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Crawl. Walk. (Bank) Run: The 2023 Banking Panic and the Federal Regulatory Response

Crawl. Walk. (Bank) Run: The 2023 Banking Panic and the Federal Regulatory Response

March 31, 2023

Over the last few weeks, liquidity challenges at one distressed bank have escalated into broader concern across the banking industry in the United States and Europe. The nascent crisis has already caused the second and third largest bank failures in US history and forced the rescue purchase of a global systemically important bank in Switzerland. These events have prompted an unprecedented regulatory response, including (i) US regulators backstopping uninsured depositors after invoking the “systemic risk exception”¹ and (ii) the Board of Governors of the Federal Reserve System’s (the “Federal Reserve”) creating a term loan facility to make additional liquidity available to US banks.²

Below, we briefly take stock of the situation, provide legal background on the most critical developments, and assess some of the potential downstream effects for banks, depositors, and the courts.

I. What Happened? A Timeline.

Wednesday, March 8, 2023:

Against the backdrop of rising interest rates and increased withdrawals to meet liquidity needs from emerging company and technology clients, Silicon Valley Bank (“SVB”) sells a US$21 billion bond portfolio to fund withdrawals.
That bond sale results in a US$1.8 billion loss, leading SVB’s parent company, SVB Financial Group (“SVBFG”), to seek additional capital to reassure investors and stabilize the bank’s balance sheet.

Thursday, March 9, 2023:

SVBFG announces plans to issue US$2.25 billion of equity and preferred convertible stock, including raising US$500 million from private equity fund General Atlantic.
Though designed to instill confidence, this announcement has the opposite effect: SVB’s stock trades down roughly 60% on fears that fundraising to cover withdrawals will be dilutive to equity.
Some venture capital funds advise their portfolio companies to withdraw their funds from SVB, which quickly spreads among SVB’s concentrated client base, setting the stage for a classic bank run.

Friday, March 10, 2023:

The California Department of Financial Protection & Innovation shutters SVB and appoints the Federal Deposit Insurance Corporation (“FDIC”) as receiver.
The FDIC creates the Deposit Insurance National Bank of Santa Clara to protect insured deposits of SVB.
The Bank of England and the United Kingdom’s banking regulator, the Prudential Regulation Authority, announce their intention to place Silicon Valley Bank UK Limited into a bank insolvency procedure under the Banking Act of 2009, effectively shutting down SVB’s U.K. operations.

Sunday, March 12, 2023:

The New York State Department of Financial Services closes Signature Bank and appoints the FDIC as receiver for the bank, which had significant exposure to cryptocurrencies, particularly through its operation of Signet, a 24/7 fiat settlement network used by digital asset service providers.
The FDIC creates Signature Bridge Bank, N.A., and transfers all the deposits and substantially all of the assets of Signature Bank.
Greg D. Carmichael, former CEO of Fifth Third Bank, is named CEO of Signature Bridge Bank.
After concerns spread for flight of uninsured deposits from large regional banks, US regulators announce “systemic risk exceptions” for SVB and Signature Bank, which fully protects all deposits, including uninsured deposits, and allows depositors to access all funds by Monday, March 13.
The Federal Reserve, under section 13(3) of the Federal Reserve Act, establishes a term loan facility called the Bank Term Funding Program (“BTFP”) to make available additional funding to eligible banks to help ensure they can meet all depositors’ demands.

Monday, March 13, 2023:

The FDIC announces that all deposits, both insured and uninsured, and substantially all assets of SVB, including all Qualified Financial Contracts, are being transferred to a newly created, full-service FDIC-operated “bridge bank,” Silicon Valley Bridge Bank, N.A. (“SVBB”).
Tim Mayopoulos, former CEO of Fannie Mae, is named CEO of SVBB.
The Bank of England and other U.K. financial regulators announce that HSBC UK Bank Plc has acquired Silicon Valley Bank UK Limited.
The Federal Reserve announces that Vice Chair for Supervision Michael S. Barr will lead a review of the supervision and regulation of SVB, which will be released by May 1, 2023.

Wednesday, March 15, 2023:

Credit Suisse, a global systemically important bank based in Switzerland, announces measures to strengthen its liquidity by exercising an option to borrow up to 50 billion Swiss francs from the Swiss National Bank under a “Covered Loan Facility” and a short-term liquidity facility collateralized by “high quality assets.”

