Chris Whalen - Institutional Risk Analytics
A not so fictional FSOC memo for Bank of America
Default and Liquidation under Dodd-Frank
Under the provisions of the Dodd-Frank legislation, the FSOC may appoint the FDIC as receiver if the Secretary determines any covered company "is in default or in danger of default," but the FSOC does not need to act if there are alternatives. It is clear from both the provisions of Dodd-Frank and the Congressional record that a private solution ought be the first choice.
In view of the fact that the subsidiary banks of BAC are still book solvent and that the primary issue facing BAC arises from the legacy liabilities of the parent, and not of the subsidiary banks and broker dealer, our recommendation is a commercial Chapter 11 reorganization under the federal bankruptcy code, with the full acquiescence and cooperation of the FDIC, other regulators and the banking industry.
A commercial alternative will be modeled after examples such as Lehman Brothers and more specifically MCorp, when a parent BHC reorganized while the subsidiary banks remained open. A commercial reorganization will allow the management of BAC to work with creditors to resolve the legacy liabilities of the parent, and also sell assets, in a fair, deliberate and timely fashion without disrupting the operations of the subsidiaries of BAC. Such a solution meets the convenience and need of the public, and also minimizes the risk of a loss of the FDIC's insurance fund.
The depositors of the subsidiary banks of BAC and, indirectly, the FDIC, are senior to all of the creditors of the parent BAC. In a Dodd-Frank resolution, the equity and debt holders of the parent can take a near-total loss, especially in view of the large magnitude of unliquidated claims against the parent.
But in a commercial reorganization under Chapter 11, the creditors will become the new shareholders of the parent BHC. A modest conversion of debt to equity, combined with an equitable settlement of all unliquidated claims, will leave a restructured BAC solvent, profitable and able to support new leverage. From both a public good and creditor perspective, a voluntary reorganization is the first and best option for BAC and not a Dodd-Frank resolution.