obtained, directly or indirectly, from or through the mediation or assistance of a deposit broker.  A “deposit broker” includes any person engaged in the business of placing deposits, or facilitating the placement of deposits, of third parties with insured depository institutions, or the business of placing deposits with insured depository institutions for the purpose of selling interests in those deposits to third parties.  There are a number of regulatory exceptions to this definition, but the FDIC applies these exceptions very narrowly, as discussed below.

Under the brokered deposit regulations, a bank that is only “adequately capitalized” and not “well capitalized” may not accept, renew or roll over any brokered deposit unless it has been granted a waiver by the FDIC. Our experience has been that such waivers are rarely granted.  Moreover, an “undercapitalized” bank simply may not accept, renew or roll over any brokered deposit, and the FDIC is not authorized by statute to grant waivers.  (The terms “well capitalized,” “adequately capitalized” and “undercapitalized” have the meanings given to each depository institution by its primary federal bank regulator.)

As a consequence of these rules, as soon as a bank suffers economic difficulty, the bank must start shedding its brokered deposits, typically at a time when it most needs those deposits.

Having brokered deposits also can result in an increase in the bank’s FDIC insurance assessments.  While this depends on the bank’s size, overall risk profile, and its ratio of brokered deposits to other deposits, brokered deposits can result in an increase in insurance assessments by up to 10 basis points.  It is important for banks to review these insurance assessment rules carefully as part of their management of brokered deposit portfolios.

The FDIC has said “no  particular stigma” should be attached to the acceptance of brokered deposits by well-capitalized banks, but some bankers might be justifiably dubious of this claim.  The FDIC has stated that substituting brokered deposits for core deposits decreases a bank’s franchise value because, among other things, brokered deposits are perceived as less stable and statistics indicate that banks that use brokered deposits tend to have higher nonperforming loan ratios and invest in higher risk loans.  It can be expected that potential investors in the bank might take a similar view.

We also are aware of banks that are required to maintain liquidity business plans with the FDIC to address how the bank would replace brokered deposits in the event they could no longer accept them.  It seems clear that banks with higher levels of brokered deposits receive unwanted regulatory attention.

Some Implications of the FAQs

A.  Many More Brokered Deposits Will Stay Brokered for All Time

In the past, banks could hope for periodic relief from the brokered deposit burdens because certain deposits would cease to be brokered deposits after a time.  The FAQs greatly narrow the availability of this relief.

As noted above, a bank that is not well capitalized cannot accept, renew or roll over any brokered deposit unless it has been granted a waiver by the FDIC.  Since at least 1992, however, the FDIC has taken the position in Interpretive Letters that a brokered CD is no longer brokered and therefore can be renewed, so long as it is renewed without any involvement of a deposit broker.  At that time, the FDIC did not explain what might constitute broker “involvement,” but some banks were told in recent years that the payment of residual fees to the broker during the term of the account would cause the account to continue to be a brokered deposit.

The FAQs now state that “any type of involvement by the third party will be sufficient to qualify the renewed account as a brokered deposit.”  This would include the payment of any “renewal fee” to the third party.  It also would include “the actual holding of the account in the name of the third party (as agent or custodian for the owner or owners).”

Broker involvement would even include continued access to account information by the broker, such as access to account balance information.  (FAQ F2.)  Some banks obtain brokered deposits through investment advisor or broker-dealer relationships, when those companies help their clients hold funds until they are invested in stocks or bonds.  Because those advisors and brokers will often know their clients’ larger deposit balances, this could cause those deposit accounts to remain brokered for all time.

The FAQs also make clear that this question of deposit broker involvement upon “renewal” of an accounts is not limited to CDs.  One FAQ states that a bank that ceases to be well capitalized must immediately close brokered deposit accounts that never mature or renew (such as an interest checking or savings account).  (FAQ F5.)  Implicitly, the FDIC is stating that checking and non-CD savings accounts “renew” every day for purpose of the brokered deposit regulation, thus triggering the rule that a bank that is not well capitalized cannot renew any brokered deposit.  Unlike CDs that renew only on a stated maturity date, where the depositor usually cannot withdraw funds prior to maturity without incurring an early withdrawal fee, a depositor can close a checking or other savings account on any day. This fact apparently is the basis for the FDIC’s view that checking and savings accounts renew every day for purposes of the brokered deposit regulation.

Accordingly, if your bank has brokered checking and savings accounts, those accounts would need to be closed immediately upon the bank becoming less than well capitalized, unless the bank can obtain a FDIC waiver.  The only exception would be if the deposit broker has no involvement whatsoever with the accounts after they are opened, and the broader definitions of “involvement” could limit the availability of this exception.

