Key Takeaways for Borrowers and Banks in the Wake of SVB and Signature Bank Failures

As outlined in our previous client alert relating to the current banking environment in the wake of SVB's failure and FDIC receivership, and notwithstanding the apparent stabilization of the banking industry and financial markets, it’s not over.  Discussions are ongoing at the Fed, U.S. Treasury and the White House on possible remedial actions to prevent further stress to the global banking industry, while efforts continue to combat rising inflation.

In the meantime, there is still some work to be done for both banks and their customers before we can entirely turn the page on this chapter. Below are checklists of key items for banks and borrowers to take into consideration now.

For Borrowers

1. Understand the risk profile of the bank, including the relationship between uninsured deposits and unrealized losses. If you are unsure where to look, Quarles can assist in obtaining the underlying information for you from the relevant government-filed reports.
2. Existing loan covenants may prohibit transferring cash to other banks. Although you may ultimately decide to transfer funds out of a bank that you consider unsafe, it is best to consult with counsel on this question. Other ways this prohibition can be addressed include:
   
   

   › Set up automatic sweeps of available cash to pay down the loan and reduce your uninsured deposit exposure at the same time;
   
   

   › Use available excess cash to invest in permitted instruments like securities, e.g., notes and bonds; and
   
   

   › Where the existing agreement does not permit transfers or investments, obtain written consent from the bank to transfer funds or use your cash to make investments.
   

3. Prepare for banks to tighten credit. When operating in a tighter credit environment, assess your ability to access new equity investments or other sources of funds, and to capital plan for your business with the idea that credit financing may not be as available as it has been, at least for a period of time. Where possible, you could decide to extend maturities on existing debt right now.
4. Expect interest rates to remain at current levels or increase, at least for as long as the Fed is raising rates. You should project how your business or household can perform with increased rates on your credit, and businesses. You could consider purchasing an interest rate hedge like a swap or collar that will mitigate the harshness of a rate rise on the debt you are paying. However, hedges may contain language tying the hedge to the existence of your underlying loan, which may affect your flexibility to refinance the underlying loan if/when rates fall.
5. Expect banks to exhibit increased wariness in the current situation. In the short term, increase your communication with your banker, especially with regard to any difficulties your business is experiencing, and deliver all required reporting to the bank under your loan agreement very timely.
6. Get good data, often available but not easy to obtain without expert help, and consult your attorneys on legal issues.

For Banks

1. Plan for the resources that you would tap into in the event of significant customer withdrawal demands, e.g., new Fed loan program (some narrowness of acceptable collateral), existing Fed programs, Fed Home Loan Bank advances, and timely new capital raising.
2. Plan for Asset and Liability Management to transition to higher interest rates in investment portfolio. Is your plan sufficient -and flexible enough- to accommodate an anticipated degree of rate uncertainty going forward?
3. Closely monitor the strength of bank counterparties to whom you extend credit (as unsecured lender, depositor, repo counterparty, swap counterparty, etc.), particularly in light of the most significant metrics in the current environment of unrealized investment losses and degree of uninsured deposit funding.
4. Consider if new capital is important to your institution and which form would have priority. Some ideas could involve acquisition partners, bringing on a new significant minority partner, or public and private underwritten offerings for larger institutions.
5. Understand the deposit insurance characteristics of your institution. This includes a thorough understanding of what is covered and what is not, which can be a complex question especially in cases of affiliated parties having separate deposit accounts. Also consider what exactly are the  insured deposits, including accounts where some of the assets are insured but others may not be.
6. Again, get good data, often available but not easy to obtain without expert help, and consult your attorney on legal issues.

Quarles continues to monitor and share updates on the banking industry as events unfold. For additional insights or guidance relative to your specific business needs, please contact your Quarles attorney or:

• Jim Kaplan: 312-715-5028 / jim.kaplan@quarles.com
• Kim Wynn: 414-277-5377 / kim.wynn@quarles.com

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