Brokered Deposit Update

Heather Archer EastepMarysia LaskowskiHunton Andrews Kurth LLP

June 18, 2019

• Interest rates and LTD ratios• Scramble for core deposits• Impact on valuations

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Market for Deposits in 2019

State of the Banking Industry – 2019 Deposits are more important to M&A

360 M&A deals

since 2015 had the

buyer’s Loan-to-

Deposits ratio

exceed 90%.

60%, or 223, of the

selling banks had

below a 90% Loan-

to-Deposits ratio.

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• Deposit beta stabilization?• Pursuit of new deposit sources• Shift in nature of deposits

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What’s next for deposits?

• “Dependence on non-core funding sources, such as Internet and brokered deposits, to support loan growth and liquidity”

• Dodd-Frank’s 2011 Core Deposit Study Findings• What are core deposits?• Findings

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Core Deposits

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Core Deposits

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Core Deposits

Source: 84 FR 2366 (Feb. 6, 2019)

• If a deposit is accepted through a “deposit broker,” the deposit is a brokered deposit

• The term “deposit broker” is defined by statute as “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”

• Statute: Section 29 of FDI Act (12 U.S.C. § 1831f)

• Regulation: 12 C.F.R. § 337.6

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Brokered Deposits Generally

Owner of the deposit

Intermediary/Third Party Broker

Insured Depository Institution

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Brokered Deposits Generally

Section 29 of the FDI Act sets forth restrictions on when an insured depository institution (IDI) may “accept, renew, or roll over any brokered deposit”

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Brokered Deposit Restrictions

Status of IDI Brokered Deposits Permitted?

Well capitalized Yes

Adequately capitalized No, unless FDIC grants waiver

Undercapitalized No

• An IDI that is not well capitalized generally may not offer deposit rates more than 75 basis points above the “national rate”

• National rates and rate caps are published by FDIC weekly (https://www.fdic.gov/regulations/resources/rates/)

• Institutions subject to the restrictions that believe they are operating in an area where rates paid on deposits are higher than the “national rate” can request a determination from the FDIC to that effect by sending a letter to the applicable FDIC regional office

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Interest Rate Restrictions

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Interest Rate Restrictions

• IDIs and employees of IDIs, with respect to funds placed with that IDI

• Trust departments of IDIs

• Trustees of pension or other employee benefit plans

• Plan administrators and investment advisers of pension or other employee benefit plans

• Trustees of testamentary account or irrevocable trust

• Trustees and custodians of certain qualified pension or profit-sharing plans

• An agent or nominee whose primary purpose is not the placement of funds with depository institutions

• An IDI acting as an intermediary or agent of a U.S. government department or agency for a government sponsored minority or women-owned depository institution deposit program*

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Exceptions to “Deposit Broker” Definition

• Key advisory opinions

• FAQs:

-Call centers

-Prepaid Cards

-Debit Cards

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FDIC Brokered Deposit Guidance

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Reciprocal Deposits @ December 2010

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Reciprocal Deposits @ December 2017

• Section 202 of the Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”) → carves out a capped amount of reciprocal deposits from treatment as brokered deposits for certain IDIs

• Took effect on May 24, 2018

• FDIC’s implementing regulation, which is essentially a regurgitation of the statute, became effective on March 6, 2019

• Reciprocal deposits = deposits received by a bank through a deposit placement network in return for placing a matching amount of deposits at other network banks

• Purpose: can offer access to FDIC insurance beyond $250,000 to attract safety-conscious customers who might:

▪ otherwise deposit large sums into a money-center bank (foregoing some access to FDIC insurance);

▪ require collateralization with ultra-safe, highly liquid government securities (e.g., Treasuries); or

▪ manually split a large deposit among multiple banks (maintaining relationships with each, negotiating different interest rates, signing multiple agreements, receiving multiple statements, etc.)

▪ Major player: Promontory

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Limited Exception for Reciprocal Deposits

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Limited Exception for Reciprocal Deposits

Source: https://www.promnetwork.com/solutions/banks/grow-franchise-value-with-reciprocal-deposits

Capital Category CAMELS(1 or 2 = “well rated”)

Amount of Reciprocal Deposit Carve-Out

Well capitalized Well rated Up to General Cap

Well capitalized Not well rated Up to lesser of General Cap or Special Cap

Adequately capitalized Well rated or not well rated Up to lesser of General Cap or Special Cap; if Section 29(c) waiver is obtained, up to General Cap

Undercapitalized Not well rated Up to lesser of General Cap or Special Cap (Section 29(c) waiver not available)

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Limited Exception for Reciprocal Deposits

General Cap = lesser of $5 billion or an amount equal to 20% of the bank’s total liabilities

