In the News - Banking Industry Turmoil
- On March 10, 2023, the California Department of Financial Protection and Innovation closed Silicon Valley Bank (SVB) and appointed the Federal Deposit Insurance Corporation (FDIC) as receiver after SVB’s ill-fated capital raise attempt was made public and depositors made a run on SVB. Subsequently, the New York Department of Financial Services took possession of Signature Bank, which was also put under receivership with the FDIC. After a weekend of scrambling by depositors, borrowers, private equity and venture capital investors, law firms and other interested parties, the FDIC, the Department of Treasury and the Federal Reserve jointly announced that all deposits at SVB and Signature Bank (even beyond the $250,000 insured FDIC deposits) would be available the following Monday, March 13th.
- The FDIC then created a bridge bank — a temporary national bank chartered by the Office of the Comptroller of the Currency and organized by the FDIC to take over and maintain banking services for the customers of a failed bank — for each failed institution: Silicon Valley Bridge Bank, N.A. (SVBB), and Signature Bridge Bank, N.A. (SBB), which assumed all deposits and obligations of SVB and Signature Bank, respectively. At the time, the FDIC stated in no uncertain terms that it expected all contractual counterparties and vendors to fulfill their contractual obligations (e.g., loan agreements) and that the bridge banks were fully operational and open for business. For borrowers who previously had credit facilities with SVB or Signature Bank, this meant that such borrowers had full access to their lines of credit, letter of credit beneficiaries could take comfort that their obligations would be honored, and existing relationship managers for each institution were available to discuss any waivers needed for breaches or defaults that resulted from borrowers moving cash to other banks in apparent contravention of loan agreement cash management covenants, all through SVBB or SBB, as applicable. The new CEO of SVBB, Tim Mayopoulos (former CEO of Fannie Mae post-financial crisis), held multiple calls for SVBB’s customers to reassure them and reiterate that SVBB was fully operational and open for business, including new business.
- On March 19, 2023, New York Community Bancorp agreed to acquire certain of Signature Bank’s assets, including a $13 billion loan portfolio and substantially all of its deposits, though the FDIC retained $575 million of liabilities in respect of subordinated notes issued by Signature Bank. In addition, approximately $60 billion in loans made by Signature Bank — primarily relating to Signature Bank’s legacy fund banking business — will remain in FDIC receivership for later disposition by the FDIC.
- On March 17, 2023, SVB’s holding company, SVB Financial Group, filed for Chapter 11 protection. The interconnectedness of SVB, the failed bank taken over by the FDIC and sold to First Citizens, and other business units of SVB Financial Group, including SVB Capital and SVB Securities, creates a challenging set of facts for the administration of the bankruptcy case.
- Meanwhile, these events shook the markets with rippling effects globally, resulting in huge losses in the stock market, particularly for regional U.S. banks. HSBC bought the UK branch of SVB in a deal facilitated by the Bank of England. First Republic Bank received a $30 billion capital infusion from 11 large banks after huge losses in its stock and downgrades to “junk” status by Fitch Ratings and S&P Global. As another example of a regional bank responding to the increased pressure from customer withdrawals, Pacific Western Bank announced that 20% of customer deposits had been withdrawn as of March 22, 2023 and that it had raised $1.4 billion in cash from Atlas SP Partners and borrowed approximately $15 billion from federal programs.
- In Europe, as a precursor to its takeover by UBS, 167-year old Credit Suisse sought more than $50 billion in rescue funds from the Swiss National Bank after its largest shareholder, Saudi National Bank, said it would not put more money into Credit Suisse. While the initial market reaction to the news of the rescue funds was positive, Credit Suisse could not survive what FINMA, Switzerland’s financial regulator, called a “crisis of confidence”, and on March 19, 2023, UBS agreed to buy Credit Suisse for a mere $3 billion (less than half of the company’s last traded market value the previous Friday) in a deal promoted by the Swiss National Bank and other regulators to avoid a protracted bankruptcy. As part of the UBS takeover, $17 billion of “Additional Tier 1” (AT1) bonds were wiped out by Swiss regulators in favor of certain equity holders thereby overturning customary market expectations as to the priority of debt over equity. FINMA defended the action by pointing to a contractual provision in the issuance prospectuses stating that the AT1s can be written down to zero in certain circumstances, and also pointing to the federal ordinance enacted by the Federal Council that authorized FINMA to order the write-down. Nevertheless, the actions resulted in additional volatility in the European markets and prompted the bondholders to consider litigation challenging the action.
