Views: What Are the Challenges that Banks Face To Raise Capital?

Gary S. Corner

Raising or replacing capital today, whether in the public or private markets, is challenging for many community banks. Potential investors are scarce, with a growing number more interested in acquiring branches and assets of failed banks, rather than purchasing stock or assets of open banks. The pooled trust-preferred securities market is no longer active and unlikely to redevelop anytime soon. Community banks are also finding it difficult to issue long-term debt, as institutional investors conduct risk-return trade-offs.

The St. Louis Fed’s Banking Supervision and Regulation division recently hosted a panel of private industry experts on the subject of raising capital. The presentation, called Industry Perspectives: Tips on Raising Bank Capital and the Trust Preferred Securities Market, was held as an “Ask the Fed” call-in session for senior officers of state-member banks and bank holding companies. Members of the panel indicated that the market distinguishes between two types of capital offerings: offensive and defensive.

  • Offensive capital is raised for the purpose of supporting growth, either internally through mergers and acquisitions or externally through FDIC-assisted acquisitions of failing banks. The objective is to take advantage of market opportunities that potentially may lead to equity returns that are attractive to investors.
  • Defensive capital, on the other hand, is typically sought by institutions wishing to offset certain elevated risk factors within the organization, such as nonperforming assets.

Panel members indicated that investors remain available for offensive capital-raising and will purchase new equity at reasonable valuations. However, investors in defensive capital-raising are scarce and require a hefty discount in valuation, thereby diluting existing shareholders. The panel also identified other factors that affect potential investor interest; these factors include the banking organization’s risk profile, asset size and the perceived marketability of the stock over time.

What Makes a Public Offering Successful?

Panel members discussed the recent success of equity offerings by publicly traded banking organizations. The equity offerings ranged in size from $10 million to $500 million. Not surprisingly, the panelists found that a banking organization’s level of non-performing assets was a primary determination in the price dilution required for a successful offering. In general, the degree of dilution became more pronounced as nonperforming assets exceeded 4 percent of total assets. Price levels across all observed equity transactions ranged from a small fraction of tangible book value upward to nearly two times. The median price level was slightly in excess of tangible book value. Median nonperforming assets were less than 2 percent.

Realities of Raising Defensive Capital

Raising defensive capital in nonpublicly traded or lightly traded organizations has become a significant challenge. Panel members noted that banking organizations that are successful in doing so often first pass the hat around the board room table. When successful, this strong signal of confidence from insiders is important. Panel members also noted that loyal community members may wish to come to the table to aid their local bank. Throughout this process, it is important to seek qualified legal counsel to guide your institution in meeting appropriate disclosure requirements.

Alternatives To Raising Capital

Some community banking organizations have considered asset sales or transfers as a means of improving their capital ratios. The challenge to this option can be found in the wide bid/ask spread that typically exists between sellers of bank assets and potential buyers. A large bid/ask spread can result in a sizeable loss to the seller.

When an asset sale is unattractive, some organizations have considered the transfer of problem assets from the bank to the parent holding company. Such transfers can be structured in a way to increase capital ratios, enhance earnings performance indicators and improve asset quality at the bank level. If your organization is considering such a transaction, please refer to the related article, “When Problems Arise: The Transfer of Problem Assets from Banks to Holding Companies,” in the winter 2009 edition of Central Banker.

If you have any questions or would like more information on this topic, contact Gary Corner at 314-444-8849. Contact Patrick Pahl concerning "Ask the Fed" at 314-444-8858.

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