Friday, March 17, 2023:

SVBF GSVB’s bank holding company, files a voluntary Chapter 11 petition in the US Bankruptcy Court for the Southern District of New York.

Sunday, March 19, 2023:

Credit Suisse announces its entry into a merger agreement with fellow Swiss bank UBS after intervention from the Swiss Federal Department of Finance, the Swiss National Bank, and the Swiss Financial Market Supervisory Authority (“Swiss FINMA”). The purchase price for Credit Suisse was reported at US$3.23 billion and to involve US$108 billion in liquidity assistance to UBS and Credit Suisse from the Swiss National Bank.
Swiss FINMA informs Credit Suisse of its determination that its Additional Tier 1 Capital (deriving from the issuance of Tier 1 Capital Notes), at face value of 16 billion Swiss francs, will be written off to zero. The subordinated AT1 notes had traded at a substantial discount to par during the prior week.
The FDIC announces entry into a purchase and assumption agreement for “substantially all deposits and certain loan portfolios” of Signature Bridge Bank by Flagstar Bank, N.A., a subsidiary of New York Community Bancorp, Inc. The agreement does not include Signature Bridge Bank’s digital assets banking business.

Sunday, March 26, 2023:

The FDIC announces entry into a purchase and assumption agreement with First Citizens Bank & Trust Co. (“First Citizens”) for substantially all loans and certain other assets as well as the assumption of customer deposits from SVBB. First Citizens Bank receives an available line of credit from the FDIC for contingent liquidity purposes and enters into a loss-share agreement with the FDIC. In connection with the transaction, the FDIC receives certain equity appreciation rights in First Citizens’ bank holding company, First Citizens BancShares, Inc., worth up to US$500 million

II. What Is FDIC Receivership?

Authority & Purpose

SVB and Signature Bank were subject to receivership by the FDIC under the Federal Deposit Insurance Act (the “FDI Act”).³ Among other things, the FDI Act gives the FDIC authority to act as a receiver of failed banks.⁴

FDIC receivership allows for the resolution of a failed bank’s assets and liabilities, with the aim of protecting insured depositors and creditors, minimizing disruption to the failed bank’s customers and counterparties, and maintaining confidence in the financial system. Banks themselves generally cannot file for relief under US bankruptcy law,⁵ though bank holding companies can.⁶

Upon appointment, the FDIC has broad administrative authority under the FDI Act and holds all the powers of the shareholders, directors, and officers of the insolvent bank. Generally, the FDIC will remove and replace senior management and the board of directors—while also eliminating shareholders’ rights and powers.⁷ Compared with other insolvency regimes, creditors of banks in FDIC receivership do not have the same ability to influence, vote on, or object to the FDIC’s decisions as receiver.⁸

Scope

FDIC receivership only applies to US banking entities insured by the FDIC, not to international bank affiliates or non-bank affiliate subsidiaries of FDIC-insured banks. For example, SVB’s parent bank holding company, SVBFG, also owned private banking and securities affiliates. Some of these entities have remained independent of SVBFG’s chapter 11 bankruptcy case. SVB also operated foreign branches in the UK and the Cayman Islands, which were beyond the scope of the receivership. Though HSBC has purchased the UK branch of SVB, the status of SVB’s Cayman branch remains unclear.

Claims Process

The FDIC notifies creditors (other than known depositors) of a deadline to submit claims that must be no less than 90 days from the notice.⁹ The FDIC will distribute the proceeds of the failed bank’s assets among the claimants in accordance with statutory priority.¹⁰ Under the FDI Act, after secured claims are paid,¹¹ administrative expenses of the receiver are paid first, followed by deposit liability claims (including insured and uninsured deposits), other general or senior liabilities of the insolvent bank, subordinated obligations, and then shareholder claims.¹²

Insured depositors are paid in full “as soon as possible” up to the statutory limit of US$250,000 per depositor, while uninsured depositors are subordinated in priority and may need to wait for an interim distribution.¹³ The FDI Act permits the FDIC as receiver to withhold distribution of deposits on account of a depositor’s unpaid liability (unless such liability is otherwise offset by the depositor).¹⁴ In the cases of SVB and Signature Bank, the “systemic risk exception” invoked by the US government obviated the need for interim distributions to uninsured depositors, who otherwise would have received an “advance dividend” based on the receiver’s conservative estimate of the bank’s remaining assets.¹⁵

In circumstances where deposits are not fully backstopped, the FDIC typically provides “receivership certificates” to uninsured depositors, and payments are made as the failed bank’s assets are monetized. The level of recoveries that holders of receivership certificates will receive or the timing of the distributions are each based on the facts and circumstances of the bank failure.

