BANKTHINK

Best Substitute for TAG May Be Product Many Banks Wrote Off

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Sweep accounts were developed in the 1970s, primarily to circumvent the ban on paying interest on business checking accounts. Some bankers believe Dodd-Frank's repeal of that ban means they are no longer relevant. In my opinion, those who hold this belief are in error.

I should disclose upfront that my bank has a division that sells software and forms for other banks to manage their sweep programs. But I'm writing as a banker who looked at various solutions to a problem most community banks now face. I found sweep accounts were the best answer for my institution, and readers are invited to share their perspectives, which may differ, in the comments section below.

The problem: As the result of hundreds of bank failures over the last several years and the recent expiration of the Transaction Account Guarantee program, large depositors are refocusing on the safety of their funds. Since TAG ended, net withdrawals at the nation's largest banks, growth in money market fund assets and noticeable declines in the overnight Treasury repo market's rates suggest some are seeking safety outside of banking. I am hearing members of my community talking about restructuring their accounts or changing banks if necessary to enhance protection. 

Those of us who want to retain this funding, or at least circle the wagons around some of our best commercial relationships, have no choice but to solve the problem of how to protect customer funds over the $250,000 FDIC insurance limit. As I see it, we still have four options. 

Bankers who aren't worried about the funding, and are confident enough to invest customer funds (and their bank's reputation) in a non-FDIC-insured product outside their control can offer a money market sweep option.  Not me.

If you can find it and afford it, private excess deposit insurance remains an option. I can't convince myself, however, that private insurance is as secure as the FDIC, nor do I want to have that conversation with my customers.

Two weeks ago, our bank hosted a presentation by a representative of Promontory regarding its Insured Cash Sweep service. Like that firm's CDARS program, ICS leverages and coordinates multiple FDIC charters. The representative reported that ICS has over 900 participants and processes about $1 billion each day through Promontory's allocation software. (Editor's note: A Promontory spokesman says ICS handles $7.5 billion a day and has more than 1,000 customers.)

With 30 years of offering sweep accounts under our belts (more on that later), we decided ICS isn't for us.  Despite being an attorney and tenured banker, I struggled with the complexity of the program, and more important, how our people would explain it to customers. Moreover, I don't know how I could convince anyone to move the daily cutoff from 2 p.m. Central time to 10 a.m.  As for the economics, despite no sign-up fee right now, ICS would add 15 basis points to cost of these funds for a bank of our size. And maybe I'm old-fashioned, but having my customers see other banks' names on their bank statements and sending them to a website other than ours is unsettling – not to mention my broader concern that a nonbank is building a system that we are paying for and that could come to have a significant influence on one of our material funding sources, large depositors.

And then there are good old sweep accounts. These were once considered a compliance challenge. But today the right legal documents and software enable bankers to easily manage fully compliant in-house sweep account programs using overnight repurchase agreements (overnight repos). Best of all, sweep repos aren't dependent on anyone else's financial performance or reputation.

With a sweep repo program, no money ever leaves the bank. The balances simply move between types of accounts: the demand deposit account and an investment account. The repo is simply a contract between a bank and its customer and constitutes a bank liability secured by government securities. After all deposits and checks affecting the DDA have been processed, the bank's core system can automatically transfer funds in excess of $250,000 to the investment account.

When sweep accounts using repos are executed properly, I know customers have the security of a perfected interest in the collateral, and the bank has a fully compliant product. FDIC regulations and resolution history since the Government Securities Act was adopted in 1986 provide bankers and their customers with the peace of mind of knowing that their money is not only safe, but remains in their local bank and transferred neither to Wall Street nor around the country through a series of transactions designed to leverage the insurance coverage afforded by other networked institutions. 

Hundreds of banks across the country continue to use sweep accounts. With dozens of customers and millions of dollars in sweep accounts, we have no plans to eliminate or replace our program. Sweep accounts are a simple and proven method for protecting and retaining high balance depositors and are by no means dead.

Joe Slavens is president and CEO of Northwest Bank and Trust Co., a $200 million-asset community bank based in Davenport, Iowa. 

 

Question from the editor: What's the best substitute for TAG? Leave a comment below.

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Comments (8)
Sweep accounts do not provide any additional FDIC coverage. Under the worse case - no other bank will buy the deposits, if a bank fails a depositor will only receive up to the FDIC limit of $250,000. Any amount over the $250,000 limit, regardless if it is in a sweep account or another type account, will receive a Receivers Certificate from the FDIC and be paid whatever percentage the FDIC can liquidate the bank for. This usually takes years as the FDIC makes "dividend" payments as it sells assets. So the sweep accounts do not afford any additional insurance protection. Here is the example I put before the FDIC: Mr. Wilson has a non-interest bearing checking account with $250,000 and an interest bearing savings account with $750,000. If the bank and Mr. Wilson enter into an agreement to sweep the $750,000 into another type of account that is backed by government securities and the bank fails, with no buyer, what will the FDIC pay Mr. Wilson? Their answer: $250,000 at time of failure and Mr. Wilson will be issued a Receivers Certificate as he is now a creditor of the bank's estate.
Posted by veribanc | Tuesday, February 05 2013 at 2:43PM ET
The following was submitted by the author, Joe Slavens:

Veribanc's comment is substantially incorrect and expressly contrary to FDIC regulations and commentary. In 2009, the FDIC adopted final rules governing, among other things, how it would handle repo sweep accounts at a failed insured depository institution (see www.fdic.gov/regulations/laws/federal/2009/09FinalAD26.pdf).

