InvestorsFriend Newsletter April 2, 2023

Bank Shareholders – Beware of Bank Bailouts!

Mythology has it that banks and their shareholders got “bailed out” in the 2008 financial crisis. And yes, some of them did, but not all of them.

Washington Mutual was the sixth largest bank in the U.S. and it was taken over by the Federal Deposit Insurance Corporation and the company went broke with zero recovery to shareholders. A complete wipeout! Certainly no bailout for shareholders. As for its executives, yeah they probably fared very well considering the circumstances. I believe the depositors were all made whole, even the uninsured deposits. So it was the depositors who were bailed out, not the shareholders. And that’s how it should be.

Other shareholders that were wiped out during the financial crisis included the shareholders of Lehman Brothers who were completely wiped out. And the shareholders of Bear Sterns received $2 a share for their shares that had peaked a year or so earlier at $171. Approximately a 99% wipeout.

There were other fairly large lenders and many small ones where shareholders were completely wiped out in 2008. Any notion that bank shareholders were all bailed out is simply wrong.

But it is true that  the shareholders of most banks did benefit from the 2008 bailouts and assistance to banks. That was was somewhat inadvertent as I will explain below.

Who or what is bank regulation meant to protect?

First and foremost, bank regulation is meant to protect bank depositors. Not bank management, not holders of bonds issued by banks and not bank shareholders. The economy would suffer greatly if people and corporations did not think their money was safe in banks. 

So why did many large bank shareholders also get bailed out in 2008?

It was because taking actions that would have protected only the depositors of the large banks while letting their shares go to zero would have been too disruptive to the financial markets and the economy. As is often said, some banks were to to big to (allow to) fail.

What happened with Silicon Valley Bank?

At December 31, 2022 it reported $212 billion in assets and $16 billion in equity. That’s leverage of 13 times but that’s not at all unusual for a bank. It had $91 billion of its assets or 43% invested in securities and the great majority of these securities were mortgage-related securities. It’s very normal for banks to invest in securities in addition to making loans. But having 43% in securities is a very high level. While these were very safe investments 95% of the $91 billion would not mature until at least 10 years. And these securities were yielding or earning an average of just 1.63%. This was a huge problem as interest rates jumped. The biggest chunk here was $57 billion in “Agency-issued Mortgage Backed Securities” with at least 10 years until maturity and earning an average of 1.54%. Mortgage rates never got that low but once bundled up and sold as agency-backed securities, the yield on these investments was down close to the yield on actual long-term U.S. treasuries which got very low. This bank was implicitly betting that interest rates would not rise.

This $91 billion was not required to be marked-to-market under accounting rules because the intention was to hold until maturity and collect the full amount. But that would become very problematic if they had to start paying far more than this 1.63% on deposits.

Looking at this, the whistle blowers who claimed that this bank was “technically insolvent” certainly had a good point. A the very least it looks like SVB was going to suffer years of low or negative profits because the rates it paid on deposits were now up very sharply and it was stuck with massive amounts of securities earning low rates that would not mature for at least 10 years.  The catalyst for the bank failure was the run on deposits that arose when SVB was said to be “technically insolvent” and word of that spread.

How did the takeover by the Federal Deposit Insurance Corporation (FDIC) proceed?

The FDIC seized the bank on Friday March 10 after the bank suffered a massive loss of deposits based on rumors that it was “technically insolvent”.

On March 26, 2023, the FDIC announced that it had sold all of Silicon Valley’s loans and all of its deposits to First-Citizens Bank. This was apparently at a Fire Sale price. It did not include SVB’s problematic securities assets (those long-maturity mortgage-backed securities). First-Citizens got $72 billion in loans at a $16.5 billion discount or 77 cents on the dollar. If First-Citizens can ultimately collect the $72 billion in loans there will be a $16.5 billion dollar gain but some of that gain (or any losses) will be shared with the FDIC. First-Citizens is also taking over $119 billion in deposits. Since the deposit liabilities of $119 exceed the discounted value of the loans ($55.5 billion) by $63.5 billion, it would appear that the FDIC will also be sending $63.5 billion in cash to First-Citizens. FDIC will next sell the problematic $90 billion in other SVB securities and assets. Those are not worth anything close to $90 billion because they are mostly long term mortgage-linked securities at far below today’s market interest rates. FDIC may sell these these at a discount even to the already discounted market value. Warren Buffett may be thinking of throwing in a low-ball bid at this very moment. And he is likely the only person in the world who could commit instantly to buying many billions of these securities with no need to check with his Board.

Conclusions and lessons:

The main lesson of the above paragraph for bank shareholders is that if a bank you own shares in suffers a run on the bank for any reason and gets seized by the FDIC (In Canada the CDIC) they will sell the loan assets of your bank at an absolute fire sale price and your shares will almost certainly be worthless. If your bank has issued preferred shares and bonds (usually bonds are issued to institutional investors), those will also almost certainly be worthless because the FDIC will sell off the loans at such a big loss. 

The lesson for the public is that yes depositors mostly get bailed out here. (Uninsured deposits above the insurance limit may or may not get fully paid.) And bank management loses their jobs but likely collects all their salary and bonus. Management loses the value of their stock options and shares. But share owners and bond investors in the bank typically get wiped out. No bail out for bank shareholders. 

The only time bank shareholders get bailed out is when there is a systematic threat to the banking system (such as happened in 2008) and the banks get rescue packages without being thrown into receivership. Receivership it seems is death to bank shareholder value. 

I suppose bank shareholders losing 100% of their investment in the event of a bank failure is fair. But I just wonder if a more orderly and slower receivership process would preserve at least some value for bank shareholders or at least for the bond investors (who rank higher in priority). One thing is for sure: It is absolutely right that the main focus be on protecting depositors. The interests of bank bond investors and bank shareholders rightly rank far below the interests of depositors.


Shawn Allen, CFA, CPA, MBA, P.Eng.
InvestorsFriend Inc.

April 2, 2023