So what went down?
The past few days have been a tumultuous saga that began with a securities filing. On March 8, 2023, SVB Financial Group (“Parent”), the parent entity of SVB, filed an 8-K with a performance update and proposed strategic actions. This revealing filing divulged SVB’s sell-off of a substantial amount of securities, totaling $21 billion, at a considerable loss due to the impact of the prevailing interest rate environment on SVB’s holdings. Following this, SVB sought to raise $2.25 billion of equity capital in an effort to mitigate recent losses. However, faced with these developments, SVB depositors—primarily venture capital and start-up companies—promptly withdrew their funds from SVB, instigating a classic “bank run.” Not more than two days following the unexpected securities disclosure, on Friday, March 10, 2023, the California Department of Financial Protection and Innovation reacted by closing SVB and appointing the Federal Deposit Insurance Corporation (FDIC) as receiver.
In conjunction with the closure of SVB, the FDIC chartered the Deposit Insurance National Bank of Santa Clara to serve as the initial “bridge bank” to allow depositors to access their insured deposits. After a weekend auction failed to produce an acquirer for SVB, the FDIC transferred all of SVB’s assets to Silicon Valley Bridge Bank N.A., a new, full-service and FDIC-operated “bridge bank,” offering “normal banking hours and activities . . .”
At the commencement of the receivership on March 10, there remained an immense amount of uncertainty with regard to the treatment of uninsured deposits and related financial arrangements. Recent news reports and regulatory filings revealed that more than 93% of SVB’s domestic deposits were uninsured as of December 31. The FDIC initially declared that uninsured deposit holders would not have immediate access to their funds, and instead, would be prioritized as creditors, receiving an advance dividend within the week, followed by a receivership certificate for the remaining amount of their uninsured funds. The prospect of delayed recovery (or potential risk of non-recovery) of uninsured deposits created substantial uncertainty and concerns of broader contagion throughout the rest of the banking sector and the economy.
The FDIC took numerous actions to address this uncertainty before markets reopened on March 13, 2023. News reports indicate that the FDIC initiated an auction process for SVB on the night of Saturday, March 11, with final bids due on the afternoon of Sunday, March 12. The clear goal of this expedited auction process was to find a strong and viable institution to purchase the SVB operating assets, and to assume the ensuing obligations to deposit holders. Regrettably, no bidder for the SVB assets emerged over the weekend. Consequently, on Sunday evening, March 12th, the Secretary of the Treasury, the Federal Reserve Board, and the FDIC took certain interim emergency measures to protect depositors, stabilize the banking system, and the larger economy. Invoking their authority under the “systemic risk exception,” Secretary of the Treasury Janet L. Yellen, Federal Reserve Board Chair Jerome H. Powell, and FDIC Chairman Martin J. Gruenberg released a statement (the “Rescue Statement”) announcing that all depositors of SVB would be fully safeguarded beyond the already existing deposit insurance and would have access to their funds on the morning of Monday, March 13, 2023. The statement also disclosed that any losses incurred by the Deposit Insurance Fund would be recuperated by special assessments on banks. The statement also stated that similar measures were being implemented for Signature Bank, New York, NY, which would also be closing and placed in receivership.
How is the Federal Reserve safeguarding depositors in other banks?
In tandem with the Rescue Statement, the Federal Reserve Board, aided by the Treasury Secretary, proclaimed the inception of the Bank Term Funding Program (“BTFP”). (Read more here.) The BTFP bestows loans with a lifespan of up to one year to “banks, savings associations, credit unions, and other eligible depository institutions” who put up qualified assets as collateral, which the Federal Reserve Board will value at par. This initiative seems tailored to buttress the liquidity standing of local and smaller institutions, in case of substantial deposit withdrawal activity, to embolden depositors to keep their funds in place. Although the BTFP disclosure did not halt the drastic market plunges witnessed by regional banks such as Western Alliance, Zions Bancorp, First Republic, and PacWest during the March 13 trading session, the market outlook seemed more balanced by March 14, on account of the BTFP news and other precautions taken to safeguard all deposits at SVB and Signature. Nevertheless, regional bank stocks and some larger equities resumed their downward trend on March 15. Volatility lingered on March 16, with Credit Suisse’s market position, a significantly larger institution, undergoing particular strain. We should brace ourselves for more turbulence in the banking sector in the near future, as investors digest the latest events and assess their effect on the Federal Reserve Board’s interest rate policy.
How will deposits be handled?
By law, accounts are covered up to a limit of $250,000 per legal entity customer/individual. Therefore, to ascertain how to apply the $250,000 insurance threshold, we must focus on the depositor’s ownership capacity or legal category of ownership over the account.
