The Dow Jones average soared in 1995s first half, but that didn't tempt banks into issuing stock. Infact, stock offerings sank to their lowest level in seven years. Yet debt issues nearly matched last year's torrid pace.

The business of underwriting bank stocks can drive someone to drink.

In another six-month period where stocks climbed 20%, it would be safe to assume that banks would have scrambled over one another to issue more shares of their common stock. But this is an era where capital ratios are still bountiful, and high profits are churning out ample amounts of retained earnings.

Put it all together, and one thing is dear: "There's just been no need for equity capital," says Robert Baldwin, a managing director for Smith Barney, "The direction of the market has been in the other direction," meaning stock buybacks.

As a result, this year's U.S. Banker's rankings of bank and thrift underwriting shows a continuation of a trend that first reared its head in 1993-a falling market for stock issues that continued slumping while a bull market for new debt continued raging.

Only 14 stock issues worth $848 million came to market in the year's first six months, the first time in seven years that banks issued less than $1 billion of new stock in the first half of a year. The last time the market for new issues of bank equities was so soft was 1988. Back then, investors and public companies were still shellshocked from the October 1987 crash. It took months before brokers could look at their Quotrons without a sense of dread.

This year, the investment pattern for stocks has almost been one of panic buying. Yet the level of banks' stock issuance dropped for the third year in a row. This year's stock offering total was only half the $1.6 billion netted from 21 issues in the first half of 1994. Two years ago, there were 41 issues worth $4.9 billion.

Those softening figures stand in sharp contrast to the almost frenzied market in bank debt. The $37.5 billion of issuance of bonds and notes was off only slightly from last year's first-half record of $38.9 billion.

The underwriting rankings are supplied by Securities Data Co., which like U.S. Banker's parent company, Faulkner & Gray, is a unit of Thomson Corp.

Merrill Lynch was the leading underwriter for commercial banks, with $5.9 billion in new issues. Almost all of Merrill's total was in debt. The $369 million in stock underwriting it had accounted for nearly 45% of that market. The second busiest firm overall was J.P. Morgan & Co., with $5.1 billion in bank underwriting, all of it for debt.

The first half's total value of commercial bank stock and bond issues was $38.3 billion, about 5% less than the record $40.5 billion total for the same period in 1994.

Lehman Brothers was the top issuer in a very soft thrift market, with four issues worth $475 million, giving it 31% of the market there. Lehman had the third-highest total among underwriters of commercial bank securities.

[Expanded Picture]While there was no need for equity capital, banks issued so much debt this year because "the underlying asset growth was quite strong, and they needed to maintain the capital supporting that," says Smith Barney's Baldwin.

On the one hand, the extra Tier 1 capital had to be worked off somehow. But in this day and age, banks aren't raising their dividends, not when the risk of a recession is always around the corner.

[Expanded Picture]"You want to manage your dividend at a level you can keep paying," says Michael Nugent, vice president of corporate finance for Citicorp.

Share repurchases are now the preferred way to increase shareholder value. In June, Citicorp said it would buy back $3 billion of its stock.

At same time, there's been a strong loan demand for many banks. Nugent says it's been too broad-based to pinpoint any one factor. So while banks have had a surfeit of core capital, they've had to find funding for this asset growth. Back in 1993, the Securities and Exchange Commission cut out much of the paperwork for new bond issues, and the bank debt market has thrived ever since.

"Banks' ability to fund through the debt markets is much more flexible than it was 5 or 10 years ago," says John Hopkins, a managing director for Lehman Brothers. Investors are much more familiar with previously unknown regional and small bank holding companies, and they have grown comfortable with unconventional maturities. There was a time when underwriters wouldn't touch a note with a maturity of 19 months, for example. Now, that sort of thing happens almost every day. When the price is right, a bank can essentially tailor a bond's maturity to its own needs.

"Banks can basically fund precisely where they want to along the yield curve," says Hopkins. "Plus, there's very little administrative cost with doing that." In today's environment, when a bank needs to fund $100 million in new assets, it's usually less expensive to do that through issuing notes than raising that level of retail deposits.

Fortunately for the banks who came to market, it was a good time to issue that debt. Not only did rates fall, but the spreads of bank-issued debt over Treasuries with comparable maturities steadily dropped until May, according to Ethan Heisler, a bond analyst with Salomon Brothers. But by May, that trend had reversed, cooling off the new debt market just before the end of the first half.

Citi may have made one of the largest share buybacks, but it was hardly the only bank doing so. Consider FFY Financial Corp., a $575-million-asset thrift holding company in Youngstown, OH, which began buying its shares in the open market two years ago. Then it had 6.6 million shares outstanding. In May, when it announced it would purchase another 285,000 shares of its common, it had 5.7 million shares.

While FFY's size and market are a far cry from the giant Citicorp's, two things the institutions have in common are an excess of capital and a desire to avoid raising dividends, says Jeffrey Francis, FFY's vice president and treasurer.

This year, the thrift company's capital ratio will drop from 190/o to 17% because of share buybacks, he estimates. Ultimately, he'd like to work the ratio down to 10% or 11%, a figure that he acknowledges is far higher than what many other bank and thrift financial officers might say is ideal--but the time when capital levels were dangerously low is still fresh in his mind.

"Capital is a funny commodity," Francis says. "When you need it, you can't find it. When you've got it, it's a load."

Notes and More Notes

While the ease of raising capital through the debt markets and low rates spurred many banks into issuing notes, one institution, First Empire State Financial Corp. of Buffalo, NY, had been unheard from until the end of June. That's when First Empire's lead bank, Manufacturers and Traders Trust, came to market with a $100-million issue of 10-year notes yielding 7%, the first debt issue the bank had sold in two years.

Technically, the issue wasn't part of the first half's financings in that it didn't close until Monday, July 3. But M&T had issued the prospectus and priced the deal by the previous Wednesday, so it was influenced by the same factors that drove other deals during that time, says Darlene Spychala, First Empire's vice president of corporate finance.

The bank issued the notes because "it was an opportune time to lock in some long-term, low-rate debt," Spychala says.

Unlike other banks whose balance sheets were flush with capital, M&T was seeking a higher ratio.

The bank's overall capital stood at 10.6% at the end of March, and according to its prospectus, the 10-year notes would raise that level to nearly 11.2%.

Given the trend of the past few years, the forecast for banks' debt issuance remains bullish. But it is offset by an equally bearish outlook on stock issuance. Hopkins of Lehman Brothers doesn't see banks' overall capital picture changing any time soon. The most common reason banks have for issuing stock is to fund acquisitions, but most banks can fund acquisitions outright through existing capital, and mergers of equals are usually done through a pooling of assets.

In today's environment, neither case would call for a stock offering.

"It's unlikely you're going to see any need for equity capital in the next few years," Hopkins says. Bank underwriters take heed.

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