Avoidance Actions

The FDIC can avoid certain transfers of interest of an institution-affiliated party (or any person whom the FDIC determines is a debtor of the institution in receivership) that were made within five years of the FDIC’s appointment as receiver. But unlike typical avoidance actions under bankruptcy law, the transfers must have been made with the intent to hinder, delay, or defraud the insolvent bank in receivership, the FDIC, or any other federal banking agency. If avoided, the FDIC can recover the property transferred or the value of the property from either the initial transferee or any immediate transferee of the initial transferee. The FDIC cannot recover from any transferee that takes for value, including satisfaction or securing of a present or prior debt, in good faith or any immediate good faith transferee of such transferee.¹⁶ There is no analogue in the FDI Act to bankruptcy law that allows the recovery of preferences and constructive fraudulent transfers.

Setoff and Loan Covenants

The FDIC has indicated a general willingness to allow for setoff by a creditor or depositor of its mutual obligations with a failed bank—typically for a setoff of uninsured deposits against loans outstanding with the institution—so long as the setoff is otherwise allowable under applicable law.¹⁷ But the FDIC usually requests that parties make a formal request, as it did in its public notices regarding the SVB and Signature Bank receiverships. If a depositor is a net creditor and sets off its deposits against other unpaid liabilities, the FDI Act does not permit the FDIC as receiver to withhold payment of insured deposits on account of any of the depositor’s unpaid liabilities.¹⁸

The D’Oench Duhme doctrine, codified in 12 USC. § 1823(e), may also impact setoff rights in certain unique circumstances. This doctrine is both a common-law and statutory doctrine that is available to certain federal regulatory agencies and their assignees when dealing with the loans of a failed lender. The doctrine operates like a “Statute of Frauds” applied to banking that precludes affirmative claims and defenses seeking to enforce oral credit agreements (or raised against the enforcement of a loan). The Seventh Circuit once applied the doctrine in Federal Deposit Ins. Corp. v. State Bank of Virden, barring setoff because it relied on contradicting the loan documents with oral statements.¹⁹ To the extent any setoff is in respect of a written agreement properly executed and recorded by the bank, the doctrine is generally inapplicable.

Many loan documents contain customary provisions requiring ongoing payments notwithstanding any setoff. Borrowers who are also creditors or depositors should normally continue to honor their existing contractual relationships with a failed bank in receivership except in certain circumstances and only after consulting legal counsel. The FDIC as receiver can enforce contracts notwithstanding so-called “ipso facto” contractual provisions providing for termination, default, acceleration, or exercise of rights upon insolvency or appointment of a receiver.²⁰

The FDI Act also provides for a temporary 90-day stay on certain actions against a bank in receivership or its property, preventing contract parties from terminating, accelerating, or declaring a default under any contract that involves the failed institution or taking possession of or control over any of the failed institution’s property or affecting its contractual rights.²¹ However, this provision does not apply to property or contracts transferred to a bridge bank, and it is unclear whether this provision would prevent the application of setoff generally. As a result, caution is warranted.²² The FDI Act provides explicit protection for setoff or netting of qualified financial contracts (e.g., swaps, forward contracts) and for setoff of certain lease obligations where the depository institution is the lessor.²³

III. What Is a Bridge Bank?

Bridge banks are national depository institutions chartered by the Office of the Comptroller of the Currency and controlled by the FDIC in connection with its takeover of a failed bank. The bridge bank gives the FDIC the opportunity to determine how best to liquidate the bank’s assets, whether as a sale to a single buyer or the piecemeal sale of assets. Sales may be to an existing bank or non-bank purchasers. Bridge banks are exempt from certain provisions of the FDI Act applicable to banks in receivership.²⁴

The FDIC can transfer any assets or liabilities of a failed institution to a bridge bank without further approval under federal or state law, even if there are assignment or consent right restrictions.²⁵ Congress mandates that the FDIC continue to honor commitments made by the failed institution to creditworthy customers and not interrupt adequately secured loans transferred to a bridge bank.²⁶

