Troubled Bank in Texas – Part II

The private $4.7 billion Industry Bancshares Inc. in rural Texas made the dramatic step in early November of asking for a meeting in December 2023 to solicit shareholder permission to issue additional ordinary shares and preferred shares. It’s unclear at this point whether they will get this permission or be able to raise additional capital. What is clear is that existing shareholders of Industry Bancshares are unlikely to end 2023 happy, no matter what happens next.


There’s a straight through-line narrative from the rapid interest-rate hikes by the Federal Reserve in 2022, to a number of large bank failures this Spring in New York and California, to Industry Bancshares recently seeking permission to raise more capital. Rate hikes have caused a slow-moving banking crisis nationwide throughout 2023. This crisis has now come home to rural, central Texas.

Other banks and bond portfolio losses

Plenty of other better-known banks have suffered this year from their bond portfolio losses, with the same root cause of aggressive Fed hikes in 2022.

Silicon Valley Bank, which in March 2023 suffered the third-largest bank failure in US history, had almost exactly the same problem as Industry Bancshares, but on a larger scale. Like Industry Bancshares, it owned many ultra-safe long-maturity US Treasury bonds which dropped in value when interest rates rose. The differences in customer profiles, however, could not be starker. Whereas Silicon Valley’s Twitter-networked high net-worth depositors yanked their money quickly and brought down the bank in the course of a week, Industry Bancshares customers appear to move at a different speed. The key difference – and this has been an advantage so far for the Texas bank – is the slow pace of deposit banking among its customers.

They owned super-safe long-dated Treasurys

Bank of America, to name another well-known bank, has a huge bond portfolio-loss problem that has been a headache for national regulators ever since the beginning of 2023. In October 2023 Bank of America reported $131 billion in unrealized bond portfolio losses. Unlike Industry Bancshares, however, Bank of America has a highly positive net worth overall of $229 billion, on a traditional GAAP accounting basis, as of September 2023.

San Antonio-based USAA, the largest Texas-based bank, had a $10.4 billion loss on its bond portfolio in 2022 and reported its first negative earnings year in its 100-year history. USAA also had a substantial positive net worth at over $27 billion at the end of last year on a traditional GAAP accounting basis.

2022 was USAA’s worst year ever

So Industry Bancshares has plenty of company among the misery of banks whose bond portfolios got hurt by the rapid rate hikes of 2022. It stands uniquely apart, however, in its dropping into negative net worth territory throughout all of 2023, a valuation place no financial institution wants to be.

Illiquidity versus insolvency

In the normal model of banks at risk, we worry about a run on a bank because of illiquidity. Illiquidity arises because banks generally only keep a fraction of their total assets in cash or highly liquid equivalents. This is usually fine because they generally assume customers will not all demand their cash back at the same time. If customers did suddenly withdraw their deposits – as you probably watched in the fictional small-town bank run depicted in the Christmas classic “It’s A Wonderful Life” – no bank generally holds sufficient cash on hand. In a traditional liquidity crisis we understand that the problem is one of timing. Meaning, if you give the bank enough time to sell off its assets to raise cash, everything will be fine. The bank ultimately holds plenty of valuable assets well above the money owed to depositors and lenders. It’s illiquid, but not insolvent. Every modern bank worries about illiquidity risk because it can happen to any bank. FDIC insurance is a great solution for illiquidity risk, because it eliminates the need for smaller depositors – anyone below $250 thousand at the bank – to demand their money back quickly out of fear of a bank run.

Our image of a bank run from the movies

In the more extreme model of banks at risk, however, we worry about a bank run due to insolvency. That could happen if a bank has a negative net worth – owing more money than it actually owns in assets. This is rare. Normally insolvency could be due to unexpectedly high losses on a bank’s real estate or business loan portfolio. Or as happened this past year, it could be because of an extreme drop in the value of a bank’s bond portfolio. The problem and the solution is not a matter of needing more time to sell assets – it’s a matter of the bank literally doesn’t have enough valuable assets to cover its liabilities, and then depositors realizing the risk they face in that situation.

