Hundreds of community banks are in danger of falling short of stricter capital requirements, if the economy once again stalls, according to a new report.
And there's a bigger problem: many of these banks have limited options to raise capital in advance of the new requirements, some bankers say.
The proposed Basel III capital standards haven't been approved and there is some question whether they will even apply to community banks. But if the new guidelines were in place, prolonged high unemployment rates and other negative economic events could produce an avalanche of smaller banks falling short, according to results of stress tests conducted New York-based Trepp.
More than 700 banks with $1 billion of assets or less failed Trepp's stress tests, which required the banks to meet certain ratios — Tier 1 leverage of 4%; Tier 1 common of 4.5%; Tier 1 risk of 6%; and total risk of 8%. It tested about 5,600 banks.
Many banks that failed Trepp's test are in states that were hot spots for bank failures the past five years, including Illinois, Georgia and Florida. But some areas where banks fell short are in states that had relatively few bank failures, such as Tennessee and Texas. Trepp did not release the names of the banks that failed.
The results should prompt many community banks to make capital planning one of their top priorities, says Matt Anderson, a banking analyst at Trepp.
"There is still quite a bit of time before the Basel rules" take effect, Anderson says. "But investors are already looking at those standards and wanting to know which banks would pass and which would need additional capital."
For healthy banks, capital is available in both the public and private markets, says Derek Cunningham, a managing director with investment bank Commerce Street Capital. It helps to have a stated corporate purpose for the capital, rather than just building a capital cushion, he says.
"If you don't have a very specific reason to raise money, then money is very difficult to raise," Cunningham says. "If your reason is that 'new capital requirements' are coming — that's not sexy enough for investors. But if you're buying a bank at a discount, then that can work."
Berkshire Hills Bancorp (BHLB), a $5.3 billion-asset company in Pittsfield, Mass., last month issued $75 million in subordinated debt to help fund the cash portion of its offer to acquire Beacon Federal Bancorp. In August, First Carolina Financial Services (which was advised by Cunningham and Commerce Street) raised $13 million in common equity to buy First Carolina State Bank in Rocky Mount, N.C., from Capitol Bancorp (CBRCQ).
"If you are a quality bank that has shown an appetite and a track record for acquisitions, then the equity markets are open for you today," says Lee Burrows, chief executive of Banks Street Partners, an Atlanta-based investment bank.
There can be other reasons to justify a capital raise. Lakeland Bancorp (LBAI) pursued its $25 million capital raise partly because of the proposed new capital guidelines, says Joseph Hurley, chief financial officer at the $2.9 billion-asset company, based in Oak Ridge, N.J. But Lakeland also wanted to take advantage of an opportunity for a private placement that would allow it to repay expensive trust-preferred securities, he says.
"We were anticipating we would have been in compliance with Basel, probably even before the capital raise," Hurley says.
The $719 million-asset Florida Capital Group has raised $33.5 million over the past 10 months, including the closing of $17.3 million during the third quarter. But Chief Executive Malcolm Jones thinks it still would not be enough for the Jacksonville, Fla.-based company to meet Basel III standards.
"Regulators are pushing for capital at every turn you make, and I'm not sure where the end is," Jones says.
The $33.5 million was raised only from existing shareholders, Jones says. Even though the holding company of Florida Capital Bank has been trying to raise money from outside institutional investors for the past two years, "it's just about nonexistent unless you are clean," he says.
Suffolk Bancorp (SUBK), a $1.6 billion-asset company in Riverhead, N.Y., last month closed a $25 million private placement with a group of institutional investors. Suffolk's chief executive, Howard Bluver, specifically cited the proposed Basel guidelines in a September interview with American Banker.
"Capital is no longer a concern for this bank," Bluver said. "We think we have more than adequate capital to grow the bank and cover any future rules that may come into place, like Basel III."
Others haven't been as lucky. Polonia Bancorp (PBCP), a $258 million-asset holding company for a mutual thrift in Huntingdon Valley, Pa., pulled its stock sale a few weeks after it had given depositors a chance to double their orders after having received insufficient orders to complete the offering.
While subordinated debt might be the first choice for many banks seeking to raise capital, it's not a realistic option for most, Anderson and Cunningham said. A debt offering would take advantage of low rates and boost earnings, but regulators prefer common equity since it directly affects capital ratios.
"Common equity has the benefit of creating a cushion for banks," Anderson says. "But common equity doesn't have required dividend payments. So when times are tough, you can ratchet your dividend down as far as you want."
"For many banks," Cunningham says, "really their only option will be selling common equity at a deep discount."