The ongoing distressed bank environment has resulted in the failure of another institution and continues to generate turbulence, together with corresponding responses from the government and private sector. On May 1, 2023, the California Department of Financial Protection and Innovation (DFPI) closed First Republic Bank (First Republic), appointing the Federal Deposit Insurance Corporation (FDIC) as receiver. The FDIC sold the bank’s deposits and most of its assets to JPMorgan Chase Bank, N.A. (JPMC) in a negotiated transaction that concluded an auction process over the weekend. This appears to be the second largest bank failure in U.S. history, following just weeks after the March receiverships of Silicon Valley Bank (SVB) and Signature Bank of New York (Signature), which were at the time the second- and third-largest bank failures in U.S. history, respectively. The FDIC, Board of Governors of the Federal Reserve System (Federal Reserve), and Secretary of the Treasury made a systemic risk determination in the SVB and Signature receiverships, providing deposit insurance coverage for all deposits at these institutions (including those exceeding the FDIC deposit insurance limit, which would otherwise have been uninsured). A systemic risk determination was not made for First Republic because JPMC has assumed all of the deposit obligations of First Republic. In connection with the SVB and Signature receiverships, the FDIC also established two bridge banks — Silicon Valley Bridge Bank, N.A., and Signature Bridge Bank, N.A. — which assumed the deposits and certain obligations of the failed institutions, to help preserve the value of the businesses while the FDIC sought a buyer for each.
Since our last Sidley Update around the time the FDIC established the bridge banks, there have been several key developments that we describe in the sections below,1 including these:
- First Republic has been placed into receivership, with its deposits and most of its assets being purchased by JPMC. According to the FDIC, all depositors should have access to their funds beginning today, most borrowers should continue making payments as usual, and JPMC has acquired all qualified financial contracts of the former First Republic.
- The FDIC released additional guidance regarding the manner in which bridge banks generally operate and how the FDIC expects customers and counterparties to conduct business with bridge banks.
- The FDIC sold nearly all of the deposits and many of the loans of SVB and Signature, and the branches of both institutions have reopened under new ownership, while the FDIC has begun the process of selling the remaining assets of both institutions that were not included in those deals.
- On April 28, several U.S. governmental agencies publicly issued reports outlining their understanding of the causes of the SVB and Signature failures and how supervision and regulation may change in order to address those causes more broadly in the banking industry.
Failure of First Republic
On May 1, the DFPI closed First Republic, appointing the FDIC as receiver for the institution. The FDIC, as receiver, promptly sold First Republic’s deposits and most of its assets to JPMC. The closure of First Republic follows a first quarter earnings report released by the bank on Monday, April 24, disclosing that First Republic’s deposit base had shrunk from $176.43 billion in the fourth quarter to $104.47 billion (and to $103.9 billion as of April 13). This decline in deposits occurred despite a consortium of banks placing $30 billion in deposits at the bank during the quarter. Following precipitous declines in First Republic’s stock price, and media reports of ongoing withdrawals from the institution, further reports emerged on Friday, April 28, that the FDIC was in the process of marketing the institution to potential buyers, with the intention of facilitating a sale before markets reopened on Monday.
Public details regarding the terms of the transaction remain limited for the moment.2 Given that the FDIC was able to facilitate a sale of the institution with JPMC assuming all of First Republic’s deposits, the FDIC, Federal Reserve, and Secretary of the Treasury did not need to make a systemic risk determination to provide deposit insurance coverage in excess of $250,000 for First Republic depositors, as was done for the SVB and Signature failures. Federal law also generally prohibits interstate mergers if the acquiring company controls, or following the acquisition would control, more than 10% of the total amount of deposits of insured depository institutions in the United States. However, the statute includes an exception where the acquisition target is in danger of default.3
The FDIC has indicated that First Republic branches should reopen as JPMC branches, with no interruption in depositor access to funds held at the former First Republic. It will take additional time, however, for JPMC to integrate First Republic’s systems with its own. As such, deposits should initially be available through the existing First Republic branch network, with accessibility through JPMC branches to follow. The FDIC has further stated that all transferred deposits will be separately insured from any accounts a depositor may already have at JPMC for at least six months after the failure of First Republic up to an amount of $250,000 per entity, per capacity. Checks drawn on First Republic that did not clear before the closure will be honored as long as there are sufficient funds in the account.
