Prepaid Cards Get Stung by FDIC Brokered Funds Guide

WASHINGTON — The Federal Deposit Insurance Corp.'s recent guidance on what qualifies as a brokered deposit has dealt an unlikely blow to prepaid cards.

The agency's Jan. 5 document effectively lumped in prepaid accounts with other brokered funds — which are obtained through a third party — subjecting banks offering prepaid services to potential costs including higher deposit insurance fees and possible restrictions on accepting new funds.

At least one bank, Wilmington, Del.-based The Bancorp, already reported a higher insurance premium as a result of the FDIC guidelines and observers believe others could feel the impact as well. Another institution, MetaBank, notified investors that it was reclassifying many of its prepaid deposits as brokered.

Some say banks may now need to allot more capital to provide prepaid card services, which would divert resources away from other opportunities.

"It is going to be a concern and could raise the opportunity costs of managing these programs if you have to start offsetting the capital for those deposits," said Ben Jackson, director of the prepaid advisory service at Mercator Advisory Group. "A lot of banks … are going to have to look at their overall deposit gathering strategy."

A customer's prepaid funds are typically held in custodial deposit accounts owned by the card provider. But the guidance, which provided answers to "frequently asked questions," said such accounts in most cases do not apply for an exemption from the "brokered" definition. "In placing the cardholders' funds into custodial accounts at insured depository institutions," prepaid card "companies … qualify as deposit brokers," the document said.

Although the FAQ was intended to be a collection of previously stated guidance, some in the industry said the FDIC's formal interpretation of prepaid accounts as "brokered" had not previously existed in the public sphere.

There were "conversations the FDIC has had with some of the banks in the past," but "this is the first time we have seen it put out clearly across all prepaid products this way," said Judith Rinearson, a payments lawyer and partner at Bryan Cave.

Generally, the FDIC exempts deposits from the brokered definition "if the intent of the third party, in placing deposits or facilitating the placement of deposits, is to promote some other goal" than the placing of funds for someone else, the document said. But the FDIC noted that that exemption "applies only infrequently." In the case of prepaid cards, products that are part of a rebate program — where a corporation is placing its own funds into an insured account — are exempted.

To be clear, nothing about the guidance stops banks from accepting brokered deposits. But such funds, which can be less stable than core deposits, attract greater regulatory scrutiny. Large banks and institutions in higher risk categories used by the FDIC to price insurance can pay up to 10 basis points extra for carrying high amounts of brokered deposits. Meanwhile, banks that are just "adequately capitalized" must apply for a waiver to accept or renew brokered deposits, and "undercapitalized" banks cannot accept or renew them at all.

In a Jan. 14 securities filing, The Bancorp said its bank subsidiary would have to pay the 10-basis-point surcharge as a result of the classification of certain prepaid accounts.

Matthew Kelley, an analyst and managing director at Sterne Agee, warned in a recent note that the guidance reduces some of the benefit for banks to get into the prepaid space. He said banks active in offering prepaid services — including The Bancorp, MetaBank and Green Dot — could feel the effect.

"In our view, this decision to classify prepaid [general purpose reloadable] deposits as brokered reduces the long-term value of these deposits and this business for the banks involved," Kelley said.

"Several of the prepaid issuing banks noted above have been considered potential longer-term acquisition candidates. While prepaid GPR deposits have solid and proven value as very low cost sticky funding, the brokered classification reduces their perceived value, in our view."

Even though MetaBank told investors it was reclassifying certain deposits as a result of the guidance, the bank said its earnings would not be affected due to the institution's already strong financial condition.

"This is something that has been a question in the industry for some time and since we have this new guidance and are reacting to it, we thought it was appropriate to do," Brad Hanson, president of MetaBank, said of steps to redefine deposits and inform investors. "We didn't consider any of our deposits as brokered."

Hanson added that the bank's historical data show that its prepaid deposit base is stable. He also noted that the agreements on terms of conditions for prepaid products are between the bank and the cardholder, with any third party merely functioning as a service provider.

"That is why we didn't list them [as brokered deposits] in the past, but this clarification of how broadly they are defining facilitator has changed that, so we are reacting to that," Hanson said. "We believe the value of the deposits is still intact."

On Monday, the American Bankers Association said on its website that the group had met with FDIC officials to discuss issues related to the guidance, including its effect on prepaid card accounts. "FDIC recognized that a bank may require time for careful review and consultation with FDIC staff to determine a prepaid card-related deposit to be brokered," the ABA said in the "Newsbytes" section of its site. "As a result, characterization of such deposits as brokered may be reflected in first-quarter 2015 call reports, and could be resubmitted for prior quarters if appropriate under the materiality test."

Jackson said the guidance, to a certain degree, undercuts some of the advantages of operating a prepaid business.

"For a long time people would talk about prepaid as a way to boost core deposits and now if they are viewed as brokered deposits, the value of those … might change a little bit," Jackson said.

But some believe it was only a matter of time before prepaid cards, which is a relatively new and expanding product line, were viewed like other brokered deposits.

"The prepaid card industry as a whole is going through significant growth and as a result of that growth they are getting the necessary regulation at the federal level," said Edward Mills, a financial policy analyst and managing director at FBR Capital Markets.

However, others, including Rinearson, questioned the association of prepaid cards with brokered deposits, which in the housing crash were found to have funded overheated loan portfolios that resulted losses.

"The linkage between those higher loan risks and banks that hold prepaid deposits — that was disappointing to me," Rinearson said.