While the four partner banks, Evolve Bank & Trust, Lineage Bank, American Bank NA, AMG National Trust Bank, hold roughly $180 million in cash of users' funds and reserves, Synapse's records show a trial balance of $265 million owed to consumers of a dozen of affected fintech companies. As a result, the trustee of the bankruptcy case, former chairman of the Federal Deposit Insurance Corp. Jelena McWilliams, estimated a shortfall of roughly $85 million in deposits — though the numbers could change because the banks do not necessarily agree with Synapse's records and continue to work on reconciliation.
At a hearing June 7, the judge on the bankruptcy case, Martin Barash, said his team has reached out to regulatory agencies to "find the appreciate agencies that might have an interest in this problem and perhaps resources to help."
While it is clear that Synapse is not in bank regulators' territory, a unique factor in the case is the close tie between the fintech apps and the partner banks. Customers'
While fintech companies refer to their customers as "end users," they are really depositors and should be treated as such, Barash said at the hearing. The question now is who to absorb the potential loss if there is indeed a shortfall, whether it is the banks, the fintech companies, or some or even all of the customers.
An indirect relationship with bank regulators
While Synapse's partner banks have FDIC insurance, it does not apply in the case of the bankruptcy, because it is the uninsured fintech that has failed, rather than the partner banks.
Since Synapse moved some of the consumer deposits to its brokerage affiliate for cash management or sweep deposits, McWilliams said at the hearing that she spoke with the Securities Investor Protection Corp., an entity that protects investors' securities and cash when a brokerage firm fails. But the entity's protection is designed for money in brokerage accounts to buy securities in rare cases of brokerage failures, whereas the consumers stored funds on many affected fintech apps as deposits.
While McWilliams would not comment on behalf of the Consumer Financial Protection Bureau, she noted that the CFPB has the supervisory authority primarily over banks having $10 billion in total assets, while all the four affected banks are below that asset threshold.
Another bank regulator, the Federal Reserve, reached out immediately upon McWilliams' appointment as the trustee, to discuss how the Fed can help outside of the confidential supervisory information, she noted. The Federal Reserve Bank of St. Louis supervises Evolve Bank & Trust.
Banks should expect greater scrutiny from regulators of their supervision processes related to ledgering, data integrity, disaster recovery and operational resiliency, Adam Cohen, a partner at Skadden Arps Slate Meagher & Flom LLP, said in an interview.
"The regulators could look at it as a case study for what could go wrong, and build from that expectations for how banks should manage their third-party partners in the future," Cohen said in an interview.
Heightened risks at the banks
As the trustee continues to lead the resolution efforts, there are broader implications at the partner banks, which will come under regulators' microscope. On June 14, the Federal Reserve issued an enforcement action against Evolve Bank & Trust and its parent company, Evolve Bancorp Inc. for deficiencies in anti-money laundering, risk management and consumer compliance programs, independent of the Synapse bankruptcy.
"The currently known missing dollars may be the tip of the iceberg," Chip MacDonald, managing partner at law firm MacDonald Partners, said in an interview. "This situation will reduce confidence in bank and fintech service providers and further heighten regulatory scrutiny of banking-as-a-service and banks' other third-party arrangements."
The banks are not failing, but the record-keeping mess will likely increase the complexity for the FDIC in a failed bank resolution. Regulators are increasingly wary of that risk after the March 2023 bank turmoil, MacDonald said.
The confusion between Synapse and its partners about what has become of customers' deposits is especially striking to industry experts, considering that keeping an accurate record of customer funds is one of the most critical functions of a banking organization.
"It's certainly foreseeable that the federal regulators could put greater scrutiny on banks' ability to do that in a safe and sound manner in light of the recent situation involving Synapse," Cohen said.
Managing balance sheet impact
Also at issue is the safety and soundness of the partner banks. Mounting requests from consumers to withdraw funds imply heightened volatility of deposits, and if there is indeed a shortfall of funds, there is a possibility that the banks could be held accountable.
In a May 17 news release, Evolve emphasized that it is "robustly well-capitalized" and exceeds the capital threshold of the highest regulatory category. As of March 31, Evolve's risk-based capital ratio was 15.11%, according to S&P Global Market Intelligence data.
Evolve does not expect a shake-up as reconciliation moves forward, because it has already returned nearly $4 million, or roughly three-quarters of the total amount of withdrawals that Evolve will need for customers of Synapse's fintech partners, according to a source familiar with the bank. The funds are in Evolve's demand deposit accounts where it has clear records, and the return process began in late May or early June, he added.
Evolve still needs to reconcile payment records such as credit or debit card transactions with Synapse's brokerage affiliate.
A spokesperson at Evolve said in an emailed statement: "Evolve, along with other partner banks, is working with the independent US trustee appointed in this matter to determine the appropriate distribution of funds to impacted Synapse customers."
Lineage Bank has informed the trustee that it only provided payment processing services to Synapse, with the exception of one demand deposit account, and that it terminated the master services agreement with Synapse for cause in March, before the events unfolded in Synapse's bankruptcy.
In February, Lineage appointed a new chairman and interim president, to shift its focus back to community banking, according to local newspaper Williamson Herald. The impact of the Synapse bankruptcy on deposits is minimal, in part because Lineage had already been winding down its banking-as-a-service business under the new management team, according to a source close to the bank. Carl Haynes, the interim president, did not respond to a request for comment.
American Bank had also been winding down the relationship with Synapse before its bankruptcy, according to the trustee's status report. The bank holds $43,339.67 in customer funds, and is owed roughly $2.34 million by other partner banks due to unsettled debit transactions between May 8 and May 23. American Bank declined to comment.
AMG mainly processes payments and brokered sweep deposits for Synapse Brokerage, according to the status report filed May 6. AMG could make initial distribution of customers' funds for which it has clear records within two weeks, with most of the dollar amount flowing out within a week. AMG National Trust declined to comment.