Weirdly, as I wrote about a few months ago, just 15 out of 4,697 banks in the United States reported a negative net worth mid-way through 2023, putting them at risk of insolvency if too many depositors and lenders decided to ask for their money back. Even more weirdly, 6 of those 15 negative net worth banks are actually part of the same bank, the bank holding company Industry Bancshares. This holding company is made up of 6 small Texas banks with 27 branches located in rural counties between Houston, San Antonio, and Austin: Citizens State Bank of Buffalo, Bank of Brenham National Association, Fayetteville Bank, First National Bank of Bellville, First National Bank of Shiner, and Industry State Bank.

When I first wrote about the bank, each one of the six individual banks had a negative net worth. In total the six were collectively in the hole for $128 million, or $108 million at the bank holding company level. That value was based on public filings from the end of June 2023. Unfortunately, due to further interest rate rises and bond portfolio losses, each of the six individual banks now has a significantly larger, that is to say worse, negative net worth. Collectively that balance sheet hole ballooned to $401.4 million by September 30 2023, or $381.9 million at the bank holding company level.

$108 million reported negative equity in June 2023 for Industry Bancshares. Line 15 is the key. Line 3 is as of year-end December 2022. Bank management reported this position to regulators since at least late 2022.

The solutions

The last time I wrote about Industry Bancshares, I mentioned possible solutions management could pursue were to: 

1. Try to sell to a larger, better-capitalized, bank 

2. Raise new investor capital 

3. Do nothing, and hope to earn their way over time out of their negative equity position, or

4. Do nothing, and hope for bond portfolio values to improve.  

I don’t know if they are trying option 1. They reported to shareholders that they hired a financial advisor known as Hovde Group to seek strategic financial solutions. The December 2023 shareholder meeting is a necessary step in the direction of option 2. Option 3 is a longer-term strategy which requires patience on the part of regulators and depositors to overlook their negative net worth for a few years in the hopes that consistent profitability solves the problem. Industry Bancshares reported $19 million in net income through September 2023, so this is possible, but it would take a while. Option 4, which they elected to do by default, appears to have exacerbated the situation. 

Further bond portfolio losses led to negative $381.9 million equity capital position by September 2023. Line 12 is how much worse the bond portfolio got in Q3 2023 alone, as interest rates rose.

Interest rates jumped again in the 3rd quarter of 2023, and losses deepened. Option 4, doing nothing with the bond portfolio, has made their negative equity position 3 times larger than was previously reported, halfway through the year.

Bank Accounting v. GAAP Accounting

Because of a quirk in the way banks are regulated, banks can choose to have their portfolio losses on “available for sale” bonds ignored by regulators, when regulators look to see if a bank is solvent or has sufficient capital. Only when bonds are sold – and Industry Bancshares has not sold theirs – are the losses counted. And bonds don’t have to be sold, as long as depositors or other lenders do not request their money back. As a result, Industry Bancshares can state with a straight face that they meet regulatory standards for “well capitalized.” At the same time, in ordinary business terms and according to common sense, they have a deeply negative net worth.

An October letter to shareholders from management included this message: 

“You may have seen an article or two about the Company that have not been very favorable and have been very misleading in many respects. The articles have painted our Company and the banks in an unnecessarily poor light due to an accounting concept that requires banks to report unrealized losses and gains on a certain portion of their securities portfolios.”

I would posit that my article in September was not “very misleading in many respects” at all, although readers can render their own judgment on that. Bankers – who literally evaluate corporate solvency and business valuations for a living – understand very well what the difference is between positive and negative net worth, despite what regulators permit them to report and claim.

Dividends, valuations, and at-risk people and groups

It is notable that the bank paid $4.027 million in dividends via two payments to shareholders in April 2023 and July 2023, even though the bank as a going concern was worth less than zero dollars in the ordinary sense of a business enterprise.

