FDIC Chairman Martin Gruenberg said on Sunday that until the orderly failure of “systemically important financial institutions” is managed, skepticism over the ability of regulators to “impose the consequences of failure” on shareholders and creditors will remain.
“I would note, however, recent indications by rating agencies of the possibility of downgrades of some of these companies because of a reduced expectation of public support in the event of failure are a promising sign,” Gruenberg said before the Volcker Alliance Program.
The Dodd-Frank Act provided regulators with new authority to oversee and wind down a failing financial institution that could pose a risk to the financial system, in the event that no viable private-sector alternative is available.
“We have, I believe, developed a viable strategy, the Single Point of Entry, under which the FDIC would take control of the parent holding company, allowing the firm’s operating subsidiaries, domestic and foreign, to remain open and operating, diminishing contagion effects while removing culpable management and imposing losses on shareholders and unsecured creditors with no cost to the taxpayer,” Gruenberg said.
Gruenberg discussed how the process would work after the FDIC places the holding company into receivership and establishes a bridge financial holding company, into which it would transfer assets from the receivership.
“The newly formed bridge financial holding company would continue to provide the holding company functions of the failed parent,” Gruenberg said. “The company’s subsidiaries would remain open and operating, allowing them to continue critical operations and avoid the disruption that would otherwise accompany their closings.”
The Dodd-Frank Act prohibits the company from retaining officers and directors responsible for the failure, and replacements would be found. Gruenberg said the FDIC would appoint a board and nominate a new CEO and other managers from the private sector as replacements.
During the restructuring process, Gruenberg said measures would be taken to address the problems that contributed to the institution’s failure, including changes in the company’s businesses, the break-up of the institution and the liquidation of certain subsidiaries.
“From the outset, the bridge financial company would be created by transferring sufficient assets from the receivership to ensure that the bridge company is well-capitalized,” Gruenberg said. “The well-capitalized bridge financial company should be able to fund its ordinary operations through customary private market sources. The FDIC’s explicit objective is to ensure that the bridge financial company can secure private sector funding as soon as possible after it is established.”
The FDIC is also responsible for managing the Orderly Liquidation Fund established under Dodd-Frank. The proceeds of obligations issued by the Treasury would serve as a liquidity back-up. Gruenberg said the FDIC estimates that OLF borrowings would be issued in limited amounts for a brief time period and would be repaid promptly after access to private funding resumes.
Losses would be calculated during the bridge holding company’s operation as the assets are put to market. The losses would be apportioned according to the order of priority among the claims of former shareholders and unsecured creditors.
“The FDIC’s objective is to limit the time during which the failed SIFI is under public control and expects the bridge financial company to be ready to execute its debt for equity exchange within six to nine months,” Gruenberg said. “Execution of this exchange will result in termination of the bridge financial company’s charter and establishment of one or more new, well capitalized companies under private ownership and management.”