The FDIC has also indicated that First Republic borrowers should continue making payments as usual and in accordance with the terms of their loans, while those whose loans are in process (or who had a line of credit) should contact their loan officer. The transfer of loans is being supported by a loss-share agreement entered into between the FDIC and JPMC covering certain single-family, residential, and commercial loans that JPMC purchased of the former First Republic. According to the FDIC, JPMC is also assuming all qualified financial contracts of First Republic. The FDIC has estimated that the Deposit Insurance Fund is likely to experience losses of approximately $13 billion in connection with the receivership and sale process, although the actual amount of losses will be determined by the FDIC at a later time. Unlike SVB, First Republic did not have a parent holding company, and as such, there will not be a parallel bankruptcy proceeding for a holding company.
Bridge Bank Legal Authority
For the SVB and Signature failures, the FDIC established a bridge bank for each institution, which it did not need to do with respect to First Republic. Prior to this, there had been no significant bridge banks established since the 2008 financial crisis. On March 14, the FDIC published a Financial Institution Letter4 addressing the treatment of contractual obligations between institutions in receivership and their counterparties when those contractual obligations are transferred to a bridge bank. Given the lack of bridge bank activity prior to the SVB and Signature failures, this was the first time we are aware of that the FDIC had addressed certain issues in this format and provided market participants with needed clarity.
Bridge banks are newly chartered national banks that are initially a shell until the FDIC exercises its power to selectively transfer certain assets and liabilities of failed institutions to them. The bridge banks are then operated as going concerns with the aim of preserving as much value from the failed bank’s business as is possible. Based on this guidance, as well as the subsequently released transfer agreements between the failed institutions and their bridge banks, it is clear that the FDIC (1) generally views counterparties as obligated to bridge banks in the same manner as they would be to a bank in receivership, (2) generally views its powers to enforce contracts with a bank in receivership as continuing once a contract has been transferred to a bridge bank, notwithstanding any limitations on transfers contained in such contracts, and (3) generally takes the view that bridge banks are similarly obligated to continue to perform under such contracts with counterparties.
Purchase and Assumption of SVB and Signature Deposits and Loan Portfolios
On March 19 and March 26, respectively, the FDIC announced the entry into purchase and assumption agreements, under which Flagstar Bank, N.A. (a subsidiary of New York Community Bancorp, Inc.) (Flagstar) would acquire substantially all of the deposits and certain loan portfolios of Signature, and First Citizens Bank & Trust Company (First Citizens) would acquire all the deposits and loans of SVB. The Flagstar acquisition of Signature excluded a number of categories of assets and liabilities, including all deposits related to Signature’s digital-asset banking business, cryptocurrency or digital assets and any loans secured therewith, certain residential real estate loans, commercial and non-owner-occupied real estate loans, acquisition, development, and construction loans, credit card loans, certain lending arrangements with private equity and venture capital firms, and all securities and qualified financial contracts. The First Citizens acquisition of SVB excluded different categories of assets and liabilities, given that First Citizens generally acquired SVB’s lending arrangements with private equity and venture capital firms, as well as SVB’s loan-related qualified financial contracts. The FDIC entered into a loss-share transaction with First Citizens with respect to certain purchased commercial loans, pursuant to which the FDIC will reimburse First Citizens for a portion of losses to the portfolio.
The FDIC received equity appreciation rights in the acquiring institutions in both transactions, and it is estimated that the cost of the bank failures to the FDIC’s Deposit Insurance Fund would be approximately $20 billion for SVB and $2.5 billion for Signature. These losses are expected to be recovered through a special assessment on all FDIC-insured banks.
Sale of Retained SVB and Signature Assets
On April 3 and April 5, respectively, the FDIC announced how it will conduct the sale process for both the Signature loan portfolio, which it retained and for the securities portfolios of both SVB and Signature.
The Signature loan portfolio — which is approximately $60 billion in size — comprises primarily commercial real estate loans, commercial loans, and a smaller pool of single-family residential loans. The commercial real estate loans include a concentration of multifamily properties, primarily located in New York City. The sale process is expected to occur during summer 2023, and the FDIC has retained an adviser on the sale. Prospective purchasers will need to be certified to bid, and it is expected that this loan portfolio may be pursued by a wide range of buyers, which could include nonbank investors. Additional information regarding the sale of the Signature loan portfolio may be found on the FDIC’s website,5 through one of the authors of this Sidley Update, or your regular Sidley contact.
