Excess Capital Gives Banks Strategic Options

The banking industry is facing a good problem — how to deploy excess capital.

The industry is well capitalized and that is expected to continue. Thirty percent of banks with less than $100 billion in assets are expected to have more than 200 basis points in excess capital by year end of 2027, according to a presentation from Tom Michaud, CEO of the investment banking firm Keefe, Bruyette & Woods, during Bank Director’s recent Acquire or Be Acquired Conference.

“The capital level today versus 20 years ago is incredible,” says Bill Burgess, co-head of financial services investment banking at Piper Sandler Cos. “It continues to build because the banks are making so much right now. Of all the problems to have, this is a good one. How to deploy that capital is a real topic of conversation.”

There are certain regulatory capital requirements that banks must follow to be considered well capitalized. But in addition to that, most management teams will hold capital beyond those thresholds to feel comfortable, says Jeff Davis, managing director of the consulting firm Mercer Capital’s financial institutions group. The amount above that is generally considered excess capital.

For instance, the regulatory requirement for the community bank leverage ratio is 9% and there is a good chance regulators will decrease this to 8%. In the fourth quarter, almost 1,700 institutions opted to use the community bank leverage ratio, with the average being 12.37%, according to the Federal Deposit Insurance Corp.’s quarterly banking profile.

“Community banks will be very conservative by their nature,” Davis says. But he notes that once banks are past the threshold they feel comfortable with, they should think about how to deploy those funds. “It doesn’t mean you need to use the capital this year, but the business model is leveraging the equity capital to produce returns for shareholders.”

Larger banks prefer the common equity Tier 1 ratio since this accounts for common equity as well as risk-weighted assets, Burgess says. This stood at 14.03% for 2025, according to the FDIC data. The regulatory minimum is 7%, when the stress capital buffer is included.

Bank management teams and boards have a few ways they can put these funds to work, primarily M&A, stock buybacks, dividends or using it to support organic growth. Claude Hanley, a founder and partner at the consulting firm Capital Performance Group, primarily works with banks with under $10 billion in assets, and his clients are mainly considering the last option. This can include taking steps such as boosting lending, implementing new technology and building new branches or renovating existing locations. M&A is also on the table.

“They all feel like they have opportunities to support loan growth or buy other banks,” Hanley adds. “So, it’s a combination of organic growth and M&A. To me, no one within our clients is talking about stock buybacks. It is much more, ‘Let’s put our capital to work for our core banking business.’”

This can be an especially good idea if the bank is already a high performer with a strong return on equity, Davis says. The industry’s return on equity was 12.03% in the fourth quarter of 2025, according to the FDIC’s quarterly banking profile. “The first and best use of capital assuming a competitive or better ROE is to reinvest it into the business,” he adds. “If your ROE is at 7% or 8%, then there are probably multiple other issues you need to deal with.”

However, Hanley acknowledges that larger publicly traded institutions may face more pressure to return excess capital to shareholders through stock buybacks or dividends. Investors tend to like stock repurchases because they can either get cash for their own shares or they see the bank’s stock price get a boost.

Burgess expects more banks to initiate stock repurchase programs. “It is a positive signal that, ‘I think my stock is undervalued,’” he adds.

However, if bank stocks are trading at a healthy premium, then this could dampen repurchase plans since that makes these initiatives more expensive. Burgess notes that bank stocks are currently trading at roughly 1.5 times tangible book value and 11 times earnings. It tends to make more sense for CEOs to do share repurchases when their shares are trading closer to book value, he says.

Increasing dividend payments is another route that banks could go. But this is less attractive than the other options. Bank management teams tend to be reluctant to boost dividends because they don’t want to have to lower them in the future if the need arises. Doing so “is perceived to be a sign of distress,” Burgess says.

“I think if you asked bank CFOs, most would rather buy back the stock at a reasonably attractive price,” Davis adds.

Finally, banks could use excess capital to help support an acquisition. Bank M&A began to heat up in 2025, with 181 deals announced, according to data from S&P Global Market Intelligence. That’s up almost 45% from 2024. There are expectations that deal activity will remain elevated through this year. Acquirers could pay for an acquisition with both stock and cash on hand so having excess capital could give would-be buyers more options. And even if the deal is all stock, the buyer could use excess capital to cover transaction costs and for credit marks applied to the seller’s loan portfolio, Davis says.

Additionally, the banking industry is still experiencing some drag from underwater securities portfolios. Numerous banks boosted their holdings of bonds and mortgage-backed securities during the early days of the Covid-19 pandemic when they were flush with deposits, but loan demand was low. Those securities decreased in value when interest rates began to steeply rise in 2022. As a result, bank M&A slowed significantly. “On a mark to market basis, if you adjusted the balance sheet, there were banks with no capital at all,” Burgess says.

Today, a buyer could use capital to help support a purchase of an institution that still has issues with its securities portfolio. Additionally, acquirers could use strong capital levels to support the purchase of a nonbank entity, such as a wealth management firm or an insurance business. These businesses tend to hold less capital themselves, so a well-capitalized bank is in a better position to absorb those operations.

“I think excess capital is going to be the real key,” Burgess adds. “It is an impetus for M&A going forward.”