Special Cap = the average of the total amount of reciprocal deposits held by the bank on the

last day of each of the 4 quarters before the quarter in which the bank was found not to be well

rated or was determined to be not well capitalized

• Significant reduction in percentage of reciprocal deposits that are classified as brokered deposits

3/31/18: $48.5 billion reciprocal deposits

6/30/18: $17.1 billion brokered reciprocal deposits

9/30/18: $13.7 billion brokered reciprocal deposits

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Effect of Reciprocal Deposit Carve-Out

“The Federal Deposit Insurance Corporation (FDIC) is undertaking a comprehensive review of the regulatory approach to brokered deposits and the interest rate caps applicable to banks that are less than well capitalized. Since the statutory brokered deposit

restrictions were put in place in 1989, and amended in 1991, the financial services industry has seen significant changes in

technology, business models, and products. In addition, changes to the economic environment have raised a number of issues

relating to the interest rate restrictions. A key part of the FDIC's review is to seek public comment through this Advance Notice of

Proposed Rulemaking (ANPR) on the impact of these changes. The FDIC will carefully consider comments received in response to this

ANPR in determining what actions may be warranted.”

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Advance Notice of Proposed Rulemaking

• Appendix 2 → update to 2011 study

• Still concerned about link to irresponsible growth

• Two issues related to interest rate restrictions:▪ Low “national rate” due to low interest rate environment post-2008

and disproportionate effect of largest banks

▪ Does not take into account promotional bonuses or deposit products with special features (e.g., step up rates)

• Comments were due May 7, 2019

• Hurdle: statutory constraints

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Advance Notice of Proposed Rulemaking

“Historically, most institutions that use brokered and higher-rate

deposits have done so in a prudent manner and appropriately measure,

monitor, and control risks associated with brokered deposits.”

Factors the FDIC considers when evaluating whether a third party is a “deposit broker”:

1) Whether the third party receives fees from the bank that are based (in whole or in part) on the amount of deposits or number of deposit accounts

2) Whether the fees are for administrative or other services (such as recordkeeping) rather than compensation for bringing the deposits

3) Whether the third party’s deposit placement activities are directed at the general public as opposed to members (or “affinity groups”) or clients

4) Whether there is a formal or contractual agreement between the bank and third party to place or steer deposits

5) The extent of the third party’s continued involvement in the relationship between the bank and the depositor

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ANPR Takeaways

• IDIs hold $986 billion in brokered deposits (8.0% of the $12.3 trillion in industry domestic deposits)

• 40.6% of all IDIs hold brokered deposits

• High concentration among a small number of banks:100 of the 2,221 IDIs that hold brokered deposits hold 89.4% of the deposits, and 5 institutions account for 39.4% of all brokered deposits

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Key Statistics from ANPR (as of 9/30/18)

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Brokered Deposits Held by IDIs as of September 30, 2018

Source: 84 FR 2366 (Feb. 6, 2019)

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Brokered Deposits as a Share of Domestic Deposits

Source: 84 FR 2366 (Feb. 6, 2019)

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Reciprocal Brokered Deposits as a Share of Total Brokered Deposits

Source: 84 FR 2366 (Feb. 6, 2019)

• Reads broadly, but interpreted very narrowly

• Is the agent’s placement of deposits incidental to some other purpose?▪ Reason/intent/incentives

▪ Fees: based on amount of deposits placed? Justified as compensation for recordkeeping or other work performed for the IDI?

▪ Programmatic relationship: formal/contractual agreement?

• Broker dealer affiliated sweeps generally qualify, but have to meet certain requirements (2005 advisory opinion)

• ANPR: Accounting/software companies generally do not qualify; prepaid cards do not qualify

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Primary Purpose Exception

• Typically not reported as brokered deposits

• Distinction between providing information about deposit accounts in a passive manner versus facilitating the placement of deposits

• Requirements (2004 advisory opinion):▪ Only subscription fees or listing fees

▪ Flat fees

▪ No other services; no steering

▪ No involvement in actual placement of deposits

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Listing Service Deposits

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Listing Service Deposits as a Share of Total Domestic Deposits

Source: 84 FR 2366 (Feb. 6, 2019)

• What are they?

• Are they brokered?

• Supervisory concerns

• Accounting

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Earnings Credits

• Look for FDIC’s proposed rule on brokered deposits by year-end → regulatory overhaul

• Reciprocal deposits: what’s next?

• Room for flexibility: statute vs. regulation vs. interpretation

• Are brokered deposits a scapegoat?

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Closing Thoughts

This power point presentation is an educational tool that is general in nature and for purposes of

illustration only. The materials in this presentation are not exhaustive, do not constitute legal advice

and should not be considered a substitute for consulting with legal counsel. If legal advice or

other expert assistance is required, the services of a competent professional should be sought. Certain

materials presented in this presentation were developed by industry sources or obtained from

industry publications and research reports prepared for other purposes.

Disclaimer