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By Stephen Gandel

NEW YORK, Jan 21 (Reuters Breakingviews) - A fix for the U.S. banking system is at risk of fraying. IntraFi, which enables lenders to offer deposit insurance far beyond the statutory $250,000 cap, enjoyed booming business after Silicon Valley Bank’s collapse. Backed by buyout shops Warburg Pincus and Blackstone, it now faces rising competition and declining credit ratings. This little-noticed corner of finance merits closer scrutiny.

IntraFi is itself a product of regulation. Because the Federal Deposit Insurance Corporation's guarantees against losses in the event of a bank’s failure apply per institution, rather than per depositor, individuals have long been able to open accounts at multiple banks to gain additional coverage. IntraFi's contribution was to automate, and greatly ease, that process. Banks send balances in their clients' accounts that exceed $250,000 into IntraFi's reciprocal deposit network, which matches up above-limit client balances and swaps them between lenders, creating newly linked accounts that will also qualify for $250,000 in deposit insurance.

The workaround has been popular, particularly since SVB's collapse. There are now $438 billion in such swapped deposits nationwide, up from $158 billion in 2022, according to data from the FDIC. IntraFi is by far the dominant network.

Banks pay a fee to be part of IntraFi’s network. Since the government provides the actual insurance, this is, unsurprisingly, a great business. In 2024, IntraFi generated $506 million in EBITDA on $635 million of revenue, a chunky 80% margin.

Yet S&P and Moody's both downgraded IntraFi’s credit rating in August, which is now six notches below investment-grade. At issue was IntraFi's growing debt load, which is in part a product of its private equity ownership. As lending markets have rebounded, PE firms have levered up portfolio companies to pay themselves dividends, and IntraFi is no exception, which issued $2 billion in debt in August, of which $1.4 billion was for dividends.

The new leverage implies additional interest expense of $170 million annually. Added to 2024’s $233 million, IntraFi’s EBITDA would only cover its debt obligation by less than 1.5 times. Since IntraFi is private, so is the full state of its balance sheet. It could be that new funds may have retired old debts, and interest rates are falling. Still, EBITDA growth has slowed to just 9%, down from 73% in 2024, as the spike in demand for reciprocal deposits after SVB's failure has ebbed.

IntraFi says its indebtedness is "appropriate" for its size and business model, and is in-line with peers. Nonetheless, competition in the niche is also rising. Bank-owned deposit network NBID launched in August, with IntraFi co-founder and former CEO Gene Ludwig on its board. In September, financial technology giant Fiserv acquired rival StoneCastle. Meanwhile, both Treasury Secretary Scott Bessent and Democratic Senator Elizabeth Warren have backed a plan to boost FDIC insurance on non-interest-bearing accounts to $10 million. IntraFi’s network is mostly interest-bearing, but a higher cap may sap potential future demand.

IntraFi says it welcomes competition, arguing it provides a "superior experience" and longer track record than rivals.

To be clear, IntraFi doesn’t hold deposits directly, lowering risk if anything goes awry. Yet how potentially flighty depositors might react to signs of stress at a key financial intermediary remains uncertain. Christopher McBride, an official at the Office of the Comptroller of the Currency, warned in 2024 at a forum for minority-owned banks about overreliance on reciprocal deposits and the potential disruption if IntraFi's credit was downgraded. "It can be astronomical amounts of money just moving around the system," said McBride. "What happens if something goes wrong there?"

IntraFi says it has $200 million in cash "to handle anything unexpected," and that "its outlook for future growth is positive."

Watchdogs have options to more strictly regulate such companies to ensure that they are just as financially sound as the banks they service. The Bank Service Company Act allows regulators to impose rules for companies servicing depository institutions, including leverage. Another option would be to mandate that banks diversify across multiple reciprocal networks. Either way, oversight now is cheaper than fixing any problems later.

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CONTEXT NEWS

On November 24, the Federal Deposit Insurance Corporation released quarterly data showing that banks held $438 billion in deposits that had been swapped between them to maximize public insurance coverage.

In August, credit agencies Moody's and S&P Global both downgraded the debt rating of IntraFi, a company that facilitates these reciprocal deposits, to the equivalent of B-, or six notches below the lowest investment-grade rating of BBB-. The downgrades followed a $2 billion debt offering that raised the company's leverage ratio to 9 times expected EBITDA, according to Moody's.

(Editing by Jonathan Guilford; Production by Maya Nandhini)

((For previous columns by the author, Reuters customers can click on GANDEL/ stephen.gandel@thomsonreuters.com))