When a Bank Fails: What Does it Mean for Depositors and Borrowers?

Client Alert

The increase in interest rates, and the contraction of the money supply, which are intended to tame inflation, have also had significant negative consequences. Those consequences include adverse impacts on the banking industry, which have been on display this week and are likely to continue. Manatt’s financial services attorneys are experienced with the economic pressures currently facing the banking industry, including when one or more banks fail.

When a bank is seized and the Federal Deposit Insurance Corporation (FDIC) is appointed as receiver, the FDIC can take a number of restorative actions, including creating a new national bank to protect insured depositors and transferring all deposits (both insured and uninsured) over to the new national bank. The FDIC will pay off insured depositors quickly and then establish procedures for handling uninsured deposits. Generally, uninsured depositors will receive a percentage of advance payments on their uninsured deposits and then a receivership certificate for the remaining amount of their uninsured funds together. As the FDIC sells the assets of the failed bank, future dividend payments may be made to uninsured depositors.

What Does This Mean for Depositors?

To answer this question, the depositor has to determine the amount of the deposits maintained at the failed bank and the ownership structure of each deposit. This should provide the answer to how much in “insured deposits” the depositor has.

  • Deposits in banks insured by the FDIC are insured up to $250,000 per depositor, per bank and per ownership category. For example, if a person has a certificate of deposit at Bank A and a certificate of deposit at Bank B, the amounts would each be insured separately up to $250,000. Funds deposited in separate branches of the same insured bank are not separately insured because they are held by one person in the same ownership category.
  • The FDIC provides separate insurance coverage for money that depositors may have in different categories of legal ownership. The FDIC refers to these different categories as “ownership categories.” This means that a bank customer who has multiple accounts at the same bank may qualify for more than $250,000 in insurance coverage in total if the customer’s funds are deposited in different ownership categories and the requirements for each ownership category are met.
  • The FDIC recognizes the following ownership categories that can qualify for insurance coverage above $250,000 at one bank:
    • Single Accounts
    • Certain Retirement Accounts
    • Joint Accounts
    • Revocable Trust Accounts
    • Irrevocable Trust Accounts
    • Employee Benefit Plan Accounts
    • Corporation/Partnership/ Unincorporated Association Accounts
    •  Government Accounts

Special rules apply to each type of deposit ownership structure. A helpful basic guide for FDIC deposit insurance can be found at https://www.fdic.gov/resources/deposit-insurance/brochures/documents/your-insured-deposits-english-hr.pdf.

The FDIC then may pay an advance on liquidation proceeds (often called a “dividend”) payable to uninsured depositors. Any amounts that are not covered by the FDIC insurance amount ($250,000) and the special dividend will be covered by a receivership certificate. The receivership certificate represents a participation interest in whatever funds are generated in the liquidation of the remaining assets and payment of creditors. The priority of collection of deposits is as follows:

Collection Priorities Source and Timing of Collection
1. $250,000 per account per owner (insured amount) Immediate
2. Excess over $250,000 (uninsured amount) Advance of estimated liquidation proceeds as soon as practicable, amount unknown
3. Excess over 1 and 2 Payable as liquidation proceeds are received

The best result which may still occur for a failed bank is a rapid sale by the FDIC as receiver of substantially all of the assets and assumption of substantially all of the liabilities. In the usual receivership sale all or substantially all of the deposit liabilities are assumed by the acquiring bank. This can represent a unique opportunity for the right bank to acquire enterprise value at a modest premium. However, if such a sale is not promptly arranged, or sooner thereafter, the assets and business will have to be broken up and sold separately, which likely will result in a lower return on the receivership certificates.

What Happens to Held Assets That Are Not Deposits?

A customer’s relationship with a bank may involve additional investment products that are not insured and that may be with separate entities affiliated with the bank, including broker-dealers. Those products are not FDIC-insured, and the impact of a bank’s failure on these nonbank products will depend in large part on the terms of the products and the nature of the entity at which the products are held. Some of these may be covered by different insurance.

What Happens to Borrowers Who Have Loans?

The impact of the closing of a failed bank on borrowers depends on several factors including the prospects for an overall sale, the appetite of the purchaser for specific types of borrowers and loans, and the nature and status of the credit. As receiver, the FDIC seeks to maximize the amount of the sale, which should encourage maintaining a portfolio of performing loans and customer relationships. We expect the FDIC will promptly provide more information about the status of term loans and lines of credit during the receivership process. Borrowers with loans that are classified negatively or are in default may be encouraged to move the credit elsewhere to the extent possible.

Should you have any questions about this alert or what happens when a bank fails, please reach out to a member of the Manatt Financial Services Group.



pursuant to New York DR 2-101(f)

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