Lending Law Report : Corporate Finance Lawyer & Attorney : Reed Smith Law Firm : Lending Transactions, Secured Investments

This post was written by Colleen McDonald, a partner in the Financial Industry Group here at Reed Smith.

The FDIC has given banks a temporary reprieve from the impact on their securitizations of the recent changes in GAAP, until March 31, 2010. By then, the FDIC has promised new securitization rules.

The FDIC has stated (pdf) that it will issue new rules for bank securitizations in December 2009, which rules will likely impose mandatory structural changes to bank securitizations including credit risk retention, increased disclosures to investors, and more flexibility for servicers of securitized debt. There will be a comment period before the revised rules go into effect, during which time interested parties will be invited to provide comments and feedback to the FDIC on the proposals.

The FDIC's action under the Interim Rule (Fed. Reg. Vol. 74. No. 220, Nov. 17, 2209) extends the current safe harbor for bank securitizations contained in the "Securitization Rule" (12 CFR 360.0) until March 31, 2010, thereby giving banks the ability to securitize without considering whether the recent GAAP accounting changes in FAS 166 and 167 (the "New GAAP Rules") affect their securitizations during the interim period. We've prepared a separate report on the content of these recent changes to GAAP.

Under the "Securitization Rule", the FDIC clarified its authority as receiver or conservator to reclaim as property of a bank any financial assets transferred by the bank in connection with a securitization did not apply to a sale which met all conditions for sale accounting treatment under GAAP. The New GAAP Rules may affect whether an issuing entity has to be consolidated on the bank's balance sheet for financial reporting purposes. Given the changes in the accounting treatment, securitizations would not likely meet all conditions for sale accounting treatment. As a result, the safe harbor provision of the Securitization Rule may not apply to the transfer.

The Interim Rule provides that for securitizations and participations for which transfers were made or interests were issued before March 31, 2010, the FDIC will not exercise its statutory authority and reclaim as property of the institution any transferred financial assets notwithstanding that such transfer does not satisfy all conditions for sale accounting treatment under the New GAAP Rules for reporting periods after November 15, 2009, if such transfer satisfied the conditions for sale accounting treatment set forth by GAAP in effect for reporting periods before November 15, 2009. The FDIC has requested comments on all aspects of the Interim Rule, which must be received by January 4, 2010.

Of course, not all issuers are banks. Non-depository institutions will continue to have to deal with the impact of the GAAP changes on their securitization structures.

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A new set of FASB rules may impact whether a securitization is treated as a "true sale" and whether companies with financial assets will have to consolidate their special purpose entities on their balance sheets.   For banks, the new rules may also mean that there will be additional capital requirements, to cover their conduits.  The Wall Street Journal has reported (subscription-based content) that the cost of securitization will likely go up as a result of this change, and that it could create a "logjam" in the securitization market, further slowing market recovery.  My partners Michael Brown and Colleen McDonald have written a report on the proposed changes -- if the securitization market affects you, you'll want to check it out.  

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In our prior posts on this topic, we focused on what your loan agreements might say about how to deal with a defaulting lender.  In this post,  we'll talk about what happens when a member of your bank group goes into default because it is taken over by the FDIC.  Special rules apply in that case.

Automatic Stay.  The Federal Deposit Insurance Act  provides for an "automatic stay" whenever a lender is taken over by the FDIC.  In part, the statute says that no one may "exercise any right or power to terminate, accelerate, or declare a default under any contract" that the failed institution is a party to, for a period of 90 days after appointment of the FDIC as receiver (45 days, if it is a conservatorship).  

My colleagues Colleen McDonald and Nikki Kolhoff have explained (pdf) that this means you can't do anything that would affect the contractual rights of the defaulting lender, if such action is based solely on the insolvency or FDIC takeover.  So, for example, you can still amend your loan documents, but you have to invite the defaulting lender to vote, and the amendment can't affect the rights of the defaulting lender without that lender's consent.  According to McDonald, the bottom line here is "if you are going to amend your loan agreement, make sure you do it correctly."  She points out that both the "D'Oench Dhume doctrine" (D'Oench, Duhme & Co. v. FDIC, 315 U.S. 447 (1942)) and 12 U.S.C. Section 1823(e) impose specific requirements on modifications of loans involving financial institutions taken over by the FDIC.  Contracts that don't meet the requirements can be avoided altogether by the FDIC - so it's worth taking the time to make sure those requirements are met.

In addition, even if the loan agreement would otherwise permit you to stop sharing payments with a defaulting lender, if the lender is taken over by the FDIC, you'll still have to share all principal and interest payments with it -- at least, to the extent of the obligations it has previously funded.  (As discussed in our prior post, the loan documents should ordinarily prohibit the defaulting lender from sharing in principal and interest payments relating to advances it did not fund.) 

As a practical matter, the automatic stay can create significant problems for a bank group, particularly if the defaulting lender is the administrative agent for the credit facility.  Since the agent manages the funding and payment processes, and often holds the borrower's bank accounts and controls other collateral for the loan, an FDIC takeover could bring everything to a halt - at least temporarily.  

McDonald recommends that to help protect against these problems, the loan agreement should include the right to declare the lender in default early -- before FDIC takeover.  This would allow the bank group to take action before the automatic stay kicks in.  For example, if the agent in a syndicated loan goes into default (pre-FDIC takeover), its rights as agent could be terminated and assigned to a successor, and all the collateral could be transferred to the new agent -- thus permitting the credit facility to function pretty much as usual through the FDIC takeover.  McDonald suggests including a definition of  "Impaired Agent" in the loan agreement that would include an agent that fails to make payments or fund loans required under the loan documents, or that rescinds or repudiates a loan document.

Exceptions.  There are other sections of the Federal Deposit Insurance Act that provide exceptions to the automatic stay, including an exception for when the FDIC as conservator/receiver fails to comply with otherwise enforceable provisions in the loan agreement.  Sometimes these exceptions can provide relief for the bank group, though their full effect is as yet untested.   I have a feeling we'll get the chance to test some of these provisions over the next few months.

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