A bridge bank’s status is terminated as soon as any of several specific conditions is met, such as the sale of a majority of its capital stock to an entity other than the FDIC or another bridge bank. A bridge bank’s status can also expire after two years, with the possibility of three one-year extensions.²⁷

IV. What Is the Bank Term Funding Program?

The Federal Reserve established the BTFP on March 12, 2023, under Section 13(3) of the Federal Reserve Act, as a source of emergency liquidity provided against high‑quality, pledged securities. The principal function of the BTFP is to eliminate a bank’s need to liquidate those securities under stress, with the broader goal of supporting US households and businesses and increasing confidence in the financial system.

The BTFP provided for advances of up to one year to most US banks pledging collateral eligible for purchase by the Federal Reserve Banks in open market operations, including US government securities.²⁸

In contrast with regulatory discount-window lending, the BTFP values eligible collateral at face value, not market value, which strikes at the heart of the stress faced by SVB and Signature Bank: Both institutions held securities whose market value was significantly lower than face value because of recent interest-rate increases. The loans under the BTFP have recourse beyond the pledged collateral to the borrower.

The Federal Reserve has indicated that eligible banks’ use of the BTFP will not raise supervisory concerns.²⁹

The Federal Reserve has also indicated its intent to publicly disclose information concerning the BTFP one year after its closure, currently scheduled for March 11, 2024. That information will include identifying details of participants in the facility along with the amount borrowed, interest rate paid, and collateral type pledged.³⁰

V. What’s Next?

This crisis could have several knock-on effects, including changes to standard banking practices and new or adjusted rules for bank supervision.

Cash Management Practices. Large depositors may begin to more critically examine where they hold cash deposits—uninsured deposits in particular—and whether they should implement risk-mitigation strategies such as sweep accounts or diversification of deposit accounts.
Deposit Insurance. Continued calls to reform the FDIC’s national deposit insurance program are likely, particularly to increase or even eliminate insurance limits that many now claim were illusory.
Regulatory and Legislative Responses. Calls for increased supervision over regional banks are expected to grow louder. Senator Elizabeth Warren and Rep. Katie Porter have introduced companion bills to re-impose heightened regulations on small- and medium-sized banks. Regulators have already announced inquiries into the recent bank failures. And the Senate Banking Committee and the House Financial Services Committee are holding hearings with FDIC Chairman, Martin Gruenberg; Federal Reserve Vice Chairman for Supervision, Michael Barr; and Department of Treasury Undersecretary for Domestic Finance, Nellie Liang.
Government Enforcement Investigations. Multiple reports have suggested that the SEC and Department of Justice have opened investigations into events surrounding SVB’s failure, and Massachusetts regulators have announced a formal investigation into stock trading by SVBFG executives.
Bankruptcy Cases.
- In addition to SVBFG’s bankruptcy filing—the first major bank holding company Chapter 11 filing since the global financial crisis—other bank holding companies may seek bankruptcy protection in connection with the failure of their depository institutions.
- In its Chapter 11 case, SVBFG has already previewed disputes with the FDIC over access to more than US$2 billion in cash held at SVBB. The FDIC has allegedly declined to honor requests to transfer the accounts and to allow access to certain books and records that were held at SVB, and it has allegedly attempted to claw back certain payments to the debtor’s bankruptcy professionals.
- One major issue that will arise in Chapter 11 cases of bank holding companies is the application of section 365(o) of the Bankruptcy Code, which requires a Chapter 11 debtor to assume any commitment to a regulator to maintain capital at an insured depository institution. The provision also affords priority to claims of the regulator arising from a breach of this capital maintenance commitment. Section 365(o) is, therefore, a stark departure from the otherwise wide discretion that the Bankruptcy Code grants a Chapter 11 debtor to reject burdensome agreements and choose not to perform under agreements during the pendency of the bankruptcy.
Source of Strength. US banking law has long imposed a “source of strength” doctrine on bank holding companies, which generally requires that a bank holding company be a sufficient source of financial and managerial strength to its subsidiary bank. Questions remain as to how the doctrine, which Congress clarified and strengthened in the Dodd-Frank Act, would apply to bank holding companies by way of section 365(o).

