The seizure of Silicon Valley Bank's (SVB) assets on Friday, March 10, 2023 and Signature Bank's assets on Sunday, March 12, 2023, marked the second and third largest bank failures in American history, respectively. Though SVB's collapse can be attributed to a number of factors, such as increasing interest rates and concentrated risk exposure, the final blow to the bank came in the form of an old-fashioned run on deposits. Investors were unnerved by the speed of SVB's collapse, prompting a similar run on Signature Bank's deposits. In an effort to restore confidence in the financial system, regulators took swift action which included, among other things, the creation of "bridge banks" for each institution (discussed in more detail below). While many macro insights can be gleaned from these incidents, less attention has been placed on the particular consequences for borrowers or co-lenders participating in syndicated credit facilities involving a collapsed bank.
Background
Founded in San Jose, California in 1983, SVB grew to become the 16th-largest bank in the United States at the time of its collapse. SVB built its business, in large part, by establishing lending and depository relationships in the venture capital and private equity spaces, industries that often do not match more traditional banks' preferred risk profile. In the past four years, SVB thrived on substantial increases in investor liquidity, allowing it to grow its deposit base from just over $60 billion in 2019 to over $170 billion by the end of Q4 of 2022.
The Federal Reserve's recent decisions to increase interest rates in an attempt to combat inflation slowly created a problem for SVB. Higher borrowing costs resulted in a slowdown of venture capital activity. At the same time, SVB's holdings of treasury securities experienced sharp pricing decline, given the higher interest rate environment. SVB's internal crises accelerated rapidly when it announced on March 8th that it had incurred a $1.8 billion loss from a sale of fixed-income securities and was in need of fresh capital. Upon hearing this news, several venture capital firms advised their portfolio companies to withdraw their deposits from SVB. Before trading was halted on the morning of March 10th, shares of SVB, which were already down 60% from the day before, had lost an additional 65% of their value. When the dust settled, SVB's customers had withdrawn over $42 billion of deposits and the bank was posting a negative cash balance of over $950 million.
Following SVB's collapse, Signature Bank, a New York-based institution known for its willingness to do business with crypto and digital asset customers, suffered its own run on deposits. On March 10, 2023, Signature Bank's customers, spooked by the SVB news, withdrew more than $10 billion in deposits. Signature Bank's executives described the bank run as "purely contagion" from SVB, as they had no prior indications of any problems.
Regulators' Actions
Given SVB's and Signature Bank's sudden insolvency and inadequate liquidity, the Federal Deposit Insurance Corporation (FDIC) was promptly appointed as receiver over both banks' assets. In its capacity as a receiver, the FDIC acts much like a Chapter 7 bankruptcy trustee, with the goal of maximizing recovery for the bank's creditors (namely depositors) in as efficient a manner as possible. At a high level, such an operation involves the disposition of bank assets and the pursuit of any claims available to the bank.
Following an initial announcement that only FDIC-insured funds (up to $250,000) would be immediately available to depositors, on the evening of March 12, 2023, the Department of the Treasury, the Board of Governors of the Federal Reserve System and the FDIC issued a joint statement that SVB depositors would have access to all their money as of March 13, 2023. Similarly, the FDIC has assured depositors with Signature Bank that they will be made whole.
The FDIC has already begun seeking bids for the purchase of SVB as an enterprise, with the hope of finding buyers for both institutions' assets as soon as possible. However, given the size of these banks, there is a relatively small pool of potential single-institution buyers for the loan portfolios. In the event that the FDIC is unable to sell the banks as entire enterprises, the FDIC would likely explore sales of bank assets in a piecemeal fashion.
SVB's and Signature Bank's sudden collapses have sparked a flurry of questions from borrowers and lenders alike. While depositors are understandably concerned about recovering their funds from these institutions, lenders too are facing sudden uncertainty. Chief among lenders' concerns is the effect of collapses on syndicated loan facilities in which these banks were a participant, bringing to light an important discussion regarding the mechanics and importance of strong "defaulting lender" provisions in credit agreements for syndicated loan facilities.
Questions Around "Defaulting Lender" Status
Defaulting lender provisions are now customary in U.S. syndicated credit agreements as a protection against lenders who fail to perform their funding commitments or otherwise default. Defaulting lender provisions became commonplace as a result of the 2008 financial crisis, which resulted in the bankruptcy of numerous financial institutions. Such provisions are especially prevalent in multi-lender financing agreements, particularly those with revolving or delayed-draw credit facilities. Most major American banks follow the defaulting lender provisions set forth in the Model Credit Agreement Provisions published by the Loan Syndications and Trading Association (LSTA). While defaulting lender provisions are an important consideration for borrowers, such provisions are critical for the administrative agent and bank group as well. Defaulting lender provisions establish rules and procedures for the treatment of commitments and payments to defaulting lenders which alleviate some of the disorder that arises when a bank-group lender defaults.
The Bridge Banks Are Not "Defaulting Lenders" According to the FDIC
As of March 13, 2023, the former assets of SVB were transferred to newly-formed Silicon Valley Bank, N.A. and the former assets of Signature Bank to newly-formed Signature Bridge Bank, N.A. (collectively, the "Bridge Banks"). The intent of the Bridge Banks is for the respective bank assets and businesses to continue to operate in the ordinary course in order to preserve enterprise value, which, in turn, should allow maximum market value to be realized in an eventual sale of the failed banks' assets.
The FDIC, through recent market commentary and guidance, has made it clear that it does not view the Bridge Banks as "Defaulting Lenders," as that term is customarily used in credit agreements of syndicated loans; nor does the FDIC view the Bridge Banks as being in "default" solely on account of "bankruptcy/receivership/insolvency" type default provisions contained in other loan agreements or qualified financial contracts, including traditional hedging agreements documented on International Swaps and Derivatives Association (ISDA) forms. The reason for this position is twofold. First, and one which will resonate with bankruptcy practitioners, the Federal Deposit Insurance Act contains anti- "ipso-facto" provisions which essentially render unenforceable contractual provisions in loan documents that would otherwise create an automatic default upon insolvency, receivership or conservatorship of a depository institution.1 Second, although FDIC receivership facilitated the transfer of assets into, and the formation of, the Bridge Banks, as chartered national banks, the Bridge Banks are not operating under FDIC receivership, according to the FDIC. As a result, absent some independent grounds for default (i.e., defaults based on non-performance), the Bridge Banks will expect counterparties to continue to perform; and counterparties, therefore, should expect performance from the Bridge Banks, notwithstanding contractual provisions which would otherwise deem FDIC receivership an automatic default.
Footnote
1. See 12 U.S.C. §1821(e)(13)(A).
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