Industries Banking/Finance

Capital pains

Banks face tough sell in public stock offerings

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Print this page by Doug Childers

Herb Marth can tell you exactly when his bank took a hit.

“Fannie Mae and Freddie Mac went broke, and our bank lost approximately $18 million” as the value of its investment in the mortgage giants plummeted in late 2008, says Marth, president and CEO of Powhatan-based Central Virginia Bankshares, the parent company of Central Virginia Bank.

The losses put Central Virginia Bankshares in a tight spot. To shore up its capital, it announced in June that it would raise $15 million in a public stock offering. But the market for community bank stocks soured, and the company decided in September to postpone the public offering. “The market wasn’t there,” Marth says. “If no one’s there to buy the shares, why go through with it?”

Central Virginia Bankshares isn’t the only financial institution in the commonwealth having trouble selling stock in a tough market. Arlington-based Virginia Commerce Bancorp and Richmond-based Virginia Business Bank also retracted public stock offerings last year.

And four publicly traded Virginia banks delayed or withdrew stock offerings in 2009.

Before that, the last time a Virginia bank withdrew a stock offering was in 2004, according to SNL Financial, a Charlottesville-based distributor of financial information. “Seven withdrawn offerings in the past two years is an abnormally high number,” says Kevin Curry, senior analyst for SNL.

It’s not all bad news. Virginia’s banks generally have performed well during the “Great Recession” and its subsequent slow recovery in comparison with financial institutions in many other states.

While regulators closed 133 commercial banks and 24 savings and loan institutions in the U.S. in 2010, Virginia saw no commercial banks and only one savings and loan close during the year, according to SNL. (Martinsville-based Imperial Savings and Loan, a thrift with assets of under $10 million, failed in August.)

Nonetheless, as of Nov. 30, 14 Virginia banks, including Central Virginia Bankshares and Virginia Business Bank, were under regulatory arrangements to improve their capital.

Banks that aren’t well capitalized according to regulatory standards will find it more difficult to lend, says Bruce Whitehurst, president and CEO of the Virginia Bankers Association. That situation in turn could affect small businesses trying to find a loan.

Overall, Virginia’s business-friendly economy and its low unemployment relative to other states have helped establish a solid banking industry, Whitehurst says. “A diverse economy and good economic climate are good environments for a strong banking industry, and that helps bankers drive growth,” he says. “It’s a virtuous circle.”

Lingering TARP concerns
These days, though, the circle has turned vicious. The sluggish recovery has left businesses and consumers too uncertain about the future to reach into their wallets or ask for a loan. Meanwhile, for community banks that haven’t repaid funds received from the Treasury Department’s Troubled Asset Relief Program (TARP), the burden to raise more capital looms. And owing the government TARP funds isn’t making that task easier, especially if a bank hopes to repay the money through public stock offerings.

“Banks that applied for TARP and didn’t get it — the worst cases — are trading at 59 percent of their tangible book value nationwide,” says Jake Savage, senior managing director and co-head of equity investment banking at Scott & Stringfellow, a brokerage and investment banking firm in Richmond. (Tangible book value is equal to a company’s total book value minus intangible assets such as core deposit intangibles, goodwill, patents and intellectual property.) “Banks participating in TARP are trading at 70 percent of tangible book value. Banks that applied but declined TARP are trading at 102 percent of book. And the banks that redeemed TARP are in the catbird seat. They’re trading at 132 percent of tangible book.”

In Virginia, 27 community banks accepted TARP funds, and 22 of them had not repaid the money as of Nov. 30, according to SNL Financial. While the federal government hasn’t imposed a deadline for TARP repayments, the rate a bank pays for the funds will increase to 9 percent (up from 5 percent) five years after the bank joined the program.

TARP concerns aren’t limited to community banks. According to the Atlanta Journal-Constitution, James Wells, the CEO of Atlanta-based SunTrust Banks Inc., said at New York financial services conference in December that an upcoming “stress test” for the nation’s 19 largest banks could determine when SunTrust will repay $4.85 billion in TARP funds. SunTrust is one of Virginia’s largest banks in terms of market share.

Saying it preferred to wait until market conditions improved, SunTrust did not join a number of banks that sold stock in 2009 to repay their TARP funds. The company still wants to avoid a stock offering because it would dilute the holdings of current shareholders.