Industry Bancshares Org Chart as of 2019

In January 2023, bank management communicated to shareholders that bank shares were worth an estimated $37.25 per share, down from approximately $44 per share in 2022. This despite a December 31 2022 equity capital position of negative $159.7 million across all six banks combined. Management has suggested that a new share offering after December 2023 would be in the range of $1.5 to $2.5 per share. Even before the issuance of new shares, existing shareholders are facing a 95% loss in value over the past year.

The owners of the more than $2 billion in more than 3,100 deposit accounts with balances above $250 thousand, employees who may have their net worth tied up in an Employee Stock Ownership Plan (ESOP), and ordinary shareholders should seek to more fully understand their situation at Industry Bancshares.

A version of this post ran in the San Antonio Express News and Houston Chronicle.

Please see related posts

A Troubled Texas Bank, Part I

USAA had a very bad, no good year in 2022

It’s A Wonderful Life, a failed banker origin story

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SIGTARP, Part IV – What Small Banks Are Going Under Next?

Ok, so it’s no secret I’m pretty sweet on SIGTARP, the Norse God of Financial Accountability.

There’s the pleasure of calling a fellow US Treasury colleague a liar.

There’s the feistiness of a government official pointing out that through our failure to rein in TBTF banks, we’ve laid the groundwork for the next crisis

There’s the carefully balanced review of the Citigroup Bailout.

Frankly there’s the plain old fun of SIGTARP himself, Neil Barofsky, responding during his book tour[1] to my tweet about Geithner, unconcerned that Geithner would jump to Goldman, Sachs, because at least at GS he’d do less harm than as Treasury Secretary!

Barofsky’s response to my question about Geithner going to Goldman. “He could do less harm there.”

But I digress.  There’s a good deal of valuable information in SIGTARP reports, and in this installment I thought I’d highlight a few things we can learn about small and medium size banks.  I’m sad to say that four years after the Credit Crunch, many small and medium size banks are doing terribly.

US government regulators NEVER tell you which banks are in distress.[2]  But SIGTARP consistently goes where other regulators dare not tread.[3]  Read the full report to find out which small banks will go under next, probably by 2013, or simply go to the list of banks which have missed dividend payments.

On missing Dividend payments owed to Treasury for TARP money

The stated reason for TARP was to ensure that TBTF banks did not bring the entire financial system to a grinding halt when taken over by the FDIC or placed in receivership.  For less clear-cut reasons[4] however, Treasury also offered small and medium size banks a chance to take advantage of the fast-track route to recapitalization via government investment.

As it turns out, and despite explicitly forbidding this[5], the TARP money extended a lifeline to small and medium size banks that have failed to thrive following the Great Credit Crunch.  A few hundred of these banks have either succumbed to failure or have missed so many dividend payments to the Treasury that survival seems doubtful.

SIGTARP reports list not only those banks which have outright failed or those where the government has lost money, but also those banks that have missed dividend payments to the Treasury and the number of those payments as well.  The missed dividend signals the banks that are probably too far gone to survive.

Wondering if your local TARP-bailout bank is in good shape?  You can check for it in the SIGTARP report HERE.

To save you some time scrolling through the SIGTARP report, you can look on the following pages for:

Pp 98-102: 162 Banks that have missed one dividend or many dividends.

Pp 102-103: 41 Banks where the US Treasury has realized a loss through its TARP investment.

Pp 110-117: 99 Banks that have failed, gone bankrupt, or had their US Treasury investment forcibly restructured.


On troubled Community Banks that still owe TARP money

One measure of recovery from the Great Credit Crunch would be the strength and stability of banks in the United States.  And, unfortunately, a great number of small community banks, we learn from SIGTARP, are really still sucking wind.

While 90% of the original TARP money[6] from late 2008 has been repaid from all of the TBTF banks (except Regions Bank), small and medium size banks have been much slower to repay.

As of the latest Congressional report, approximately 400 small and medium size banks have yet to pay back TARP funds.  Even that group of 400 TARP banks overstates smaller banks’ ability to repay, since an additional 137 banks swapped TARP funds for a program custom-designed to let them off the TARP hook, through a financing called SBLF.

What are the implications for the future of small banks unable to repay TARP?

