Oops. How the FDIC Guaranteed the Deposits of SVB Financial Group

When President Biden announced the rescue of Silicon Valley Bank depositors, he emphasized that "investors in the banks will not be protected.  They knowingly took a risk and when the risk didn’t pay off, investors lose their money.  That’s how capitalism works." Unfortunately, that's not how US law works. 

There seems to be a gap in the Federal Deposit Insurance Act that is going to protect some investors in Silicon Valley Bank’s holding company, SVB Financial Group. The holdco’s equity in the bank will be wiped out in the FDIC receivership, but the FDIC doesn’t have any automatic claim on the holdco. This is basic structural priority/limited liability:  creditors of a subsidiary have no claim on the assets of a parent.

What's worse is that the holdco, which filed for bankruptcy today, has substantial assets including around $2 billion on deposit with SVB. Almost all of that $2 billion deposit at SVB would have been uninsured, but by guarantying all the deposits, FDIC accidentally ensured that the holdco’s bondholders would be able to recover that from that full $2 billion deposit.

There isn't any provision in the Federal Deposit Insurance Act that subordinates the claims of insiders—like corporate affiliates or executives—that exceed the insured deposit limit to other creditors. So once FDIC guaranteed all deposits, it necessarily guaranteed the deposits of the holdco and other insiders. 

Now the FDIC might have some sort of tort-based claim against the holding company—breach of fiduciary duty or fraudulent transfer or the like—but that's fact-dependent, and no complaint has been filed yet. Additionally, the fact that federal bank regulators were cool with SVB (including with its solvency) until they suddenly weren't is a pretty powerful defense to any mismanagement-based claim. As for fraudulent transfers, the FDIC can only bring claims for actual fraudulent transfers—those made with actual intent to hinder, delay, or defraud creditors. That's unlikely to go very far here.

The simple fact is that there's no automatic claim for the FDIC against a bank holding company when the FDIC takes over the failed bank as a receiver and pays out on the deposit insurance because the holding company is not a guarantor of the bank.

The situation is different for G-SIBs (really, really big banks)--their holdcos are required to have a certain amount of bail-in-able capital (TLAC) and to have a single-point-of-entry resolution model. But that doesn't apply to smaller bank holding companies like SVB Financial Group. There's also the source-of-strength doctrine, codified in Dodd-Frank, but that doesn't create any concrete financial liability—it's just exhortatory.  

Bankruptcy law prioritizes claims for commitments to federal bank regulators to maintain the capital of insured depository institutions, but I don't think we have such a claim here--a commitment has traditionally meant a specific promise to do so (that's why it's covered under section 365(o)). I don't think we have one here. Perhaps the holdco's resolution plan, which is supposed to state how the holdco will be a "source of strength" for the depository would suffice, but I'm very skeptical of that argument. It's just too vague of an obligation and a resolution plan doesn't seem like an otherwise enforceable commitment. So I don't think there's any obvious FDIC claim on SVB Financial Group. There should be, but that's another matter. 

To the extent that FDIC does have a claim, however, it might seek to setoff its claim against the SVB Financial Group deposit, and a setoff claim is a secured claim in a bankruptcy. The FDIC would need the automatic stay to be lifted to exercise setoff, but it could temporarily freeze the funds in the account until then. But unless the FDIC as receiver has a valid claim against SVB Financial Group, then there's no possibility of setoff. 

Maybe the FDIC will come up with a theory that gives it a bankruptcy claim against SVB Financial Group. But if not, the FDIC seems to have accidentally guarantied $2 billion for the creditors of SVB Financial Group without any offsetting claim. 

Comments

[Ben]

Great piece, thank you. Been a long time since I took biz orgs, but is there any way to pierce the holdco veil? Subsidiary was an alter ego etc?

[Karl]

"Oops" ... "FDIC accidentally ensured that the holdco’s bondholders..."

Oops? Accident? Why assume that? The FDIC has taken over numerous banks. Surely that includes holdcos.

The role of the FDIC, the SF Fed, Governor Newsom, the VC, et. al. is pretty stinky, yes? I hope your great reporting can put the spotlight on this next layer of the story.

[Scipio Africanus]

"Additionally, the fact that federal bank regulators were cool with SVB (including with its solvency) until they suddenly weren't is a pretty powerful defense to any mismanagement-based claim."

It has come to light that SVB has been been being reviewed by the Feds for the past year and found wanting. Lots of meetings w SVB and the Feds where the Feds said "hey, you're not managing this big risk to standard."

SVB obviously didn't fix the problem, and the degree to which the Feds could step v in and take over at each stage was presumably limited, and for obvious bank-run related reasons this federal risk review was not made public while it was happening... but to say that the Feds were OK until they suddenly weren't is not true.

[Adalman]

i hope too

[diptherio]

proofreading note: I think you are missing an "isn't" in the fourth para.

"There *isn't* any provision in the Federal Deposit Insurance Act that subordinates the claims of insiders—like corporate affiliates or executives—that exceed the insured deposit limit to other creditors."

[c]

Will this actually mean the FDIC is out for $2billion or does it just favour Holding company creditors ahead of bank creditors? The numbers are so large and volatile that its very hard to fathom the impact. Total assets last year were something like $200billion and deposits 175 or so? This treasuries declined a lot and will no doubt wipe out equity, but all of the debt?

[Adam Levitin]

Proofreading corrected.

Two separate issues for "c":
(1) Does FDIC have to honor the guaranty of the parent's deposit?
(2) Does FDIC have a claim on the parent (and if so, can it exercise setoff)?

For (1), I think the answer is "yes"--there's be no indication of a carve-out for insiders, and I don't know what legal basis would exist for doing so. That means that the bank owes the parent $2B, and that $2B is guarantied by the DIF.

For (2), I think the answer is "not automatically." The FDIC might come up with some sort of tort claim on the parent, but there's no contractual or statutory obligation of which I am aware. If the FDIC can make a claim on the parent, it could then claim that it has a setoff right against the deposit account, which would make it a secured claim in the bankruptcy (ahead of the bondholders). But until it does so, the parent should be able to withdraw the funds from the bank. The FDIC could have a temporary account freeze, but it won't be able to drag that out too long.

[adam]

Also for "c"--it isn't clear how much the Deposit Insurance Fund is actually going to have to pay at the end of the day in Silicon Valley Bank. Even with the decline in collateral value, there's lots of value left in the securities. But it seems likely that the FDIC will be paying out more than $2 billion.