The commentary to the regulations make it very clear how well taken care of a bank customer is if the repo sweep arrangement is "properly executed" (and thus how important it is to comply with the applicable regulations) when it provides: "In a properly executed repo sweep arrangement, as of the depository institution's normal end-of-day, the sweep customer either becomes the legal owner of identified assets (typically government securities) subject to a repurchase agreement or obtains a perfected security interest in those assets. In such cases, where the sweep customer either owns or possesses a perfected security interest in the identified securities, upon an institution failure, the FDIC will recognize the customer's ownership or security interest in the securities. If the value of the securities at least equals the dollar amount of funds swept from the customer's account, the customer's swept funds will be fully protected in the event of failure. After failure, the disposition of the swept funds invested in securities will depend on the nature of the transaction structured by the FDIC. In a purchase and assumption transaction, the securities and the underlying repo arrangement will be transferred to an acquiring institution, which could include a bridge institution. Under this transaction structure, the funds normally would be swept back into the customer's deposit account on the business day following failure, thus giving the customer full access to these funds at that point. In a payoff of insured deposits, the customer would receive a check or other payment from the FDIC to reacquire the customer's interest in the securities according to the FDIC normal procedures."

As an aside, a good custodial agreement governing the duties of a fiduciary holding the government securities to perfect the customer's security interest under a repo sweep arrangement should provide that if the FDIC does not pay the customer its sweep balance promptly, say 30 days, the fiduciary is instructed to liquidate the government securities serving as collateral and pay the customer. Whether paid by the FDIC or through this process, not only is the customer fully protected, that protection is prompt.

Veribanc correctly points out that "Sweep accounts do not provide any additional FDIC coverage." That they do was never my claim. I do maintain, however, that repo sweep accounts are an excellent way to protect customers with more than $250,000 at a single financial institution.

Joe B. Slavens
President & CEO
Northwest Bank & Trust Company
Posted by Marc Hochstein, Executive Editor, American Banker | Tuesday, February 05 2013 at 4:58PM ET
The FDIC coverage is not increased and therefore there is additional risk. Interestingly, the comparisons made were with alternative ways to provide additional FDIC protection - Promontory's Insured Cash Services or private excess FDIC coverage. These comparisons are not consistent with a sweep account mechanism and the "additional" protection offered. Again, if no bank buys the deposits then the value of the securities and the way the FDIC settles these assets may or may not cover the entirity of the deposit - but it does not increase the FDIC insurance coverage.

VERIBANC., Inc.
Michael M. Heller, President
Posted by veribanc | Tuesday, February 05 2013 at 5:13PM ET
Editor's note: the following is a comment from the author, Joe Slavens:

First, thanks to Mr. Heller and veribanc for engaging in this discussion.
With respect to second comment posted by veribanc, properly executed repo sweeps are secured solely by government securities (securities that are the direct obligation of, or the principal and interest of which are guaranteed by, the United States, one of its agencies or one of its government-sponsored enterprises). As a result, the credit risk of properly executed repo sweeps and FDIC insurance are identical. The only other theoretical risk to the customer is price risk.
However, properly executed repo sweeps must be fully (or over) collateralized based upon market value and the date the sweep is initiated. In fact, the Government Securities Act requires that confirmations include that market value. And while 12 CRF 360 does not address the date fair market value is determined, based in part upon our comments to their proposed rule, in its role as liquidating receiver under 12 CFR 380 governing the liquidation of a failing financial company that poses significant risk to the financial stability of the United States (see: http://www.fdic.gov/regulations/laws/federal/2011/11finalJan25.pdf), the FDIC's own final rule says it will use the fair market value of collateral as of the date that the FDIC was appointed as receiver, the same day the repo sweep in initiated!. If this rule is applied (and I see no reason why it would not), there is no price risk.
As set forth in my commentary, over 26 years of history demonstrate that repo sweep customers have not lost a penny. I do not know the resolution/recovery success of customers with money-market sweeps, ICS or private deposit insurance, but I know it couldn't be any better than repo sweeps. And, with regard to the later, there is no such thing as "private excess FDIC insurance." Deposit insurance is either excess private deposit insurance or provided by the FDIC and subject to its limits. I should also point out that the other alternative discussed in the commentary, money-market sweeps, is an alternative that has nothing to do with FDIC insurance.

Joe Slavens, President & CEO, Northwest Bank & Trust Company
Posted by brilewis | Tuesday, February 05 2013 at 8:15PM ET
Thank you Mr. Slavens for your commentary, obvious creativity, thoughtfulness, and concern for your customers. However, there is still a difference of opinion based on various communications that we have had with the FDIC over the years.

Specifically, we submitted a question to the FDIC about a similar scenario that deals with pledged securities that most municipalities require for their deposits.

On 3/26/2012 the FDIC responded to the following question: Could you help us understand what happens when a bank fails that has pledged securities for a municipality's deposits?

The FDIC's response was: "an Assuming Institution or AI does not have to honor any agreements made by the failed bank. As well, if FDIC is unable to locate a purchaser for the banks deposits, FDIC will pay the depositors in a Payout."

So our concern is - since the AI does not have to recognize any prior agreements or if the FDIC operates under a Payout there is additional risk regardless of the structure of any agreement.

As respects "private excess FDIC insurance" - General RE, Kansas Surety Bankers, BancInsure, and Travelers previously offered this coverage. Neither General RE nor Kansas Surety Bankers offer this coverage now and I am not sure about any of the others.

VERIBANC, Inc.
Michael M. Heller, President
Posted by veribanc | Wednesday, February 06 2013 at 10:02AM ET
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