Richard Hendrix is always looking for a way to connect banking companies to public capital markets despite ongoing fears between the two sides.
Hendrix, the president and chief executive of FBR & Co., has made it a key part of the growth strategy during downturns. Since the 2009, FBR has completed 13 capital raises, bringing $3.7 billion into banking companies. The most recent deal was a $96 million initial public offering for the struggling HomeStreet Inc. in Seattle, which was the first recapitalization via IPO since the financial crisis.
Hendrix recently spoke with American Banker about re-engaging public markets, what investors look for in a bank, and resetting expectations for investors and banks. Here is an excerpt of the interview.
What characteristics must a bank have to get noticed in the public capital markets?
RICHARD HENDRIX: I've talked to a couple investors about this recently, and asked, "What would it take for you to invest in a healthy bank IPO in terms of pricing and numbers?" I would say that you probably need to be 10%-20% below peer levels in terms of credit statistics. So if the peer group has 1.5% nonperforming assets, you probably need to be 10%-20% better than that. You need to be generating a 10% return on equity with healthy capital levels. … A bank that looks like that can probably get something done in a new IPO that's at a reasonable premium to book value.
Reasonable premium isn't two-times book. Maybe it's 1.15 and then it trades to 1.2 or 1.25. If you're not healthy and you need capital, you're going to have to come in at a lower price, which is at or below book value.
Has the price-to-book value in an offering changed from a year ago, particularly for distressed institutions?
As fears are subsiding around the loan books, investors are generally willing to get closer to book value, but they still want a discount when the banks think that they should get a premium. I know a number of directors and management teams who would like to raise money at a premium of 1.2 to 1.4 times book. But they don't have the ROE to support that pricing. Either the price at which they want to raise capital falls or their ROE goes higher for those expectations to find a market.
There's a disconnect between sellers and buyers in terms of what shares of banks are actually worth and I think that will ultimately work its way through the system. Expectations will get reset on both sides but we're still early in the cycle.
Is that disconnect like the problem we're seeing with bank mergers?
Right. Now, when the market sees something like the HomeStreet [Inc.] IPO, which was done at $44 a share and is now trading at $52-$53, or right around book value; it gives people some confidence in a smaller capital raise. We raised roughly 60% of the total capital that bank has in the IPO. What you really want to do is raise 20%-25% of existing capital so you'll probably not end up with quite as steep a discount.
Where are we in the cycle in terms of investor's comfort with bank earnings?
Everybody is resetting expectations around what bank earnings are going to look like. It is a process that is still ongoing, even with big banks. You've seen a lot of big banks — both domestic and international — say that they have lower ROE targets today than they've had previously. That's going to cascade its way down through the system and then we'll find out where investors ultimately are going to trade bank shares.
The market is a forward-looking entity so I'm not sure that we are as far through the cycle for bank earnings as we are through the expectation resetting process. Good investors can look forward six to eight quarters and anticipate where earnings are going to shake out.
The big wild card is the regulatory environment because nobody knows what it is going to mean or how to price that in, particularly for big banks. I'd say we're three quarters of the way through getting to the point where investors can create a good set of expectations about where earnings are going to be. However, this does not mean we're three quarters of the way through working out all the credit problems and getting to normalized earnings.
As bankers face headwinds such as low interest rates and new regulation, how long will it be before they can start raising capital above book value?
It depends on how badly the bank needs capital and what the capital will be used for. There are a lot of small banks out there that still need to repay [Troubled Asset Relief Program] funds. Ultimately, this will create a capital-raising cycle for small banks. With the environment we're in today, it's going to have to be through equity or business combinations that create the ability to repay. There's capital out there to come into the system but it's not going to come in at any price. How long it takes will have a lot to do with what the use of capital is for. If it's to grow a bank, it's probably going to be a while because if you're the issuer of that capital you're going to wait until you can raise it at a premium to book value. If you have to raise capital because you have a repayment need or something that isn't really growth oriented, you can make it happen sooner rather than later but it is probably going to be at a price you don't like.
Is the mindset shifting to where investors are becoming less fearful of investing in banks but banks are more fearful of going to public markets?
Yes, I think we are right around that point, and it's about the price and what that means in terms of dilution to existing shareholders.
Is now the time for some banks to reconsider public capital markets?
The capital markets are still difficult. We don't have positive flows right now into domestic equity funds — mutual or hedge funds. That is one of the biggest determinants to show the health of the capital markets. We have not seen positive flows in quite a while. In fact, last year we saw significant outflows, and while those outflows have slowed we're not getting much in the way of inflows. Until that happens, we're not going to see a widespread, positive tone to the capital markets.
Will HomeStreet's success encourage more IPOs?
There will be more than one a year but you're not going to see 20 of them. There will be more this year than last year but I think it will be sporadic. There may be two or three grouped together, then a pause, and then a repeat four or five months later. I actually think this fund flow issue is going to be with us for a couple more years and that means that good deals will get done, but I don't think there's going to be a lot of them.