^[1]12 U.S.C. § 5383 et seq.; Fed. Deposit Insur. Corp., PR-17-2023, Joint Statement by the Dep’t of the Treasury, Fed. Rsrv., and FDIC (2023), https://www.fdic.gov/news/press-releases/2023/pr23017.html.

^[2] Bd. Of Governors of the Fed. Rsrv. Sys., Federal Reserve Board announces it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors (2023), https://www.federalreserve.gov/newsevents/pressreleases/monetary20230312a.htm.

^[3]12 U.S.C. §§ 1821(c)(2)(A)(ii), (c)(2)(B); see also Fed. Deposit Insur. Corp., Crisis & Response: An FDIC History, 2008-2013 at 176–77 (2017).

^[4] The FDI Act also provides the FDIC with the authority to insure bank deposits and supervise and regulate state-chartered banks that are not members of the Federal Reserve System, with the purpose of promoting stability and confidence in the banking system of the United States and promoting safe and sound banking practices.

^[5]11 U.S.C. §§ 109(b)(2), (d).

^[6] Id. §§ 101(41); 109(d).

^[7] 12 U.S.C. § 1821(d)(2).

^[8] In contrast, under U.S. bankruptcy law, a debtor’s estate is administered by a debtor-in-possession or trustee in a legal proceeding overseen by a federal bankruptcy court. Though court approval is often necessary for taking actions outside of the ordinary course of business, often management is retained and both creditors and the debtor’s management often have significant control over decisions. Affected creditors generally can vote on a plan of reorganization of a debtor.

^[9] 12 U.S.C. § 1821(d)(3)(B)(i).

^[10] See Id.§ 1811(b).

^[11] Secured claims can be disallowed if not proved to the satisfaction of the FDIC as receiver, and, with very limited exceptions, the FDIC may treat as unsecured any claim amounts in excess of the fair market value of the security. 12 U.S.C. § 1821(d)(5)(D).

^[12] 12 U.S.C. § 1821(d)(11).

^[13] Id. §§ 1821(a)(1)(C), (E); (f)(1).

^[14] Id. § 1822(d).

^[15] Id.. § 1821(d)(4)(B); Fed. Deposit Insur. Corp., Glossary, Resolutions Handbook, https://www.fdic.gov/bank/historical/reshandbook/glossary.pdf (last visited Mar. 11, 2023).

^[16] 12 U.S.C. § 1821(d)(17).

^[17] See, e.g., Fed. Deposit Insur. Corp., Fin. Inst. Emp.’s Guide to Deposit Insur. (2023), https://www.fdic.gov/resources/deposit-insurance/diguidebankers/insurance-basics/index.html.

^[18]12 U.S.C. § 1822(d) (permitting the FDIC as receiver to withhold distribution of insured deposits on account of a depositor’s unpaid liability except if the liability is “offset against a claim due from such depository institution”).

^[19] 893 F.2d 139, 143-44 (7th Cir. 1990).

^[20] 12 U.S.C. § 1821(e)(13)(A).

^[21] Id. § 1821(e)(13)(C).

^[22] Notably, not a single published court opinion cites to 12 U.S.C. § 1821(e)(13)(C).

^[23] 12 U.S.C. §§ 1821(e)(5), (8). “Walkaway” clauses, which are expressly distinguished from netting/set off rights under qualified financial contracts, are unenforceable. Id.

^[24] See, e.g., 12 U.S.C. § 1821(e)(10)(c)(i).

^[25] Id. § 1821(n)(3)(a)(iv).

^[26] Id. § 1821(n)(3)(B).

^[27] Id. § 1821(n)(9)-(12).

^[28] 12 C.F.R. § 201.108.

^[29] Bd. Of Governors of the Fed. Rsrv. Sys., Bank Term Funding Program (FAQs) (2023), https://www.federalreserve.gov/monetarypolicy/files/bank-term-funding-program-faqs.pdf.

^[30] Id.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Jarryd E. Anderson, an O’Melveny partner licensed to practice law in the District of Columbia, New Jersey, New York, and Pennsylvania, Peter Friedman, an O’Melveny partner licensed to practice law in the District of Columbia, Jordan Weber, an O'Melveny counsel licensed to practice law in California and New York, and Damilola G. Arowolaju, an O'Melveny associate licensed to practice law in the District of Columbia, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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