A Community Bank Directors Advisor

Issue #13 - July 2008  

 

Capital is King

By John F. Stuart, Reitner, Stuart & Moore

Is this 1990 all over again? The experts differ on this question and it is, at least at this point, difficult to discern whose crystal ball might be best.  Irrespective of whether there will be numerous bank failures such as occurred in 1988-90 or whether this is only a speed bump on the road to banking fortune, there is one key truism for this era – Capital is King.

Unlike the late ‘80s and early ‘90s when even Citigroup could not fund its capital needs except from a Saudi prince, most experts believe that there is a great deal of capital waiting to be invested, particularly from private equity funds and institutional investors.  Regulators should be thrilled by this eventuality and the funds are doing a good job of advertising themselves and their availability to the regulators. Additionally some of the major hurdles to investment by private funds may be disappearing as it has been reported that staff will be presenting to the Federal Reserve Board relaxed limitations under the Bank Holding Company Act for non-traditional “companies” investing in banks both on a passive and controlling basis. These two factors should hopefully lead to regulators encouraging or forcing supervisory acquisitions rather than the failed bank strategy of an earlier era. Thus, for those institutions suffering from loan problems, capital is the key to surviving the regulatory process.

Capital is also king for healthy institutions since it is a key to the opportunities that arise from the misfortune of others. Those institutions that are capital rich will be in a more favorable position to reap the opportunities for asset purchases, branch purchases, and regulator initiated or assisted transactions.

Irrespective of your reason for needing capital, it is always better to raise it before you need it. On this point, the numbers don’t lie. Investment bankers suggest that since early fall of 2007 more than $150 billion in capital has been added to the banking system. The lion’s share of this has been raised by the money centers and super-regionals that are either getting a head start on their credit problems or bulking up for strategic acquisition opportunities presented by the economy. As is often the case, community banks are likely to trail the trend of their bigger brothers by two quarters or so.    

So what are the emerging guideposts for capital expansion? While no one security or strategy is correct for everybody, there a couple of things which are becoming obvious:

  1. The pooled trust preferred  deals that fueled the expansion of the last several years appear dead. While selected institutions may have some success in private or even public offerings, the execution risk on a trust preferred deal for most institutions is going to be very high. While yields may be attractive, the private equity and institutional players are also looking for an equity upside.

  2. Unlike the last credit crisis, there are a much larger number of investment bankers and brokers who are willing to participate in capital expansion projects for community banks. Institutions are not necessarily any longer limited to trying to raise capital through a non-underwritten offering of common stock where directors and officers are the ones trying to beat the bushes for the dollars. The rolodex of these professionals, while costly, may ultimately prove the salvation of many banks.

  3. Convertible preferred stock appears to be the security of choice in this cycle. Not only do these stocks carry heavy coupon rates but they also have the equity upside that the private equity funds and institutions demand. Under prevailing regulatory capital guidelines care has to be taken to assure that the instrument qualifies for tier 1 capital treatment and it is always wise to pre-clear terms with your primary regulator before selling any of the securities.

    In the face of large losses, the hurdle for some community banks will be the legal restrictions on the payment of cash dividends on these types of securities. In some jurisdictions, this disability may be overcome with “pay in kind” provisions in the authorizing instrument.

  4. Rights offerings to existing shareholders are certainly nothing new. However, back-stopping the deal with an investor willing to take down the short-fall is becoming a popular device facilitated by the deep pockets of institutional and private equity players. Rights offerings provide the opportunity for existing shareholders to participate in financings at the lower prices prevailing at this time and are, therefore, a valuable defense to claims that securities were sold too cheaply to new investors.

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John Stuart is a founding partner of the law firm of Reitner, Stuart & Moore. Additional information concerning the firm may be found at their website www.reitnerandstuart.com. He may be reached at 805-545-8590.