The face value of the securities portfolios of Signature and SVB are approximately $27 billion and $87 billion, respectively, and consist primarily of agency mortgage-backed securities, collateralized mortgage obligations, and commercial mortgage-backed securities. The FDIC has retained a different adviser to conduct these sales. This process is expected to be gradual to account for and mitigate any potential adverse effects on market function. Additional information regarding the sale of the Signature and SVB securities portfolios may be found on the FDIC’s website,6 through one of the authors of this Sidley Update, or your regular Sidley contact.
Public Regulatory Reaction
Since the SVB and Signature failures and the general distress in the markets, several regulators have made public statements (including as part of testimony before Congress) regarding these events. Regulators have generally sought to project an image of strength and stability, seeking to calm potential market fears and shore up regional banks of similar size to SVB and Signature. In testimony before the Senate Committee on Banking, Housing, and Urban Affairs, FDIC Chairman Martin Gruenberg repeatedly flagged the “implications that banks with assets of $100 billion or more can have for financial stability,” noting that the “prudential regulation of these institutions merits additional attention, particularly with respect to capital, liquidity, and interest rate risk.”7 Treasury Secretary Janet Yellen delivered similar remarks, indicating at a conference that “[r]egulatory requirements have been loosened in recent years” and that she believes “it is appropriate to assess the impact of these deregulatory decisions and take any necessary actions in response.”8
On April 28, the Federal Reserve and FDIC released the results of formal reviews9 regarding the supervision and regulation of SVB10 and Signature.11 The Federal Reserve identified four key takeaways relating to the failure of SVB.
- First, the Federal Reserve asserted that that SVB’s board of directors and management failed to appropriately manage the bank’s risks, including with respect to the combined effects of rising interest rates and slowing technology sector activity.
- Second, the Federal Reserve indicated that its own supervisory staff did not fully appreciate the extent of SVB’s vulnerabilities as the bank grew in size (from $71 billion in assets in 2019 to over $211 billion in 2021) and complexity. It also did not appreciate the seriousness of alleged deficiencies relating to governance, liquidity, and interest rate risk management, which resulted in the bank’s remaining well rated despite these issues.
- Third, Federal Reserve supervisors, when these risks were identified, failed to take sufficient steps to ensure that SVB remediated these problems in a timely fashion. For example, the Federal Reserve identified certain issues with SVB, including regarding interest rate management, but did not issue supervisory findings on this point before the bank failed.
- Finally, the Federal Reserve indicated that its approach to tailoring its own regulations in the wake of the enactment of the 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) led to a less resilient institution (based on reduced capital and liquidity requirements) and slower supervisory action (in the name of both due process and reducing regulatory burdens on firms).
The FDIC identified a set of similar issues relating to the failure of Signature. With respect to the bank, the FDIC claimed that Signature was poorly managed and did not always heed examiner concerns or timely address FDIC supervisory recommendations. Moreover, the FDIC suggested that the bank pursued rapid growth without developing and maintaining risk management practices appropriate to the size, complexity, and risk profile of its expanded business. The FDIC also asserted that Signature was over-reliant on uninsured deposits and failed to understand the risk associated with its activities in the cryptocurrency space. With respect to the FDIC’s own practices, the report identified three key deficiencies.
- First, the FDIC failed to downgrade certain of Signature’s exam ratings as a result of the abovementioned alleged issues. Downgrading these ratings would have likely catalyzed closer scrutiny, including potential enforcement action.
- Second, the FDIC failed to timely communicate the results of examinations to Signature’s board and management. The report found that the FDIC had opportunities to engage more frequently with bank leadership and provide clearer, timelier messages regarding identified weaknesses and that it should have done so.
- Finally, the report indicated that staffing concerns resulted in the FDIC’s examination team being understaffed and thus less able to complete reviews in a quality or timely manner.
Regulatory and Legislative Responses
Regulators have not yet proposed any new rules directly and expressly responding to the failures of SVB, Signature, and First Republic. However, given the public statements of various U.S. federal banking regulators, it is reasonable to expect that there will be material changes sought in this space.
