Capital: The Wheels of the Bus
By Stephen Klein
July 22, 2010
Why Capital Is So Critical
This may seem obvious, but capital is the key to survival in today’s economic and regulatory environment. It truly represents the wheels of the bus. As one client aptly put it – either you’re on the bus or you’re under the bus.
Capital is critical for a variety of reasons, including:
- It clearly improves all your key ratios.
- It allows you flexibility in negotiating with borrowers and disposing of troubled assets.
- It creates a more positive mindset for bank regulators, especially when they examine your bank.
- It increases your lending limit and provides additional resources to lend and grow again in the future.
- It provides a cushion for unforeseen challenges.
The Regulatory Mantra
Every administrative action, formal or informal, has a capital requirement. It is at the center of what bank regulators look for, along with accurately and timely identifying your credit issues. The optimum time to raise capital is before you absolutely need it and certainly before the examiners pay you a visit. Our experience is that once banks hit a certain point, raising capital becomes extremely challenging and massively dilutive.
The Dilution Dilemma
A year ago, I attended a banking conference in Denver and a senior Federal Reserve official stated on a panel that DILUTION was something banks had to accept if they expected to raise capital in today’s environment. In essence, that person was saying “get over it.” I thought that was a bit harsh, but time has shown the truth to that statement. Just look at a number of high profile banks which have completed massively dilutive capital raises. Dilution beats the alternative – survival is the name of the game today.
What We Are Seeing Out There
The public capital market has been up and down, but several of our clients have successfully navigated these waters with substantial common stock raises. Several of our other clients have had successful private offerings and others are exploring that avenue as well. Another potential vehicle some have used with mixed success are so-called shareholder rights offerings. Those depend on the condition of the bank and the investment appetite of existing shareholders and the surrounding community. The good news is that a number of community banks have been able to bolster their capital during the past year.
The Crystal Ball
While, obviously, no one really knows what lies ahead, we expect additional bank failures in the Northwest, with a continuing stream of FDIC-assisted transactions. Until these end, I think examiners will still be very cautious and whole bank mergers will be limited. On the bright side, there does seem to be some stabilization in asset quality for many of the banks, reversing the downward trend experienced during the past two years. Hopefully, this positive trend will continue.
Conclusion
CAPITAL IS KING! Capital truly is the wheels of the bus – without it you’re stuck in the mud. While not a cure-all, sufficient fresh capital should significantly improve relationships with regulators and let you operate your bank from an offensive rather than defensive standpoint. While concerns about shareholder dilution are valid, it is clear that it beats the alternative.