Under the stress test, federal regulators will determine if the banks have adequate capital cushions to handle another economic downturn. The results of the test are not expected until March. The first round of stress tests occurred in 2009.

One of those 19 major U.S. banks is McLean-based Capital One Financial Corp., which repaid its TARP money — $3.55 billion, the largest chunk given to a Virginia-based bank — in 2009. “We’re already looking ahead to 2011 and feeling that we’re in a very strong position with respect to capital of all forms,” Richard Fairbank, the company’s chairman and CEO, told a group of analysts and investors in November. Capital One is now the nation’s ninth largest bank by deposits and eighth largest by managed loans.

Another major bank with a Virginia presence, San Francisco-based Wells Fargo & Co., received $25 billion in TARP funds in 2008 and repaid the money a year later. Wells Fargo, which acquired Wachovia Bank, has no immediate plans to raise new capital. It has a strong capital position, a company spokesperson says, with a Tier 1 capital ratio of 10.9 percent at the end of the third quarter last year. (Federal regulators deem bank holding companies with a Tier 1 capital ratio of at least 4 percent to be adequately capitalized, while those with a ratio of at least 6 percent are declared well capitalized.)

“Bigger banks that could raise capital raised it one to one-and-a-half years ago,” Savage says.  “They were able to do it, and they did, just to pay TARP back and be able to move on down the road with much less government oversight.”

Timing your move
So what’s a bank looking to raise capital to do?  It depends on the bank’s capital reserve and the number of bad loans it has on its books, Savage says. Banks wary of public stock offerings in this economic climate could raise capital through rights offerings or with private investors. That was the route taken by Virginia Commerce. It reached a deal with institutional investors in September to raise up to $21.4 million — $10 million through common stock and $11.4 million through two series of warrants —  after withdrawing a public stock offering in July. None of the Series A or Series B warrants had been exercised as of Nov. 30, according to SNL.
Bank of Virginia also turned to private investors, announcing in December that Cordia Bancorp Inc., a Washington investment firm, had bought 59.8 percent of the bank’s outstanding shares. The deal infused $10.3 million into the Midlothian-based bank.

In September, Hampton Roads Bankshares Inc., the Norfolk-based parent company of Bank of Hampton Roads and Shore Bank,  announced that it had sold 587.5 million new common shares to a group of private investors in a deal worth $235 million. The company raised an additional $40 million through a rights offering. (The company announced in November that the Securities and Exchange Commission has begun an “informal inquiry” into its provisions and allowances for loan losses and tax asset valuation allowances in fiscal years 2008 through 2010.)

“In the worst-case scenario, banks that will need to raise capital — particularly those trading at significant discounts to book value — should consider their strategic alternatives before diluting current shareholders significantly,” Savage says. “This should assure a premium over the current price compared to a material discount and massive ownership dilution for a scenario in which they offer stock to the public.”

For banks that haven’t reached that point, Savage’s recommendation is blunt. “Don’t do anything,” he says. “There’s an old saying: If you have to raise capital, it’s the worst time in the world to do it.”

Savage’s advice also applies to banks that haven’t repaid their TARP funds. A well-capitalized bank with relatively few bad loans probably would be wise to repay TARP over two to four years rather than diluting its shares with a public stock offering in the present market, he says. “That’s probably the best thing for shareholders,” he adds. Ultimately, as asset quality stabilizes, “banks will earn a lot of money.”

That’s the strategy Central Virginia Bankshares is taking. After postponing its public stock offering in September, the company shrank its total assets to $430 million (from a high of $500 million). It still needs to repay the $11.4 million it received from TARP, and regulators have asked it to raise capital. Currently, Central Virginia Bank is rated “well-capitalized” in two of the three key ratios regulators use to measure a bank’s financial health, and it’s rated “adequately capitalized” in the third category.

“Our bank is experiencing weak loan demand like every other bank,” Marth says. “But without the collapse of Fannie Mae and Freddie Mac, we’d have the capital to satisfy our regulators.”

The first step Central Virginia Bankshares takes toward recovering to full health will be raising $15 million in a common-stock issuance, and it will do that this spring, if the market improves enough. Then the company can consider repaying TARP. For now, though, Marth says, “We’re watching the market. We have good reason to think the first quarter of 2011 will be better.”

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