B.  Broader Definition of Deposit Broker

The regulatory definition of deposit broker includes those persons in the business of “facilitating the placement of deposits.”  In 1992, the FDIC latched on to this phrase and asserted in Interpretive Letters that in “common usage” facilitate means “to make easy or less difficult.”  This approach gave the FDIC all it needed to declare a broad range of third-party deposit-related activities to involve deposit brokerage.

The FAQs indicate an even broader approach by the FDIC to defining “facilitate.”  The FDIC notes that the definition of deposit broker is “very broad” and that “facilitating” is “interpreted broadly” to include actions “to connect” banks with potential depositors.  (FAQs A2 and A5.)  “Any actions that connect” a bank with potential depositors may be considered as facilitating the placement of deposits.  (FAQ B2.)  On this basis, the FAQs state that the following companies could be deposit brokers and that deposits obtained through their efforts could be brokered deposits:

  • Companies that provide marketing for a bank in exchange for volume-based fees are deposit brokers.  This includes nonprofit affinity groups and commercial enterprises.
  • Companies that design deposit products for banks are not necessarily deposit brokers, but they would be deposit brokers if they also market the products in exchange for volume-based fees.
  • Insurance agents and accountants that refer clients to banks are deposit brokers.  Implicitly, this is because those persons are “connecting” their clients to the bank.
  • Lawyers that refer clients to banks are deposit brokers.  In prior Interpretive Letters, the FDIC had stated that a tax and estate planning lawyer would not be a deposit broker when referring his or her clients to a bank, but that a lawyer receiving commissions from the bank for doing so would be a deposit broker.  It is unclear if the FAQs are intended to change the rule so that now all lawyer-referred deposits are brokered deposits, regardless of the lawyer’s client relationship or receipt of commissions.
  • Companies that endorse a bank in promotional materials that are produced or distributed by the company are deposit brokers, at least if the company is compensated for the endorsement.  This appears to be the case even if the company is compensated only on a flat-fee basis that is not linked to the number of accounts or amount of deposits.  On the other hand, a flat fee for an endorsement apparently would not cause the endorsed products to be brokered deposits if the endorsement appears only in promotional materials produced and distributed by the bank.

C.    Narrow Exceptions to the Deposit Broker Definition

There are certain exceptions to the definition of deposit broker, but they are all very narrow.  For example, the employee of the bank is not a deposit broker, so long as, among other things, he or she is employed exclusively by the bank and compensated primarily in the form of salary.  The FAQs further clarify that this exception does not apply to any contractor or dual employee.  (FAQ E3.)

Certain trustees and investment plan administrators also are excluded from the definition of deposit broker.  The FAQs remind institutions that the primary purpose test serves to distinguish normal activities of trust departments from arrangements that circumvent the statute, and that this will be determined on a case-by-case basis.

The one exception that bankers and other companies often look to is that for an “agent or nominee whose primary purpose is not the placement of funds with depository institutions.”  However, the FDIC also has interpreted this exception very narrowly.  In Interpretive Letters, the FDIC has stated, for example, that the fact that revenues from referring deposits represent a very small percentage of the company’s overall revenues does not satisfy the primary purpose standards.  Likewise, the fact that only a small percentage of a company’s overall business activities involve placing of deposits does not satisfy the primary purpose exception.

Instead, the FDIC considers whether there is any “substantial purpose” for the program other than the placement of funds in deposit accounts.  If the FDIC cannot be persuaded that there is a substantial purpose for the program other than placing of deposits, the accounts established through the program will be brokered deposits if they are established with the assistance of a third party.

The FDIC has therefore applied the primary purpose exception in relatively limited circumstances.  For example, a bank offering credit cards to be secured by deposits held at other banks selected by the credit card issuer was not a deposit broker because the primary purpose of the bank’s activities was to obtain a perfected security interest in the credit card accounts, not to place deposits.  In another instance, the FDIC determined that a securities broker-dealer was not a deposit broker when depositing customer funds at banks when it was doing so to comply with a regulation of the Securities and Exchange Commission.

The FAQs continue this narrow interpretation of the primary purpose exception, with the FDIC noting that the exception applies “only infrequently.”  For example, the exception generally will not apply to companies that distribute or sell general purpose prepaid cards.  When the debit card or similar product serves multiple purposes, such as to provide access to deposit funds and as a college identification card, the FDIC will consider various factors.  Factors such as reloadability of the card and the permanency of the account might indicate that the primary purpose is to provide access to a deposit account.

For further analysis of the impact of the FAQs on the prepaid card industry, see the recent article by Bryan Cave’s John ReVeal and Judith Rinearson on Paybefore.

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Some of the FAQs are largely consistent with existing FDIC Interpretive Letters.  Others, such as those dealing with continued “involvement” by a broker, and those stating that “facilitating” includes “any actions that connect” a bank with potential depositors, signal that the FDIC is more likely than ever to treat third-party arrangements as involving deposit brokers.  The FAQs clearly provide a lot for banks and their financial institution partners to think about.