- As the shockwaves of the SVB failure continue to reverberate through the financial world, the U.S. Justice Department and the Securities and Exchange Commission (SEC) have announced investigations into the collapse of SVB and shareholders have filed lawsuits against SVB’s parent company and former top executives.
- Early last week, the FDIC announced that First Citizens Bank, one of the largest U.S. regional banks, will acquire all of SVBB’s deposits and a $72 billion loan portfolio (which are substantially all loans held by SVBB) at a discount of $16.5 billion. Approximately $90 billion of SVB’s owned securities will remain in receivership. Of note, the FDIC and First Citizens have a loss-sharing agreement relating to losses on the loan portfolio over $5 billion and the FDIC also acquired equity in First Citizens to share in the possible upside of the transaction.
In Other News
- The Federal Reserve raised its benchmark rate by 25 bps on March 22, 2023 and signaled that it would slow or end future increases if credit conditions tighten as a result of recent events in the banking sector. Following the Fed’s lead, the Bank of England raised its benchmark rate by 25 bps as well. The Swiss National Bank raised its rate by 50 bps, despite market stress relating to Credit Suisse and its takeover by UBS. On March 16, 2023, the European Central Bank also raised rates by 50 bps.
- In the broadly syndicated loan market, pricing flex shifted in March to be even between borrowers and lenders (which is a change from February’s borrower-leaning pricing flex), and the average clearing spread for single-B new issuances increased to S+544 (up from S+499 in February). Syndicated loan issuance picked up in February thanks to opportunistic refinancings, extensions and add-ons, and SOFR transitions increased given the impending USD LIBOR cessation at the end of June 2023. Of the 23 SOFR transitions tracked by LFI in February, 15 had a flat 10 bps credit spread adjustment (CSA), four amendments were blocked by lenders, and nine didn’t require any lender consent (all of which offered the flat 10 bps CSA). Amend-and-extend volume has been healthy so far this year, with a larger mix of term loan A structures and institutional loans. Bloomberg also reports an uptick in private equity firms using leveraged loans to pay dividends through dividend recapitalizations so far in 2023.
- Mezzanine debt (e.g., second lien or subordinated debt) is expected to make a comeback as senior private credit lenders who borrowers previously relied on for senior debt facilities or blended-rate debt in the form of unitranche facilities are turning more cautious. Mezzanine debt is increasingly attractive to borrowers in the current market as they seek to raise additional capital without diluting equity or tripping an MFN pricing protection on their senior facilities and as DDTL capacity is used up. Further, PIK options may be easier to come by in mezzanine debt. There is ample dry powder in the mezzanine ecosystem after healthy capital raising in 2022.
- In other alternatives to senior secured credit facilities, borrowers continue to weather the storm of higher interest rates and general stress in the credit markets by turning to flexible financing arrangements (in many cases from special opportunities funds), including PIK interest options for new and existing loans, preferred equity, “holdco” PIK notes, and “silent" second-lien loans. On the investor side, in an effort to re-balance portfolios to reduce exposure to “risk assets” like leveraged loans and high-yield bonds, there has been increased demand for dividend stocks, which performed relatively well as interest rates rose in the last year.
- Even prior to the recent banking dislocation, traditional money-center banks had pulled back from providing buyout loans after being stuck with “hung” buyout loans in 2022, creating an opening for private credit to further step in to provide larger loans than such direct lenders had historically provided. As one example, Apollo, Ares and Blackstone (among others) are on track to provide a $5.5 billion unitranche loan backing Carlyle’s acquisition of a 50% stake in Cotiviti, a healthcare analytics company, which would be the largest direct loan on record if the deal goes through. Significantly, the borrower may be able to PIK up to 50% of the interest on the loan.
- On March 9, 2023, the United States Court of Appeals for the Second Circuit heard arguments in a case that will decide whether syndicated term loans are securities subject to federal and state securities laws. Treating syndicated loans as securities would fly in the face of decades of treatment of the now $1.4 trillion syndicated loan market. The Loan Syndications and Trading Association said that a ruling that loans are securities would be an existential threat to the loan market.
- Quick roundup of recent new direct lender debt funds (and related updates):
- Bain launched Bain Capital Private Credit, a non-traded BDC that is expected to invest at least 80% of its assets in private credit.
- Monroe Capital LLC agreed to buy venture debt lender Horizon Technology Finance Management LLC.
- MassMutual plans to move its fund finance unit Direct Private Investments under its Barings subsidiary, giving it access to additional sources of capital.
