San Antonio Express-News (Sunday)
How Industry Bancshares can dig out
In early November, Industry Bancshares Inc. took the dramatic step of setting a meeting to solicit its shareholders’ permission to issue additional shares. Apparently, it needs money.
It’s unclear whether the bank will get permission to raise additional capital.
What is clear is that existing shareholders of the privately owned $4.7 billion bank are unlikely to end the year happy — no matter what happens.
There’s a straight line from the rapid interest rate hikes by the Federal Reserve in 2022 to several large bank failures this spring and on to Industry Bancshares seeking permission to raise more capital. Rising rates have caused a slow-moving banking crisis nationwide this year and it’s coming home to rural Southeast Texas.
Since at least December, all of Industry Bancshares’ subsidiary banks have reported a significant negative net worth under traditional accounting standards. The reason: losses in their bond portfolios.
Other banks, bonds
Its banks aren’t alone. Plenty of other better-known institutions have suffered from bond portfolio losses this year with the same root cause: last year’s aggressive rate hikes by the Fed to tamp down inflation. And it’s led to some big bank failures.
Silicon Valley Bank — which in March suffered the thirdlargest bank failure in U.S. history — had almost exactly the same problem as Industry Bancshares, but on a larger scale. Like the Texas bank, it owned many ultra-safe long maturity U.S. Treasury bonds, which dropped in value when interest rates rose.
The differences in the two banks’ customer profiles, however, could not be more stark.
Whereas Silicon Valley’s social media-networked high net worth depositors yanked their money 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.
Bank of America, to name another well-known bank, also has a huge bond portfolio-loss problem that’s been a headache for national regulators since the beginning of 2023. In October, it reported $131 billion in unrealized bond portfolio losses. Unlike Industry Bancshares, however, Bank of America has a highly positive net worth of $229 billion on a traditional accounting basis as of September.
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 more than $27 billion at the end of last year.
So Industry Bancshares has plenty of company in the misery of banks whose bond portfolios got hurt by the rapid rate hikes of 2022. It stands uniquely apart, however, by dropping into negative net worth territory throughout 2023, a valuation
no financial institution wants to be.
Illiquidity vs. insolvency
In the normal model of banks at risk, we worry about a bank run because of illiquidity. It arises because banks generally keep only a fraction of their total assets in cash or highly liquid equivalents.
That’s usually fine because customers will not all demand their cash back at the same time.
If customers did suddenly withdraw their deposits — you’ve seen it happen in the fictional small-town bank run depicted in the Christmas movie classic “It’s A Wonderful Life” — it’s a problem because banks generally don’t have sufficient cash on hand to cover all those deposits.
In a traditional liquidity crisis, the problem is one of timing. If customers give the bank enough time to sell off assets to raise cash, everything will be fine. The bank holds plenty of assets worth well more than the cash being demanded by depositors and lenders. It’s illiquid, but not insolvent.
Every modern bank worries about illiquidity because it can happen to any bank. The Federal Deposit Insurance Corp. is a great solution for such risk because it eliminates the need for smaller depositors — anyone with less than $250,000 in
the bank — to demand their money back quickly out of fear the bank is at risk. It’s insured.
In the more extreme model of banks at risk, 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 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 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 that the bank literally doesn’t have enough assets to cover its liabilities and depositors realizing, and acting on, the risk they face.
Weirdly, as I wrote a few months ago, just 15 of the 4,697 banks in the U.S. reported a negative net worth midway through 2023, putting them at risk of insolvency if too many depositors and lenders asked for their money back. More weirdly, six of those 15 banks with negative net worth are owned by the same holding company: Industry Bancshares.
It’s made up of a half dozen small Texas banks with 27 branches in rural counties between Houston, San Antonio and Austin: Citizens State
Bank of Buffalo, Bank of Brenplace
ham National Association, Fayetteville Bank, First National Bank of Bellville, First National Bank of Shiner and Industry State Bank.
When I first wrote about the company, each one of its 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. Unfortunately, due to further interest rate rises and bond portfolio losses, each of the six now has a significantly larger — that is to say worse — negative net worth. Collectively, the balance sheet hole deepened to $401.4 million by Sept. 30, or $381.9 million at the holding company level.
The solutions
The last time I wrote about Industry Bancshares, I mentioned possible solutions management could pursue:
1. Try to sell to a larger, better-capitalized, bank.
2. Raise new investor capital. 3. Do nothing and hope to earn their way out of their negative equity position.
4. Do nothing and hope for bond portfolio values to improve.
I don’t know if they are trying option 1, but maybe. Management reported to shareholders that it hired a financial adviser known as Hovde
Group to seek strategic financial solutions.
The shareholder meeting now scheduled for Tuesday is a necessary step in the direction of option 2. The meeting had originally been scheduled for Dec. 6, but was moved up.
Option 3 is a longer-term strategy that requires patience on the part of regulators and depositors to overlook the company’s negative net worth for a few years in hopes that consistent profitability solves the problem. Industry Bancshares reported $19 million in net income through September so this is possible, but it would take a while.
Option 4, which management elected to do by default, appears to have exacerbated the situation.
Interest rates jumped again in the third quarter and losses deepened. Option 4, doing nothing with the bond portfolio, has made the company’s negative equity position three times larger than was reported through the first half of the year.
Accounting principles
Because of a quirk in the way they’re regulated, banks can choose to have their portfolio losses on “available for sale” bonds ignored by regulators when they determine whether the bank is solvent. Only when bonds are sold — and Industry Bancshares has not sold its bonds— 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 that it meets regulatory standards for being “well capitalized.” At the same time, in ordinary business terms and according to common sense, it has 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 disagree that my coverage of the situation in September was “very misleading in many respects,” but readers can render their own judgment on that. Bankers — who
literally evaluate corporate solvency and business valuations for a living
— understand very well the difference between positive and negative net worth despite what regulators permit them to report and claim.
Dividends, valuations
It is notable that the bank paid $4.027 million in dividends via payments to shareholders in April and July even though the bank as a going concern was worth less than zero in the ordinary sense of a business enterprise.
In January, bank management communicated to shareholders that shares were worth an estimated $37.25 per share, down from about $44 in 2022.
That was despite a Dec. 31, 2022, equity capital position of negative $159.7 million across all six banks combined.
Management has suggested that a new share offering after this December would be in the range of $1.50 to $2.50 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 the FDIC-insured level of $250,000 across the company’s six banks, employees who may have their net worth tied up in an employee stock ownership plan and ordinary shareholders should seek to more fully understand their situation at Industry Bancshares.