How the FDIC's Big-Bank Resolution Strategy Has Evolved

WASHINGTON — Almost two years after the Federal Deposit Insurance Corp. unveiled a strategy for how it would unwind a failed behemoth, the agency's thinking has evolved in ways that could have a significant impact on how firms are cleaned up in a crisis.

A paper released in late 2013 detailed how the agency plans to use a "single point of entry" approach, which envisions the agency seizing and closing a parent company while keeping certain subsidiaries open. But critics argued such a method could be seen as a bailout.

Since then, FDIC officials have increasingly talked about subsidiaries vanishing too and about what kind of company exits the process. While those steps were discussed earlier, the agency is now even more focused on post-resolution operations looking nothing like the old firm.

Some former officials point to an evolving approach. But some observers also say stakeholders may have hastily accepted the 2013 paper as gospel, when in reality the strategy document was meant to be a starting point for further development. The process has also been aided by banks' own resolution war-gaming, known as "living wills."

"I don't want to say the FDIC hasn't continued to evolve its thinking, because I know it absolutely has. But I do think the initial reaction to [the paper] … was a little different than what was intended," said Robert Burns, a director in Deloitte's advisory practice and former deputy director in the FDIC's complex financial institutions group, which oversees the resolution planning. "It wasn't intended to be the end-all, be-all solution."

Failure Followed by a 'NewCo'
The FDIC was empowered through Title II of the Dodd-Frank Act to manage huge failures, an arduous task. The agency must handle resolutions delicately, preserving some functions to calm the market. But it must also ensure the firm really fails, managers are held responsible and it is not merely reincarnated with FDIC help.

The agency began focusing on "single point of entry" in public statements to accomplish those goals before the 2013 paper. The approach provides a path to resolution through a single door: the holding company. The parent is closed, its shareholders wiped out and culpable management fired. But to limit the resolution's effect on markets, certain subsidiaries are preserved, held under a bridge structure managed by the FDIC. Unsecured creditors of the old firm would have claims converted into stock to provide a capital base.

The 2013 strategy paper discussed subsidiaries with huge losses also going into receivership and provided a description for how a new holding company — or set of holding companies — is created. Operations of the old firm would be restructured to simplify and shrink whatever venture or ventures resulted. In the FDIC's strategy paper, a resulting firm is referred as a "NewCo." Other discussions have also included mention of activities that are spun off or divested separately as "SpinCos."

But observers say the document represented just the early stage of discussions about that restructuring and the emergence of any successor firms. Since then, the agency has focused more on details of the post-bridge. Aided by livings wills, which were required under Title I of Dodd-Frank, some recent discussions have included assumptions about how different classes of subsidiaries would suffer different fates. A broker-dealer, for example, is presumed to be wound down organically, while others would be sold off.

"It seems that the way the FDIC talks about it [now], there is much greater emphasis on restructuring of the firm," said John Simonson, another former director in the FDIC's Office of Complex Financial Institutions and now a partner in the financial services regulatory practice for Pricewaterhouse Coopers LLP.

"There was that emphasis in the paper," but "the FDIC has over the course of the last year and a half seemed to take that a step further and has talked a lot now about the need for post-failure restructuring of the bank. Now, what is the framework for that restructuring, how would any such restructuring be determined, how would it be executed? I think those seem to be still very open questions."

James Wigand, a former director of the agency's OCFI and now a managing director at Millstein & Co., said having some privately-owned entity come out of the resolution is still a likely scenario. "They're not talking about the bridge vanishing into thin air … The 'spincos' would be the divested business lines or entities that get spun off separately," he said.

Wigand said ensuring that the emerging firm or firms that come out of the process are simple enough to be resolved through bankruptcy "was already part of the framework" as early as 2011. "But what that meant wasn't really defined."

"The FDIC is trying to make clear that what goes into the process is not what comes out of the process. … There has been more emphasis on that distinction and more thinking dedicated to: What does that mean?" he said.

