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FDIC revisits contracts of failed financial firms

by Ira Teinowitz in Washington | Published March 20, 2012 at 4:55 PM

The Federal Deposit Insurance Corp. Tuesday, March 20, proposed to clarify how an orderly liquidation authority of a financial holding company would affect contracts of a subsidiary.

The FDIC separately also unveiled a revised formula for measuring the risk factors used to determine individual bank assessments to support its deposit insurance fund.

In a notice of proposed rulemaking, the FDIC sought to clear up confusion about one element of the receivership process, which the Dodd-Frank Act created as an alternative to bankruptcy for large systemically important financial institutions.

One way the process differs is that in a traditional bankruptcy open contracts usually are cancelled. There has been criticism that the result would hurt already financially stressed companies, which may have to close out the contracts at fire sale prices.

The resolution process the FDIC is proposing instead would allow big financial institutions to follow the same model the FDIC uses for banks and other insured depository institutions that fail: The FDIC can either cancel contracts or keep them open either in receivership or in a bridge company, depending on which approach results in the lowest cost to taxpayers.

FDIC officials said Tuesday that the new rule is intended to address situations in which the FDIC takes over a parent holding company, but lets some or all of the failed company's operating subsidiaries continue to operate.

Often those operating subsidiaries have contracts -- for instance for data processing -- making the parent ultimately responsible for payment. Under bankruptcy, financial failure of the parent can result in cancellation of the contract.

The proposed rulemaking would allow the FDIC authority to maintain the subsidiary's contracts, even if the subsidiary itself wasn't part of the receivership process.

Under the proposal, the FDIC would have to issue a notice of its intention within one business day of taking over a holding company, but could do so by a notice on its website.

The FDIC is seeking comment on the proposal.

In a second notice of proposed rulemaking, the FDIC addressed for the third time concerns about its original method of allocating how much individual big banks must contribute to the deposit fund. The allocations are based on an analysis of the riskiness of each institution's loan profile. The allocation rules cover the 107 banks with more than $10 billion in assets.

The banking industry had complained that the FDIC's previous attempt to more closely tie the payments to risk was unworkable because banks would have had to use statistical information from customers that banks don't commonly collect.

FDIC officials said the new method measures similar risks -- high levels of subprime loans, the amount of higher-risk commercial and securities loans securitizations and other high-risk loans. But they said the new method uses commonly tracked indicators to make the assessments. The FDIC also exempted commercial loans of under $5 million from the higher-risk commercial loan category.

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