US - Bridge to nowhere

Author: | Published: 8 Jun 2012
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Morrison & Foerster

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In a recent speech, the acting chairman of the Federal Deposit Insurance Corporation (FDIC), Martin J. Gruenberg, outlined the agency’s strategy for orderly liquidation authority.

The FDIC will place only the top-tier holding company of a distressed institution whose impending default would damage US financial stability into an OLA receivership.

Large financial institutions and their creditors and other stakeholders will want to consider closely the impact of the proposed resolution approach as it differs from the traditional US bank receivership process.

In a traditional bank receivership, the FDIC has focused on minimising the costs of the receivership for the FDIC’s Deposit Insurance Fund. The resolution process has as its objective minimising the systemic effects of the failure of a significant and complex financial institution on the financial system. The FDIC as the receiver may sell the assets of the failed institution to a bridge holding company.

As part of this resolution process, the FDIC may wipe out the company’s shareholders and turn unsecured creditors (both senior and junior) into shareholders, subordinated debt holders, and unsecured creditors of a new bridge holding company. Unsecured creditors and the subordinated debt holders will hold claims against the receivership (but not against the bridge company). The assets of the receivership will be the equity in the bridge company, and the FDIC will pay a portion of the claims with this stock.

The bridge company is capitalised solely by the conversion of unsecured debt into equity. Now well-capitalised and supported by guarantees, the bridge company should, in the FDIC’s view, be able to obtain new private financing, which it can downstream into any troubled subsidiaries.

It is not clear how the bridge company will be able to obtain new financing given the circumstances that likely will surround a resolution process. In addition, the bridge company is a refinanced and nominally recapitalised version of the failed institution, with some of the same stakeholders, albeit with different stakes. Will it present an attractive investment opportunity? Historically, the FDIC has used the bridge company in bank receiverships to facilitate the sale of good assets to a new buyer and the liquidation of bad assets.

The speech also suggests that much of the unsecured debt of a holding company that will be subject to the orderly liquidation process in the US has become or will be treated as bail-in debt. Last year, we witnessed the effect that bail-in fears had on the European market for senior unsecured debt of financial institutions. This new announcement would seem to raise many of the same concerns for holders of US bank debt.