Avoiding The Devil's Triangle (of Bank Failure, part 3)
In the last post, I described the methods used by the FDIC to "resolve" banks. This post talks about what steps you can take if you are entering into a contract with a bank, and want to minimize your risk of having your deal pulled apart due to the bank's failure. Practical Steps to Take if you...
By Maura O'Connor|April 12, 2010 at 11:52 PM
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In the last post, I described the methods used by the FDIC to “resolve” banks. This post talks about what steps you can take if you are entering into a contract with a bank, and want to minimize your risk of having your deal pulled apart due to the bank’s failure. Practical Steps to Take if you are Making a Deal with a Bank that may be Failing Some kinds of deals have a reasonable chance of riding through a bank resolution. In packaging banks’ assets (including loans) for sale, regulators have discretion to favor and preserve assets they think are essential to the marketplace. The type of financial institution with which a company deals may matter also, because regulators can, and do, “play favorites” to ensure that their resolutions and bank closings do not excessively disrupt either geographic markets or market segments. In choosing which troubled banks to take over, and how to handle their receiverships and the ongoing deals those banks were involved in, the FDIC tries to keep some credit available to all creditworthy marketplaces. In documenting deals with a bank to minimize the risks of its failure, even the most careful attorney faces several handicaps. As discussed in the prior posts in this series, a bank is not likely to be able to provide timely reliable notification of its adverse or declining financial condition. So, many of the covenants, certificates or defaults typically used in deals by lawyers to create early warnings and remedies if one party is about to fail do not work well with regulated financial institutions. For this reason, if you are doing business with a bank, you usually will be best protected against receivership risk by economic, rather than contractual, deal structuring. To avoid being sucked into the morass of a bank receivership, first try to carefully select which bank you want to do business with, based on the market data you can find about that bank’s financial health. Large counterparties dealing with financial institutions frequently distribute their risk across banks, using such mundane approaches as syndicated loan commitments, letters of credit with “confirming banks” (additional banks with undertakings to pay), and other risk-diversifying options. Deal design may also play a role. Once a bank is near or in receivership, it is more likely that your deal with the bank will survive if it is a mutually positive transaction. A bank receiver who is rejecting “the bad parts” of deals is not as likely to repudiate or sever off a “good deal.” Together with your lawyers, you should watch for, and consider fixing, deal structures which put all of the bank’s obligations, or those most expensive or risky to the bank, at the end of a long timeline, such as interest rate resets, automatic extensions and certain unsecured credit funding commitments. If the bank’s obligations and your company’s obligations come due about the same time, or alternate, there’s much less risk to your company. If your company is entering into a contract with a bank, you need to work with your lawyer to protect your company in light of bank regulators’ power to reform or reject contracts and deals. If the bank fails, your company’s post-resolution fortunes may be influenced by variables, including:
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