The Extra Risks Involved in Financial Stocks
Allan Ross wants to know why no one seems to care about his losses.
Like about 400,000 policyholders, Ross invested in Executive Life Insurance Co., which failed last April under the weight of a souring portfolio of junk bonds and a flood of policy surrenders.
Now California insurance regulators are working out details of a buyout deal that promises to pay most policyholders 100 cents on the dollar. Ross, on the other hand, will probably lose his entire investment.
Why is Ross being so badly treated?
Unlike the others, Ross did not buy an insurance policy. He bought preferred stock in Executive Life’s parent, Los Angeles-based First Executive Corp. He believed that was a safe investment, even when the company’s share price began to tank about two years ago. After all, he thought, the assets of a giant company such as First Executive were worth more than a few dollars a share.
What Ross didn’t realize was that the bulk of the assets he was banking on could be ripped out from under shareholders in order to protect customers of the company’s two primary subsidiaries, Executive Life Insurance Co. of California and Executive Life of New York.
And his plight is not unique. As this country’s financial institutions have faltered in the past several years, hundreds of thousands of investors have learned the same hard lesson that Ross is just beginning to grapple with.
Investing in the shares of a regulated financial institution is unlike investing in any other type of firm. Where shareholders of a manufacturing company are likely to retain some value in their investment even if the firm falls into bankruptcy, shareholders of a financial institution usually lose everything if the institution they invested in fails.
The reason: Publicly held companies are usually set up on a two-tiered structure. The first tier is a holding company, such as First Executive, which sells stock to the public and buys or operates subsidiaries, which are separate firms, even though they often share common management with the holding company. These subsidiaries are the holding company’s primary assets.
If the holding company’s subsidiary is a bank, thrift or insurer, it is regulated by one or more state or federal agencies, which have significant control over the company’s operations. Regulators are charged with ensuring that depositors and policyholders--the company’s customers--do not lose out if a financial company gets in trouble.
For that reason, they have the right to seize a bank, thrift or insurance company if its operations put company customers at risk. They can’t and won’t seize the holding company, but by taking control of the regulated subsidiaries, they usually take the bulk of the firm’s assets.
“Generally, all shareholders are left with is litigation value,” said Gareth Plank, a thrift analyst with Dean Witter Reynolds in San Francisco.
“Shareholders often file class-action lawsuits against the board of directors or the company’s accountants, and sometimes somebody’s insurer will write a small check,” he added. “But, usually, by the time a financial institution gets taken over, there is virtually nothing left to liquidate.”
Obviously, this poses great risks to those who invest in a faltering financial services firm. The risks can be so great, in fact, that some advise consumers to bail out of a financial stock at the first hint of trouble.
Yet others maintain that such panic selling is costly and often ill-advised.
Consider, for example, San Francisco-based BankAmerica Corp., which posted record-breaking losses only five years ago. The company’s stock price had plunged, and some speculated that BankAmerica, one of the nation’s oldest and largest financial institutions, was about to go down the tubes.
Today, although the bank is grappling with many of the same ills as the rest of the nation’s financial institutions, there is no talk of failure. And the company’s stock price has more than quadrupled since those troubled days.
Nevertheless, it is very difficult to make money on a financial turnaround, Plank says. “For every investor who made a fortune on BankAmerica, there are another 10 who bought (failed) Financial Corp. of America or First Executive Corp.”
So how do you determine when and if you should get in or bail out of the shares of a money-losing financial institution?
“You have to release any emotional tie you have to the stock and look at the investment each day. Ask yourself if you would buy those shares today at the going market price,” Plank said. “You better have a reason to own that stock or sell it. If there are greater opportunities elsewhere, you should sell and buy those other opportunities.”
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