Many regional and smaller-cap banking companies are finding there are no easy answers to the question of whether to take the government's money.

For companies like South Financial Group Inc. and Zions Bancorp., there are pros and cons to voluntarily applying for additional funds under the Treasury Department's new Capital Assistance Program.

In favor of doing so: the companies say they could get access to common equity at an attractive price, to help offset further loan losses in a slumping economy. Against: the government's stake in the companies would be highly dilutive to existing shareholders, and more strings could be attached long after the banks have accepted the money.

Already, Cap carries more restrictions than the Treasury's first Capital Purchase Program, including a higher 9% dividend than the initial 5% dividend for the CPP, common stock dividends restricted to a penny, further restrictions on executive compensation per the Emergency Economic Stabilization Act of 2009, and closer monitoring of how the additional capital would be used to further lending activities.

Not to mention, the government could become a major shareholder, increasing its sway over institutions.

Still, given the uncertainty of the economy, South Financial's chief financial officer, James Gordon, said it makes sense to consider applying for Cap funds, even though the Greenville, S.C., company currently has adequate common equity.

At the end of 2008 its tangible common equity to tangible assets ratio was 6.05%, and it will rise pro forma to 7.84% in 2011 after the conversion of certain mandatory convertible preferred shares the company issued last year.

Analysts say TCE ratios below 5% generally are cause for concern, though they also say it is better for banks to have even higher ratios if their credit is deteriorating.

"When you have this much uncertainty, the one thing that is king is capital, whatever form that capital may come in," Gordon said in an interview last week. "You don't just dismiss it because it comes from the government. You've got to be prudent and evaluate it fully, and make the most informed decision possible."

The $13.8 billion-asset South Financial received $347 million in December from the Treasury's first program.

Cap involves more introspection for regional and smaller-cap banks than for the largest banks, which have no choice but to subject themselves to the government's stress tests to determine if they need more funds; companies with assets under $100 billion can voluntarily apply to receive additional capital under the program. Such companies would also be allowed to exchange the preferred shares they have already received under CPP for the new program's mandatory convertible preferred shares, to increase their tangible common equity ratios. (Cap is also open to companies that did not participate in the Treasury's first program.)

While it is not clear whether or not these companies would also have to undergo the government's stress tests, experts say banks with low tangible common equity ratios or continued asset-quality troubles should strongly consider applying for the federal money, as the additional common capital would help absorb further credit losses.

"The biggest advantage of the Cap program is that it can provide capital in a marketplace where private capital is not readily accessible," said Aaron Deer, an analyst at Sandler O'Neill & Partners LP. "But for many companies that are trading at discounts to tangible book, this is going to be very dilutive."

The $55 billion-asset Zions, which received $1.4 billion from the government in the fall, is considering whether to apply for additional capital and whether the $14 a share it would receive would be enough to offset heavy dilution, said Doyle Arnold, the Salt Lake City company's CFO. Banks have until May 25 to decide to apply for more funds and until November to decide to take it.

"It's in the best interests of my shareholders to have this 'insurance policy,' and we're waiting to see if the stated terms remain the same — that we have the right, but not the obligation to issue capital to the government," Arnold said in an interview last week.

For Arnold, the main sticking point would be the dilution, not mounting restrictions that could come from the administration and Congress.

"I don't necessarily like restrictions, but under the existing CPP program, the government already has the right to change any terms or conditions unilaterally by contract," Arnold said.

Lana Chan, an analyst with Bank of Montreal's BMO Capital Markets Corp., said the dilution may be worth it for banks struggling with asset-quality issues, because Cap gives banks access to additional common equity at a 10% discount they could receive in the private markets, if that is even possible.

"The focus should be more on tangible common equity ratios, as investors are the first stopgap for loan losses," she said.

"With more loan losses coming in commercial and commercial real estate, the alternative may be worse than the dilution."

Chan estimates that TCE ratios at regional and smaller-cap banks would improve more than 200 basis points on average if the institutions converted all their government preferred shares from both programs into common.

Companies whose TCE ratios are below 5% would be wise to consider applying for the new program, Chan said. One example would be UCBH Holdings Inc. in San Francisco, which had a TCE ratio of 4.4% at Dec. 31, though it could convert a certain amount of its existing preferred shares not owned by the government, which would raise its TCE ratio to 5.5%, Chan said.

UCBH spokesman Steve DiMattia said in an e-mail last week that the company had no comment on Chan's opinion.

Other banks with slightly better capital positions but facing further credit deterioration should also consider applying, said Andy Stapp, an analyst at B. Riley & Co. Inc. South Financial is a good example, Stapp said, as it is still working to address the ailing Florida real estate markets where half of its residential construction and development portfolio is still located, as well as its exposure to the coastal South Carolina condominium market.

Robert Patten, an analyst at Regions Financial Corp.'s Morgan Keegan & Co. Inc., said battered companies such as Colonial Bancgroup Inc. in Montgomery, Ala., and BankAtlantic Bancorp Inc. in Fort Lauderdale should also consider applying for Cap, because their capital needs are so great. However, the companies still have not gotten approval for the Treasury's first program, Patten said.

Colonial and BankAtlantic did not return phone calls.

Patten said most banking companies will likely refrain from applying for additional government capital and incur dilution unless they absolutely thought it was needed.

"Most banks will earn their way through this cycle over the next eight to 10 quarters," he said. "While there is no quick fix, banks' pretax, pre-provision earnings will allow for continued reserve build and catch up in chargeoffs during this period."

Still, regulators behind the scenes may strongly encourage struggling banks, even those with assets of less than $100 billion, to take the additional funds under Cap, Patten said.

While Zions' Arnold is more resigned to the types of new restrictions on Cap participants, others may balk, particularly if the government puts compensation limits on commercial loan officers and other leading producers, said James M. Rockett, a partner at Bingham McCutchen LLP in San Francisco.

"This could disincentivize top producers from staying at an organization, because they aren't going to be paid at a competitive level that reflects their value," Rockett said.

Those people could defect to banks that did not take government money, or they might leave the banking industry altogether.

Gary Townsend, the chief executive at Hill-Townsend Capital LLC, said the government could more easily micromanage a bank once it holds a bigger stake. Some requirements could be anathema to basic profit models, such as forcing the institutions to make loans strictly to satisfy social or political needs, even if the loans do not make good business sense.

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