Had the U.S. Treasury not stepped in to offer comprehensive protection for SVB deposit accounts, (i.e., allowing depositors access to all funds, even when the amounts on deposit surpassed the $250,000 insurance limit), depositors would only have had access to their deposits up to the $250,000 limit. In that case, the uninsured depositors would have had to await the payment of a future dividend, and then the possible sale or liquidation of the failed bank’s assets, for an opportunity to achieve a full recovery. That prospect carried substantial risks of non-payment or partial payment of the uninsured deposit holders. In case of a liquidation or sale, after paying administrative expenses and secured claims, the FDIC as receiver follows the following order of priority for distributions: (1) uninsured deposits, (2) general creditors, (3) subordinated debt holders, and (4) stockholders. Fortunately, as provided in the Rescue Statement, SVB depositors will be fully protected and made whole.
How does the FDIC treat different types of accounts?
Deposit accounts such as checking and savings accounts, money market deposit accounts, certificates of deposit, and other types of cashier’s checks or money orders are insured up to the $250,000 FDIC insurance limit. It is possible to have deposits of more than $250,000 at one insured bank and still be fully insured if the deposits are maintained in different categories of legal ownership (e.g., different EIN numbers per account). Careful review of the accounts is warranted.
Below are certain ownership categories provided by the FDIC:
- Single accounts owned by one person ($250,000 per owner);
- Joint accounts owned by two or more persons ($250,000 per owner);
- Certain retirement accounts, including IRAs ($250,000 per owner);
- Revocable trust accounts (generally $250,000 per owner per unique beneficiary, but, if there are more than five different beneficiaries, special rules apply);
- Corporation, partnership and unincorporated association accounts ($250,000 per corporation, partnership or unincorporated association);
- Irrevocable trust accounts ($250,000 for the noncontingent interest of each unique beneficiary); and
- Employee benefit plan accounts ($250,000 for the noncontingent interest of each plan participant).
- Other types of assets—such as stocks, bonds, municipal securities, annuities, crypto assets, safe deposit boxes (and contents), life insurance policies, mutual funds and U.S. Treasury bills—are not considered deposits covered by FDIC insurance. Consequently, such assets are treated as the owner’s property, and not as assets of the failed bank. It necessarily follows that the holders of these assets will not incur any loss or diminution of their position in the event of a bank closure, receivership or failure.
It is complex and potentially uncertain how to apply these rules in the context of cash sweeps and other transfers out of zero balance accounts (accounts that are cleared at the end of the banking day). For example, what happens if receivable collections and other receipts—intended to be swept and remitted to pay other obligations—are trapped in a zero balance account at the time of a bank closure? We could argue that these funds were never intended to be deposited long term at the bank and were only transiting through the institution on their way to another banking destination. But the fact remains—these funds could end up on deposit in a demand money market account at the time the institution fails. In that instance, the FDIC or receiver could argue that only $250,000 of these funds are protected, and the rest of the money becomes a receivership asset. That would clearly be a terrible and potentially quite economically significant outcome. Parties utilizing sweeps and zero balance accounts in their cash management systems would be well served to give these issues careful consideration.
Accounts held by fiduciaries are insured like ordinary accounts, but the $250,000 limit is calculated with reference to the beneficiary. The fiduciary and/or beneficiary may need to prove the existence of the fiduciary or custodial relationship through documentation unless the name and other records associated with the account clearly establish the fiduciary relationship. It will be the account holder’s burden to prove that fiduciary relationship. It should be noted that insured funds are paid directly to the fiduciary for the beneficiary’s benefit, and not to the beneficiary directly. If, however, the account itself is a fiduciary account and the bank in question is functioning as a trustee or fiduciary, a strong argument can be made that the account proceeds should not be treated as assets of a future receivership.
How shall the steadfast/committed, but undrawn/unexhausted lines of credit be wrestled with?
It remains uncertain whether borrowers will have access to credit facilities such as term loans, lines of credit, revolvers, and letters of credit provided by SVB. These facilities have been transferred to the bridge bank, and borrowers are advised to seek information from Silicon Valley Bridge Bank’s call center. In addition, just as a Chapter 11 debtor may “reject” a burdensome executory contract, the FDIC, as receiver, has the authority to “repudiate contracts” that would obstruct the smooth administration of the receivership. Contracts subject to repudiation include lines of credit and undrawn standby letters of credit that the FDIC considers as potential obligations. However, if the loan is sold to a healthy acquirer bank, the new bank may opt to take on the line of credit. Moreover, if the undrawn line of credit benefits a strong customer with alternative financing options, the receiver might decide to honor a draw on the line. The receiver will likely make decisions on a case-by-case basis on how to handle each open line of credit, and affected borrowers are encouraged to explore other financing alternatives.
Is it requisite to persist in discharging my debt’s obligations? That is, do I need to make loan payments in the wake of SVB and given the current situation?