- Ares and Mubadala formed a $1 billion JV for private credit secondaries investments.
- D.E. Shaw raised $650 million for its D.E. Shaw Diopter Fund, a special opportunities debt fund.
- Hyland Hill closed its inaugural $250 million debt fund focused on distressed loans.
- LO3 launched a $220 million private debt fund focusing on lower middle market companies.
- Crescent Capital Group LP closed a new private credit fund at $8 billion, which will focus on unitranche, second lien and junior debt for middle market and upper middle market companies.
- Marathon closed its $1.3 billion Secured Private Strategies Fund III which will focus on senior secured asset-based lending.
- Willow Tree closed a $2.4 billion direct lending fund focusing on middle market companies.
- Oaktree launched private credit fund Oaktree Lending Partners, targeting $10 billion in fundraising and looking to fund large-cap acquisitions for companies with over $100 million in EBITDA.
- Angelo Gordon closed its Annex Dislocation Fund 2 at $1.3 billion, which will primarily invest in public debt securities.
- Deerpath Capital Management closed its sixth fund at $1.5 billion, with a focus on senior debt financing to lower middle market companies.
- Evolution Credit Partners closed its Evolution Credit Opportunity Fund II at $1.05 billion.
Goodwin InsightsThe consequences of the recent turmoil in the banking sector have rippled through many aspects of ordinary-course business operations. Here we focus on its impact on credit agreements and other related documents and provide some thoughts on where we are today and where we see things going for existing and new credit facilities (please note that this is not legal advice, but rather general observations and any possible action taken would require review of actual relevant documentation and consultation with necessary legal, tax and other advisors):
- Cash Management. Companies should review with their professional advisors whether they are managing cash and risk effectively, particularly in this uncertain environment. This Goodwin article offers best practices for adopting cash management policies that can better protect companies. When adopting a cash management policy, it is important for companies to review their third-party debt documents for covenants or restrictions on cash management. For example, prior to the current banking crisis, it was not uncommon for lenders to early stage and lower middle market companies to require that the borrower keep all cash deposits in accounts with such lender. Many lenders, including SVB, a division of First Citizens, have been amenable to amending (or waiving defaults relating to) such cash management covenants in light of the current banking turbulence, so long as a percentage of a company’s cash is kept on deposit with the lender, therefore allowing the borrower to diversify its risk by keeping cash at other banks and financial institutions. These lenders and any existing credit document will also likely require deposit account control agreements (DACAs) to be in place with any other banks to give the lender proper perfection in accounts at other banks. We recommend ensuring that enough lead time is allowed to put any such DACAs in place, typically 30-90 days after the date of opening an account. Also, in credit agreements that have liquidity tests or leverage tests or baskets with cash netting, any requirement that the cash or cash equivalents be “unrestricted” in such tests or baskets should carve out any restricted access caused by bank failures or FDIC receiverships. Further, attention should be focused on the criteria to qualify as “cash equivalents” in credit agreements.
- Fund Facilities. Before they failed, SVB and Signature Bank provided loans and lines of credit to private equity, venture capital and other similar investment funds secured in many cases by such fund’s (or its general partner’s) right to call capital from investors (aka subscription or capital call facilities). It is common for the agreements governing such subscription facilities to require that the relevant fund borrowers cause their respective investors to fund all capital calls exclusively and directly into an account with the lender and to have any distributions from investments flow through an account with the lender. Unlike credit agreements for operating companies, however, fund facility agreements typically do not require fund borrowers to keep the proceeds of capital calls in such account and also permit fund borrowers to maintain bank accounts at other institutions. Although most fund borrowers use the proceeds of capital calls relatively quickly upon receipt, in some situations they are required to hold cash longer than initially anticipated (e.g., if an M&A transaction is delayed after a capital call is made). Accordingly, fund borrowers, like their operating company counterparts, should consider whether they should diversify where they maintain their cash. Although the majority of previous SVB fund borrowers will continue to have access to their loans and accounts — now through First Citizens — fund borrowers across the industry nonetheless have begun examining the creditworthiness of their lenders in consideration of whether to seek alternatives. Because many of these facilities are structured as 364-day revolvers, subscription facility borrowers in search of new lenders typically will wait until maturity to switch. For fund borrowers considering changing lenders prior to maturity and for which refinancing is not an attractive or available option, it is important to review the provisions of their credit agreements relating to the ability to assign agency (or lenders, in the case of a single-lender facility) to another counterparty, as assigning an existing facility to the incoming lender can sometimes be a path to streamlining the transition process and lowering costs. Funds that are registered investment advisors should be aware of any disclosure requirements or risk factors.