First, it is likely that regulators will move to finalize and implement certain existing aspects of their regulatory agendas intended to increase the resiliency of U.S. banking institutions. For example, in late 2022, the Federal Reserve and FDIC promulgated an Advance Notice of Proposed Rulemaking seeking comments regarding potential requirements to maintain an extra layer of loss-absorbing capacity at certain institutions with $250 billion or more in total assets that could assist with resolution of those institutions (the so-called TLAC rules). This would include a long-term debt component, which could be wiped out in a resolution scenario. In light of recent events, we expect that the Federal Reserve and FDIC will proceed to formally propose a version of this rule and eventually finalize it. It is possible that the final rule, if adopted, will take the broadest possible path contemplated under the initial proposal or may be tweaked even further to address some of the perceived causes of the current distressed bank environment. The Federal Reserve is also conducting a holistic review of the bank capital framework and has publicly suggested that it intends to move forward with rulemakings to implement additional capital requirements (the so-called Basel III Endgame) and to require use of multiple scenarios in stress testing.
Second, regulators are likely to adjust their current supervisory approach to be quicker, more forceful, and more agile where needed. Commentary accompanying the Federal Reserve report on the failure of SVB from Michael Barr, the Federal Reserve’s Vice Chair for Supervision, suggests that the Federal Reserve needs to improve continuity within its supervisory structure. That continuity would allow heightened regulatory and supervisory standards to be imposed with minimal transition periods as institutions grow. It also suggests that supervisors should be empowered to act in the face of uncertainty and should be willing to respond to issues in a variety of ways (including by imposing heightened capital and liquidity requirements, or limitations on dividends and executive compensation, even where the underlying issue needing remediation is not one primarily tied to capital or liquidity).
Finally, regulators are likely to propose additional rules. Vice Chair Barr indicated in his commentary that the Federal Reserve plans to revisit, to the extent legally permissible, certain supervisory and regulatory requirements that were reduced or eliminated as part of the regulatory “tailoring” process conducted following the enactment of the EGRRCPA for banks with $100 billion or more in assets. This may include changes to how the Federal Reserve
- supervises and regulates a bank’s management of interest rate risk and liquidity risk (including potential rulemaking to impose standard liquidity requirements on a greater number of institutions)
- structures capital requirements (including by requiring additional firms to take into account unrealized gains or losses on available-for-sale securities)
- applies its stress testing requirements (which could mean increasing the frequency of such testing and the number of firms these requirements apply to)
- imposes minimum standards for incentive compensation
As further strengthening of the regulatory regime in these areas may require legislation to amend the EGRRCPA, it is also possible that there will be a further legislative response to the crisis. Sidley’s Government Strategies team continues to monitor for any potential legislative action relating to the regulation of financial institutions as well as ongoing congressional oversight efforts.
1 We also note that on March 19, UBS announced that it had agreed to purchase Credit Suisse, which had been subject to certain well-publicized issues. Under Section 163(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, acquisitions by large bank holding companies and large companies regulated as bank holding companies (those with total consolidated assets of $250 billion or more) of any voting shares of certain companies that engage in nonbanking financial activities, such as the acquisition by UBS of the U.S. operations of the Credit Suisse business, require prior notice to and nonobjection from the Federal Reserve. The proposed acquisition by UBS of Credit Suisse received Federal Reserve approval under this framework on April 14, subject to compliance with certain additional commitments.
2 The purchase and assumption agreement governing the sale to JPMC is expected to be made publicly available in the coming days.
3 12 U.S.C. §§ 1831u(b)(2), (e).
9 The U.S. Government Accountability Office (GAO) and New York Department of Financial Services (NYDFS) also released reports on these failures on the same date. The GAO report provided the results of a preliminary review of regulatory agency actions relating to the SVB and Signature failures, noting that both SVB and Signature were slow to mitigate problems identified by the regulators, and that the regulators were slow to escalate supervisory concerns to regulatory action. See https://www.gao.gov/products/gao-23-106736. The NYDFS report is the agency’s internal review on the supervision and closure of Signature, in which the regulator claimed that the bank possessed an inadequate risk control framework, amongst other issues. See https://www.dfs.ny.gov/system/files/documents/2023/04/nydfs_internal_review_rpt_signature_bank_20230428.pdf.
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