Yes, according to our sources, it appears that borrowers are still on the hook to make their scheduled debt service payments as is stipulated in their loan documents. In the event of a bank failure, it is typical for the loan portfolio to be transferred to an acquiring bank. At such a juncture, the FDIC takes charge and notifies the affected borrowers as to where they should submit their payments.
What would be the repercussions on SVB Financial Group, the parent company of SVB, in the event of a bankruptcy filing?
In the wake of SVB’s collapse on Friday, both the equity and debt prices of its parent company, SVB Financial Group, have taken a nosedive. The appointment of a restructuring committee and the hiring of advisors to explore strategic alternatives only add to the growing speculation of an impending bankruptcy filing by the parent entity. Such a filing, whether under Chapter 11 or Chapter 7 of the US Bankruptcy Code, would bring an immediate halt to all collection and litigation activities directed at Parent, and likely many of its affiliates, by virtue of the Code’s automatic stay provisions. An orderly process for the wind down and liquidation/monetization of the Parent’s assets would ensue, with the bankruptcy estate empowered to reject unperformed “executory” contracts and pursue “clawback” actions such as preferential transfers made on the eve of bankruptcy or fraudulent transfers made for less than reasonably equivalent value. However, the bankruptcy process may also lead to jurisdictional tension with the ongoing FDIC receivership process for SVB. Under section 365(o) of the Bankruptcy Code, the Parent would have continuing obligations to maintain SVB’s capital, and defaulting on such obligations could result in an administrative priority claim in Parent’s bankruptcy case.
What is the impact of SVB’s bankruptcy filing on other Chapter 11 proceedings in the US?
For the sake of America, we must consider the impact that SVB’s bankruptcy filing could have on other Chapter 11 bankruptcy proceedings in the United States. This is a matter of utmost importance, as it could set a precedent for how such proceedings are handled in the future.
The sound of shots echoed through the financial world as SVB, once an authorized depository bank for chapter 11 debtors, was disqualified from serving in that role. This leaves chapter 11 debtors with SVB deposits, including some cryptocurrency debtors, to face delays and obstacles in the administration of their ongoing cases. In the case of BlockFi, Inc., the U.S. Trustee wasted no time filing a motion on Friday afternoon claiming that approximately $227 million in deposits belonging to the debtors at SVB are uninsured. The motion requests that the court compel the debtors to comply with section 345 of the Bankruptcy Code by posting a bond in favor of the United States. The debtors, however, have refused the U.S. Trustee’s demands, claiming that the funds are invested in government securities and earning interest that is necessary for the case. The stakes are high and the outcome uncertain, as the fate of these chapter 11 debtors hangs in the balance.
What are some ways to manage risks and remedy concerns?
After the recent protective actions taken by Treasury and the Federal Reserve Board, we now find ourselves in an interim period where parties can contemplate how to safeguard their positions and prevent future risks in the event of insolvencies or failures of other institutions. For those evaluating their risk profile vis-à-vis their current depository institution, there are some pressing issues to consider:
- Is your depository bank’s risk profile similar to that of SVB, and if so, what can be done to protect deposit account balances that exceed FDIC insured limits?
- Should deposits that exceed the FDIC cap be invested in securities?
- Would changing your depository institution or cash management system impact existing credit agreement covenants that mandate maintaining deposit accounts with your lender institution?
- Should existing trust and fiduciary relationships be re-examined to ensure proper structuring and documentation?
- Can existing credit arrangements be enforced against existing lenders or moved to new lenders, depending on lender replacement provisions?
- How will these banking developments affect key customers, suppliers, vendors, and counterparties?
- Will these developments impact the ability to complete a capital call if limited partners hold their cash or credit facilities with SVB?
These are crucial considerations to address during this period of uncertainty, as the outcome of these decisions will have far-reaching consequences.
Potential Disclosure Issues for Public or Private Entities and/or Crypto Protocols Foundations:
Along with the considerations mentioned earlier, it’s crucial for public companies and other entities with publicly traded securities to contemplate the disclosure requirements triggered by the SVB situation and its aftermath. The disclosures that need to be made will depend on the particular effects of the situation on each company. Initially, some companies voluntarily disclosed their uninsured deposit circumstances or confirmed that they had no significant exposure to the uncertainties created by SVB. These disclosures were made to provide information to the marketplace or to avoid selective disclosure of material nonpublic information, as required by Regulation FD.
With all deposits now covered for SVB and Signature, companies are free to disclose the absence of exposure to loss, but such disclosure should not be viewed as necessary since it is generic and widely available. Nonetheless, this doesn’t mean that there may not be unique consequences of the recent bank failures that need to be considered for public disclosure, either as required disclosure or voluntary disclosure to inform investors and avoid selective disclosure and potential violations of Regulation FD.