- Potential Document Considerations for New Facilities. Although the situation continues to evolve, our initial thoughts on potential document considerations for new facilities include:
- As mentioned above, careful attention should be paid to any cash management covenants or requirements, including any minimum amounts required to be maintained with any particular lender, requirements to diversify where bank accounts are held, and deposit bank liquidity or ratings requirements. Companies may want to consider keeping payroll accounts in a separate bank from their lender banks (note that while payroll accounts are excluded from collateral and any control agreement covenant, covenants in bank credit agreements with a minimum amount of accounts and cash requirements to be maintained with such banks typically do not exclude payroll accounts from such requirements). If a company is interested in utilizing any sweep arrangements as part of its cash management program, ensure that the credit agreement contains the necessary flexibility to allow for such arrangements. Lastly, consider including flexibility that, to the extent a lender faces certain liquidity issues, cash management covenants are no longer in effect.
- Consider including a debt covenant basket/carve-out allowing financial sponsors or other investors to temporarily put money into portfolio companies to fund payroll for a certain period of time. Be mindful of related credit agreement provisions that might restrict the repayment of such indebtedness. In addition, be mindful of any carve-out to the affiliate transactions negative covenant that is based on “arm’s length” that also requires any such transaction to be in the “ordinary course”. These recent events provide good reason why the arm’s length basket to the affiliate transactions negative covenant should not be subject to an ordinary course condition.
- As companies seek additional investments and custodial arrangements for their liquid assets — including participation in the DDA-MMDA and CD options of IntraFi Network Deposits (formerly ICS and CDARS) — the definition of “Cash Equivalents” should be reviewed to ensure that such investments or arrangements are permitted under their credit facilities and that companies get credit (e.g., for cash netting or liquidity covenant purposes) for any such investments or arrangements. Also, companies should make sure any control agreement requirements are not too stringent by requiring that money or accounts above the $250,000 that swept from the primary financial institution to other member institutions be covered by a control agreement (best practice would be to include specific carve-outs from any control agreement requirements). Please note that if companies are considering IntraFi Network Deposits, companies and lenders are likely going to focus on having a record with the primary financial institution of knowing exactly what member institutions are being sent money beyond $250,000 that is being maintained at the primary financial institution and how to obtain such money if the primary financial institution fails or is in receivership.
- Consider creating a “super holdco” structure in all deals where an extra holding company sits above the credit group, free from the senior credit agreement restrictions, to allow for potential holdco financing in the future. Note that any structuring considerations should be discussed with legal and tax professionals.
- For credit agreements that have an event of default tied to a “Material Adverse Effect”, consider adding a carveout in the definition of Material Adverse Effect to address bank failure risk.
- Consider carving out from the clean audit requirement in credit agreements any potential qualification included by auditors for bank failures or cash management diversification risk. While we do not know whether auditors will start to include any sort of carve-outs from the aftermath of the turmoil in the banking industry, it would be prudent to be proactive on this front with any new credit agreements being negotiated.
- Consider additional borrower protections relating to replacing defaulting lenders (perhaps the ability to yank a defaulting lender below par value based on the trading level of the debt at the relevant point in time), having faster time periods to designate a defaulting lender and to yank a lender, or designating disqualified lenders retroactively.
- Borrowers should consider requesting limited setoff rights, particularly when cash becomes unavailable due to a bank failure or receivership.
- With the purchase by First Citizens of certain assets and liabilities of SVBB and the purchase by New York Community Bancorp of certain assets and liabilities of SBB, it is important to note that the FDIC is now again only insuring a maximum of $250,000 of deposits maintained by any customer at First Citizens and New York Community Bancorp (including those deposit accounts previously maintained at SVBB and SBB that were acquired by First Citizens and New York Community Bancorp, respectively).
- Protecting Against Wire Fraud Scams. Given the increase in wire transfers as customers open new accounts and move money to different banks, it is important to remember that companies are targeted for fraud when engaged in this process and companies must remain vigilant throughout. Check out Goodwin’s article on Protecting Against Wire Fraud Scams.
Please reach out to anyone on the Goodwin Debt Finance team, or your usual Goodwin contact, to discuss any of the options above or for any other questions you have on your existing or new credit facilities.
In Case You Missed It – Check out the Goodwin Bank Failure Knowledge Center which includes helpful FAQs, US and UK Model Form Bridge Financing Documents, thoughts on cash management options and recordings of our webinars.
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