Momentum Builds to Get More Capital into Smallest Banks

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An effort to encourage more private-equity investment in banks is gaining momentum.

A group organized by the Conference of State Bank Supervisors has lined up support from investment bankers, private investors and lawyers to review existing legislation. They are looking at ways to make investment in small banks more appealing to outside investors.

Diminished access to capital is one of the most important issues facing smaller banks, says Joshua Siegel, the chief executive of StoneCastle Partners, a New York fund that invests in community banks.

"There's a $90 billion need for capital from community banks," Siegel says. Healthy and struggling banks need capital to fund growth, to cover loan losses that are still lurking in their portfolios, and to meet what is expected to be higher capital requirements.

One of the big stumbling blocks is the Bank Holding Company Act's requirement that outside investors who own more than 24.9% of a bank must be regulated as a bank holding company. That means that banks with assets of less than $1 billion are largely shut out of the market for private equity, says Brennan Ryan, a lawyer at Nelson Mullins Riley & Scarborough.

For instance, a bank with $100 million in common equity would be unable to accept more than $25 million from an outside firm, unless that investor was willing to accept added regulatory oversight.

"That's too small for private equity," Siegel says. "It's not worth their time. It takes as much effort to write a $50 million check as it does to write a $500 million check."

"We run into this all the time," says Ryan, who has advised banks and investors on raising capital. "The first thing the investor says is, 'I don't want to be a bank holding company, because of all the regulations.' "

This particular area of the banking industry is also partly controlled by the Change in Bank Control Act. Ryan says the group may need to address that law as well.

The CSBS-led group does not yet have specific legislation drafted, and it does not have a timetable for recruiting a member of Congress to file a bill, says Michael Stevens, a senior executive vice president with the bank supervisor group.

The final legislation might specifically address changes to the Bank Holding Company Act, or it could adopt another tactic.

"We're open to whatever the best solution is," Stevens says.

A huge number of banks are challenged.

Of the 7,437 banks operating in the United States, about 92% have assets of $1 billion or less, according to data from SNL Financial in Charlottesville, Va.

Many of those banks are attempting to raise capital. Investors are interested, but only up until the point when the regulations kick in, says Lee Burrows, the CEO of Banks Street Partners in Atlanta.

"If there's anything that's needed in the industry, it's additional capital," Burrows says.

"But investors are worried" that if they invest above 24.9% "they would have to be the source of strength for the bank, and they don't want to be that."

It's understandable that the Federal Deposit Insurance Corp. and other regulators are wary of private-equity investments in community banks, Ryan says.

If a private-equity firm that controls a community bank leads the institution into risky ventures, and the bank ultimately fails, "then it's the FDIC and other regulators left holding the bag," Ryan says.

Even regulators in states that have seen a large number of bank failures appear to be open to encouraging an increase in private-equity investment in community banks.

"The more things we can do to make it easier for community banks to raise capital, so they have the funds to lend to consumers, is beneficial," says Scott Clarke, assistant director of banking for the Illinois Department of Financial and Professional Regulation.

"I think there is room to distinguish that between a community bank and a large bank," Clarke says.

Since 2008, there have been 51 bank failures in Illinois, and more than 30 banks based in the state remain in the Treasury Department's Troubled Asset Relief Program.

Most state banking supervisors would feel more comfortable with private-equity investments, "as long as they know who the private-equity investor is," Siegel says.

Any change to the Bank Holding Company Act would require approval from both Congress and the Federal Reserve Board.

Barbara Hagenbaugh, a Fed spokeswoman, declined to comment.

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Community banking Law and regulation
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