For instance, adverse consequences of the failures may include credit lines becoming unavailable, resulting in liquidity problems, financings for announced transactions no longer being available and putting the transactions in jeopardy, and amendments to existing loan arrangements that were material and are now in question. Additionally, it’s essential to consider the potential consequences of crypto protocols and foundations losing access to their USDC, which could have a significant impact on their operations and financial stability. These are significant issues that must be addressed, and the stakes are high.
At what juncture does the FDIC exercise setoffs of loans against deposits?
As we witnessed during the infamous Great Recession, the availability of setoff is contingent upon an array of intricate legal points and timing matters, and hinges on the nature and timing of the pertinent debits and credits, as well as the terms of the underlying loan agreements and applicable laws. Determining whether and when to exercise setoff rights often hinges on whether the underlying loan with the borrower is performing or in default. In the event of delinquent loans, the FDIC’s directive stipulates that “the FDIC will ‘set off’ the loan against the borrower’s deposits (if any) before paying deposit insurance.” On the other hand, for performing loans, “the depositor may choose to ‘set off’ the loan against his/her deposits to receive full value for any uninsured funds (i.e., funds exceeding the $250,000 insurance limit).” It is important to note, however, that “no ‘offset’ is possible unless the obligations are ‘mutual’ – meaning that the borrower and the depositor must be the same person or legal entity acting in the same legal capacity.” This was a notable point of contention during the Lehman collapse and warrants careful deliberation when evaluating options.
What does this mean for Crypto and Digital Assets?
The recent bankruptcy of SVB and the subsequent fallout from its failure have raised significant regulatory and risk concerns for the crypto industry. SVB was a prominent bank in the crypto industry, with many companies and entities relying on its services to facilitate their operations. With its failure, the industry is left to grapple with the potential implications of losing access to key banking services, such as wire transfers, ACH transfers, and USDC.
From a regulatory standpoint, the crypto industry is already facing increased scrutiny and regulation from governments around the world. The recent events with SVB are likely to lead to further regulation and oversight, which could have a significant impact on the industry’s future. There is also the risk that the crypto industry could become a target for increased regulatory enforcement and penalties, which could have a chilling effect on innovation and growth.
From a risk standpoint, the SVB failure has highlighted the importance of risk management and mitigation strategies for the crypto industry. Companies and entities must be prepared for the potential loss of access to key banking services and have contingency plans in place to ensure their operations can continue uninterrupted. This could involve diversifying banking relationships, establishing alternative payment methods, and exploring decentralized financial solutions.
Overall, the implications of the SVB failure for the crypto industry are significant and far-reaching. The industry must navigate a changing regulatory landscape and adopt robust risk management strategies to ensure its continued success and growth. The key will be for companies and entities to work together to address these challenges and emerge stronger on the other side.
In the wake of the SVB failure, it’s worth noting that certain aspects of the crypto industry are decentralized and beyond the reach of traditional banking institutions. This decentralization is particularly significant when it comes to the property rights of individuals and businesses. The immutable nature of blockchain technology provides a secure and reliable way for individuals to assert ownership and control over their assets, without relying on traditional banking services.
Moreover, the importance of crypto for property rights extends far beyond the traditional financial system. The technology has the potential to revolutionize the way property rights are established and enforced across a range of industries, from real estate to intellectual property. By providing a secure and tamper-proof ledger of ownership and transactions, blockchain technology could help to reduce fraud, increase transparency, and empower individuals to assert greater control over their assets.
While the SVB failure has highlighted the risks and challenges facing the crypto industry, it’s important to recognize the enormous potential of this technology. As the industry continues to mature and evolve, it will be critical for regulators and businesses to work together to ensure that the benefits of crypto are realized while also mitigating the risks. Ultimately, the decentralized nature of crypto provides an optimistic vision for the future of property rights, one that emphasizes individual control and ownership over traditional banking institutions.
Summary & Offer to Help and Collaborate:
As ongoing volatility in the banking sector continues to shake us, and as companies and investors grapple with these significant events and the responses from Treasury and the Federal Reserve Board, it’s essential that we work together to monitor the situation as it evolves on a daily basis. Companies and investors must remain vigilant and consider the resulting disclosure and risk mitigation issues, obligations, and opportunities that arise. At Montague Law, our experienced and integrated restructuring, finance, and corporate teams are dedicated to monitoring these developments in real-time and working with our clients to develop appropriate responses, solutions, and plans of action.
We recognize the challenges that our clients may be facing in connection with these developments, and we stand ready to offer our support and guidance. Please do not hesitate to reach out to any member of our team to start a conversation. Together, we can navigate through these turbulent times and emerge stronger on the other side.