400 banks account for approximately 5% of banking institutions in the country, not a huge portion of the total.  In a strictly macroeconomic sense, it is systemically irrelevant whether these banks live or die in the years to come.  A case can even be made that fewer banks in the United States would be just fine.

From a taxpayer perspective the $20 Billion value in small bank preferred shares and warrants represents less than the US Treasury risked with individual banks such as Citigroup and Bank of America in the early days of the crisis.

On the other hand, comparing small bank failure to household financial failure shows the locally devastating effect if they implode financially.  That is to say, it matters to those banks and their communities if they fail.  Not only that, we can assume, not unreasonably, that failing banks will be concentrated in depressed regions of the country, exacerbating access to credit for small businesses and real estate developers in precisely those areas which can least sustain losses.[7]

The SIGTARP report provides evidence, if you read between the lines, that a great number of these smaller 400 TARP recipients are on life-support, and many will not make it out of the intensive care unit.

Congress passed the Small Business Lending Fund (SBLF)[8] nominally to provide more credit for small business, but in reality to allow medium and small banks to exit TARP and roll into a less restrictive government program.[9]  One hundred thirty-seven banks qualified for Treasury funding under SBLF by proving their likelihood of increasing their loan portfolio to small businesses – and exited TARP shortly thereafter.  Those who could exit TARP at that time, did – the rest could not.

Furthermore, executive compensation restrictions make it unlikely that any bank still owing TARP money has a profitable and sustainable banking franchise.  If they could have paid it back, they would have by now.

The 162 Banks Most Likely to Fail

As of the July 2012 report, one hundred sixty two, or almost half of the remaining 400 TARP banks, have missed dividends (currently with a 5% coupon rate) on the preferred shares owed to Treasury.  By law, the dividend rates jump to 9% on these bank preferred securities beginning in 2013.  Payments of 9% on their capital is an exorbitant rate for banks to pay when the costs of funds in the money markets for healthy banks remain below 2%.

In sum, the picture is grim for remaining small and medium TARP banks, but the financial system and ordinary taxpayers will not suffer extraordinary losses.  To badly hit communities, however, more pain awaits, probably in the second half of 2013 when 9% dividends deal the fatal blow to weak banks.



Also see:

In Praise of SIGTARP Part I, “Truth in Government”

In Praise of SIGTARP Part II, “We blew it on the repayment of TARP by the largest financial institutions”

SIGTARP Part III – “The Citigroup Bailout”

and SIGTARP V – The AIG Bailout

[2] There’s a good public policy reason for this.  Exposing a weak bank publically may create a self-fulfilling prophesy of weakness, as depositors and customers leave the zombie bank for its stronger competitors.

[3] Which is why it’s kind of an illicit thrill to see struggling banks publicly outed this way.  I know, I’m weird.

[4] One strongly implied reason at the beginning of TARP was the ‘safety in numbers’ idea.  That is, if many banks took TARP funds at the same time it would remove the stink of government intervention from the actual targets, the TBTF banks on the financial precipice.  Another reason is probably the sway of small and medium banks with their Congressional representatives.  One reason that makes less sense is the systemic value of small and medium banks.

[5] TARP funds were supposed to be only available to Qualifying Financial Institutions (QFIs.)  But the definition of a QFI included the mandate that they be “healthy, viable institutions.”  We know with hindsight that at least both Citigroup and Bank of America would have failed to qualify for this designation had “healthy, viable” been a truly disqualifying condition.  But we now also know hundreds of small banks failed that test as well.

[6] In this posting, by “TARP funds” I really mean to refer to the Capital Purchase Program (CPP) by which Treasury bought preferred shares and warrants in 707 banks, including the largest 17 TBTF banks.  Technically “TARP funds” could include a wide variety of other investment programs authorized under TARP, but I’d rather use the acronym TARP than CPP, since it is better known.

[7] See this interesting site with stats and maps of bank failures.

[8] In September 2010

[9] The initial dividend rate of 5% matches the TARP dividend rate of 5%, but crucially SBLF funding does not carry restrictions on executive compensation.  Much better, Smithers.

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