The Federal Deposit Insurance Corporation's (FDIC) elaboration of its plan to unwind failing banks has further clarified and reinforced the trend to remove federal support from U.S. banks. Fitch had previously downgraded U.S. support ratings based on the FDIC's proposed strategy. In a speech Thursday, FDIC chairman Martin Gruenberg added clarity on tools the FDIC has at its disposal to successfully handle its responsibility for the orderly resolution of large and complex banking companies.
The FDIC's proposed dismantling process includes receivership of the financial institution and the transfer of some assets and liabilities to a bridge holding company. Gruenberg said the bridge would allow the bank's subsidiaries that were equity solvent to remain open and operate as going-concern counterparties. With that, the FDIC would expect qualified financial contracts to function normally, preserving the franchise value of the firm. Debt from the parent company would be converted to equity to capitalize the bridge. Gruenberg added that debt holders would be given equity in the new entity, but the financial institution's original equity holders would likely be wiped out.
We maintain our view that the FDIC framework is workable for large domestic financial institutions. Should a purely domestic institution fall under Orderly Liquidation Authority (OLA), the FDIC will impose losses on creditors in accordance with their expected treatment under a Chapter 7 bankruptcy, which includes major losses absorbed by bondholders. The bridge holding company framework is one that Fitch would expect the FDIC to regularly consider as an option for resolving a large complex bank.
Still, while the FDIC plan is designed to limit systemic risk and provide clear expectations for all stakeholders, we believe the execution of OLA could produce contagion risk. Repercussions could include, but are not limited to, losses for senior creditors, which could in turn raise the cost of funds for all U.S. banks.
We also note the process would become increasingly complicated when and if applied to an internationally active bank. Application could potentially lead to disputes with foreign regulators or private litigation regarding treatment of various claims. In that instance, greater harmonization and cooperation would be necessary to make such efforts "orderly."
We maintain our view that the FDIC can and will use its authority should another financial crisis occur but note that heightened supervision and regulatory reform add to the lowered likelihood of extreme cases and provide greater clarity as to how situations will be handled by the regulatory authorities.
For more information, including perspectives on regulatory frameworks, see "U.S. Banks --Sovereign Support: When Does It End ," dated Dec. 16, 2011, at www.fitchratings.com.
Additional information is available on www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
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U.S. Banks -- Sovereign Support: When Does it End -- Amended
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