In the spring of 2023, the banking regulators took control of several high-profile banks. These actions created many flashbacks for me as a former federal regulator for commercial banks and savings and loan associations. During this period, it was popular to say that the banks were bailed out when nothing could be further from the truth. In a nutshell, here is what happened during the previous and current failures:
- Equity and debt holders were wiped out;
- Insured depositors were made whole, and
- In most instances, bigger and better-capitalized banks gobbled up the assets of the failed banks at favorable/discounted prices.
Please carefully note that the bank’s owners were not bailed out; instead, the depositors were repaid their deposits per the insurance limits at the time of the failure. Recent failures were different from other crises generally associated with financial institution failures. The recent failures were not tied to bad loans but were more a result of poor investment decisions. In essence, these banks had more deposits than they could prudently invest. In other words, they had more money than they knew what to do with. Plus, the latest failures resulted in the government insuring (nationalizing?) all depositors.
Word of mouth used to be how information was circulated when a bank began to experience problems. I know as I managed a group of brain-dead financial institutions during the late ’80s and early ’90s and was constantly looking out for run-on deposits. The situation is much different now since the Internet allows depositors to withdraw their money with only a few clicks on a computer.
Banks generally fail in one of two ways:
- a negative capital position, otherwise known as financial insolvency or
- a liquidity crisis.
Banks can survive a negative capital position if allowed by the regulators; however, a liquidity crisis is fatal.
In my opinion, this is where the impact of the recent issues will be most pronounced for the banking sector. The recent failures resulted in many depositors moving their money into large multinational banks, which are considered by many to be too big to fail; however, the outflow of these deposits will most likely not be the biggest issue facing many small—to medium-sized regional banks.
According to a recent study, close to $3 trillion in commercial real estate loans must be renegotiated within the next several years. This is a massive number for the regional and smaller banks. This group of banks has two-thirds of these loans on their books. As these loans are refinanced – at substantially higher interest rates – these banks will face significant challenges. For example, the Westfield San Francisco Center – the largest shopping center in central San Francisco – has been returned to its lender(s). The borrower just handed the lender(s) the keys and said it is yours. It is impossible to say how many banks can survive this situation; however, most regional or community banks cannot.
Here is where it gets interesting regarding responsibility for these failures. When a bank is placed into receivership, the federal government becomes involved. The recent failures and others that will likely happen over the next several months will result in substantial and aggressive litigation involving the former directors, senior officers, and others who impacted or made policy decisions at these banks. The legal actions will likely include the accounting firms that expressed opinions on these institutions’ financial statements.
The individual board members and senior management will be vulnerable and viable targets to both FDIC lawsuits as the receiver and to enforcement actions. There is generally a lag between 6 and 12 months between the bank’s failures and the pursuit of litigation. I say with great certainty that the FDIC and others involved in the receivership of these failed banks will forcefully pursue these actions. I know this as a former federal regulator engaged in over 100 receiverships.
Whenever a bank fails as spectacularly and suddenly as Silicon Valley Bank, it is appropriate and, in most cases, legally required for the government to conduct a post-mortem review and analysis to determine why things went wrong and who was responsible. It is easy to speculate that many of these former insiders will soon be soliciting assistance to help them navigate their legal responsibilities regarding these failures.
To the legal profession: If you require a regulatory perspective to prepare a legal strategy regarding future litigation associated with these failures, please feel free to contact me.
Prepared by Terry L. Stroud – Updated August 2024
