FDIC's Poor Track Record in Holdco Bankruptcies

Last week I did a post about how the FDIC as receiver for Silicon Valley Bank probably doesn't have a claim against SVB Financial Group, the holdco of the bank. I got some pushback on that (including from a former student!), but I'm sticking to my guns here. It's a result that seems wrong and surprising, but if you look at the three most recent big bank holdco bankruptcies (this takes some digging in old bankruptcy court dockets), the FDIC has ended up with little or no claim.

In IndyMac, the FDIC filed a $5 billion proof of claim based on capital maintenance, fraudulent transfers (primarily dividends), tort claims for breach of fiduciary duty, and alleged ownership of a tax refund that had gone to the holdco. The FDIC alleged that it was all a priority claim. After a few years of litigation, the FDIC settled for an allowed $58 million general unsecured claim...and got a distribution of about $5.6 million.

In WaMu, the FDIC and holdco each had claims against each other. The FDIC was claiming similar things as in IndyMac. The end result was a settlement in which the FDIC dropped its bankruptcy claim entirely and got no payment whatsoever from the holdco, just a release.

And in Colonial Bancorp, the FDIC filed a $1 billion proof of claim, primarily based on capital maintenance obligations...and got nothing. The FDIC lost in the bankruptcy court on whether the capital maintenance obligations were actually an enforceable monetary obligation, and then settled on this and a bunch of other issues while an appeal was pending. As part of the settlement, the FDIC dropped its claim, but got a release. Unlike with IndyMac and WaMu, there was actually something sort of like a capital maintenance agreement, although it wasn't quite right for creating a claim. I don't know of any equivalent document for SVB Financial Group, which suggests that the case is even more like WaMu or IndyMac. Maybe the FDIC can maintain a claim for some small fry things like a share of tax refunds, etc., but I don't see how FDIC will have an allowed claim for anything close to the $2B or so that SVB Financial Group has on deposit at the bank, and if that's the case, any setoff FDIC might claim will be limited.

Whatever package of reforms we see going forward really ought to ensure that FDIC as receiver can recover against the holdco--that is source of strength doctrine needs to have some teeth, including in bankruptcy. A key way to do that is to mandate single-point-of-entry (SPOE) resolution for all banks, not just the really big ones (G-SIBs).

The rescue of SVB and SBNY depositors seriously undermined whatever market discipline might exist in the deposit market. But there is a way to restore an important level of market discipline to banking:  take the model that exists for really big banks—SPOE, which involves  bail-in-able holdco debt—and apply it to all banks. That will make holdco level bondholders structurally subordinated to bank-level deposits (and the FDIC). Those holdco-level bondholders are going to be very concerned with monitoring the financial health of the bank. And the credit default swap spreads on the holdco-level bonds will be a very visible indicator to everyone of the market's evaluation of the bank's health, basically a market check on regulators' work.

Comments

[Zhuotong Cai]

This is a great piece for understanding the current tension between bondholders of SVB Financial Group and the FDIC.

However, I don't believe that extending the SPOE strategy to all financial holdco will be helpful.

Even if the FDIC has the power to put holdcos in receivership, the principle of "non-creditor-worse off" set by the Financial Stability Board (we may also found similar provisions in the Dodd-Frank Act) dictates that no creditor should bear higher losses in the resolution than if the company under resolution had been liquidated under normal insolvency proceedings. This means that the treatment of bondholders of a holdco in FDIC's receivership should be similar to that on the bankruptcy court.

Thus, unless the FDIC's claims against the holdco, whether they are based on the capital maintenance commitment or the doctrines of source of strength, are upheld by the bankruptcy court, bondholders could still challenge any asset transferred from the the holdco to subsidiaries during the receivership, arguing that they would get more under bankruptcy proceedings.

Additionally, when looking at the living wills of the G-SIBs in the U.S., holdcos use complex "security supporting agreements" with their subsidiaries to avoid potentially fraudulent and preference claims raised by the holding company's bondholders. However, all of these carefully crafted legal strategies are based on a series of hypotheses. It is still uncertain whether the transfer of downstream assets could be immunized from holdco-level bondholders' challenges.

A student of banking law