Building a Capital Plan for Your Bank
Are investors more interested in banks than they were a few years ago?
That’s what we’re seeing now. There is increasing confidence for investing in the banking sector, specifically for profitable, clean and fast-growing banks. Failures are down. Reserves and capital levels are high. The trend line is extremely strong.
What are investors demanding from capital raises?
Investors want to know how you are going to grow earnings and thus the tangible book value of the bank. They are asking: How long will it take to earn back any dilution that resulted from the capital raise? What edge do you have in growing and getting business from your competition? We have funds that invest in banks and that’s exactly what we ask in our due diligence. If I invest at tangible book value and the bank increases tangible book value per share by 10 percent growth per year for five years, I achieve a 26 percent return on my investment, and three times my money, which is terrific.
What are investments in bank equity and debt yielding?
Bank subordinated debt and preferred stock yields are approximately 4 to 6 percent, depending on how clean the bank is [in terms of asset quality and reputation]. Returns on equity demanded by investors are between 15 and 25 percent.
What advice do you have for bank boards coming up with a capital plan?
I would urge organizations to determine how much capital they need over the next three years based on their organic growth and possibly any acquisitions they may be contemplating. Next, determine what kind of investors you will sell to and at what price. Local investors are going to have different restraints and different return requirements than institutional investors. Very few banks break it down that way. Investors and market valuations are changing. Investors are moving away from a price to tangible book valuation, which is almost like a liquidation value and was common during the financial crisis, to an earnings valuation. At the top of the market, banks will trade at take-out valuations, as if they were going to sell. We are in an unusual market where we have investors valuing banks on all three methods. It’s incumbent on a bank to understand what’s appealing to the different investors when trying to access capital—know what slot you fit in, so you know whom to visit with.
How could boards improve their communication with shareholders?
Boards should be communicating with shareholders almost as routinely as they do with their regulators. Shareholders don’t want to be surprised by an event any more than a regulator does. They can schedule additional calls or letters to supplement their quarterly statements or organize more frequent shareholder meetings. This meeting could be either formal or informal, depending on the information needing to be discussed at the meeting. In short, develop a plan to contact the shareholders outside of the proxy season.