Publications & Resources
March/April 2009
Focus: Got Capital?
TARP Money or Not, Secondary Offerings Belong in Your Plan
By Lee Bradley
After a bad storm sweeps through a community, residents always go out to assess the damage. And we have all seen rooftops covered with blue tarps in the aftermath of a tornado or hurricane. These tarps give occupants time to inspect the damage and provide cover until repairs can be made. Having been the victim of a tornado several years ago, I know the value of getting a blue tarp up to keep the rain out, hoping a roofer can make the needed repairs quickly.
In today’s economic storm, tarps have come to banking. But in this case, they are green, not blue, and they are being issued by the U.S. Department of the Treasury, not Home Depot. The green TARP (Troubled Assets Relief Program) from the U.S. Treasury has terms and conditions – interest payments, warrants for equity ownership, and executive compensation and corporate governance requirements.
Consider raising capital in 2009 to enhance the muscle
of your TARP money
TARP money will only be a temporary fix for our struggling economy.
Traditional uses of capital in the banking sector have included expanding
through acquisition, pursuing organic growth by lending or even hoarding funds
to support existing operations.
Raising additional capital in 2009 is a great way to enhance your bank’s goals. In today’s market, if you need capital for the next two to three years, I suggest using TARP for half of the necessary funds and raising the other half.
So, where do you not find capital? Institutional investors, trust preferreds and traditional public offerings are not currently viable options. During the past several years, a core of institutional investors entered the market, willing and able to invest in regional and community banks across the U.S. With recent developments, that source of funding has been reduced dramatically.
During the past five years, banks were also able to access trust preferred to augment capital through securitization. But, due to recent dislocations in the segment, securitizations have disappeared. If you can find trust preferred directly, it can be very expensive. Pricing on the issuances of trust preferred in the third quarter, which was mostly to extremely large institutions, averaged 9.75% – well above the 3%-5% available previously. Traditional public offerings leveraging the broker networks of national or major regional broker dealers have also decreased dramatically as investors focus on other stock holdings.
The community offering philosophy is for a bank to raise capital from the people most committed to its success – its existing investors and members of the local community, who, along with ownership, will become the bank’s most ardent customers and advocates. It calls for strong management and a supportive and involved board who will raise the capital in pieces much smaller than an institutional investor.
Hold another capital-raise in 3 to 5 years, replacing
(paying back) TARP money
Unless you are comfortable with the government holding equity in your bank,
it may be wise to think about how you will replace that money. A secondary
offering is an excellent solution.
When should a secondary offering start? If possible, begin in 2009. If, as a public company, you raise funds equal to the TARP money, the amount of warrants issued to the U.S. Treasury are reduced by 50%. Note, however, that under TARP’s Private Bank Capital Purchase Program, while the warrants required are limited to 5% of the preferred shares issued, they will be exercised immediately on issuance, will require payment of a 9% dividend, and there is no ability to reduce the warrants by raising additional capital. Those are all pretty good reasons why you should seriously think about completing a secondary offering to replace the TARP money within a few years of receiving it. The good news is that the economy should recover over time, the current market situation should stabilize and banks will have more options for raising capital.
The key is to raise Tier 1 capital, like common stock, that doesn’t pay any dividends. Then you can redeem the government money and reduce the associated dividends.
Despite the disappearance of the financing alternatives I’ve mentioned, I
believe one alternative still remains viable, even in this market: the community
public offering, or private placement.
This economic storm will pass, and the “green” TARP will help. But you can’t and don’t want to keep it in place for too long. Start making plans to replace it with new capital that comes from your local community.
Lee Bradley is managing director of Commerce Street Capital in Dallas, Texas. This article is for information purposes only and does not constitute a solicitation or offer by Commerce Street Capital, LLC, to buy or sell any securities, futures, options, foreign exchange or other financial instrument, or to provide any investment advice or service. Commerce Street Capital, LLC, is located at 1700 Pacific Avenue, Suite 2020, Dallas, TX 75201, (214) 545-6800, Member FINRA & SIPC. www.commercestreetcapital.com
Unauthorized reproduction of all or part of this material without the express written consent of the author is strictly prohibited. All rights reserved.