More than One Option
The 2013 paper got mixed reviews. Large banks hailed "single point of entry" as proving mammoth institutions could fail without wrecking the economy. But concerns were raised by some, including two members of the FDIC's board, about subsidiaries of large firms having a competitive edge from the assumption they would be preserved.

While the paper laid out a scenario of shareholders getting nothing and managers getting fired, others worried about the perception from the creation of a new private company exiting the resolution. Former Federal Reserve Board Chairman Paul Volcker, who praised the FDIC's work generally, said at an agency advisory committee in 2013 that a "disadvantage" of single point of entry is "it looks like the whole company is being protected in some sense."

Since then, the FDIC has appeared to focus even more intensely on firms coming out of the resolution process being much narrower in purpose than the original company that failed. For example, a May speech by FDIC Chairman Martin Gruenberg providing an update on the agency's work left out mention of any new company emerging. He said the "resolution process would end with the termination of the bridge financial company."

"The change in how the FDIC talks about their approach does seem to be in response to observations like" those of "Paul Volcker. There were similar observations from certain congressmen as well," said Simonson. "Marty Gruenberg's speech in May definitely appeared to have an evolving view of a much more substantial restructuring and shrinking of the firm post-receivership."

Burns said the FDIC has gained "optionality" during the planning stages. He said the 2013 paper "described a strategy that the FDIC wanted to put forth for discussion that could be used," but "it certainly didn't indicate that it was the only strategy the FDIC would consider."

Under Title I of Dodd-Frank, big banks must prove how they could be unwound through a traditional bankruptcy. But the resolution plans also are seen as a resource for the FDIC if the agency must step in when a bankruptcy is seen as having potential systemic harm.

Those plans may be giving the FDIC greater confidence that subsidiaries could be closed without disastrous effects on the economy, Burns said.

"The agency might consider more of a multiple-points-of-entry strategy where they save certain operating subsidiaries in order to minimize the systemic impact of the firm's overall collapse, but certain subsidiaries that were the cause of the problem or their problems were so severe they may let other subsidiaries go through an alternative resolution approach," he said.

"The key here is to have optionality and alternatives. SPOE is one option. There could be others. It would be hard for an agency to say on the front end: 'This is what we would do with a firm no matter how it failed.'"

In an emailed statement responding to questions for this article, an FDIC spokeswoman indicated that single-point-of-entry continues to be a focus, but the agency does have other tools it could choose to deploy.

"Single-point-of-entry is an essential strategy should the FDIC be called upon to wind down and liquidate a systemically important financial institution," said Barbara Hagenbaugh, who heads the agency's office of communications. "In addition, the FDIC is reviewing institutions' resolution plans and reviewing firms' progress toward resolvability, including actions that promote separability of material entities. Such separability could increase the range of options available in resolution."

Expected Outcomes
While the FDIC is expected to be careful about revealing details of its plans, officials have signaled what they believe would happen in cases where subsidiaries would not be preserved.

At a 2014 meeting of the FDIC's systemic resolution advisory committee, officials described some of their assumptions. For example, a firm's broker-dealer would "self-liquidate" as a result of clients switching to other institutions, other subsidiaries would be sold off to acquirers and the firm's depository institution could be shrunk. Those outcomes tend to correspond with what some of the largest institutions have described in their living wills.

At a broker dealer, "it would be very difficult to hold the talent and the counterparties would voluntarily leave," Herbert Held, who runs the OCFI's systemic resolution and planning implementation branch, said at the 2014 meeting. "If they hadn't left before the intervention, they would be leaving very quickly and moving their business to other institutions."

Speaking at the same meeting, Gruenberg said whatever firm comes out of the process would be "narrower."

"It's our expectation under the Title II scenario that you will see an orderly liquidation of the wholesale broker dealers, the selling off of other subsidiaries that will retain some market value and a likely shrinkage of the insured depository itself, so that if there is any surviving entity coming out of this it will be a dramatically smaller and narrower entity without the systemic ramifications of the entity that entered the process," he said. "That is both the likely outcome and frankly our objective."

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