As reader Tom pointed out in comments today, perhaps the most important story in today’s Wall Street Journal didn’t get front page treatment.
Banks are finding it hard to raise new equity.
We’re not surprised at this outcome, in fact, we’re taken aback that this outcome was not foreseen. But despite the downturn in the economy and the financial sector generally, the US media is sometime leery of being the bearer of bad tidings.
The Financial Times, for months, has been reporting on signs of difficulties in capital replenishment by banks. For instnace:
Gillian Tett told us in February that sovereign wealth funds and other international investors were rebuffing financial institutions in search of capital
Tett pointed out in March that cash-rich investors were likely to remain on the sidelines until they thought credit instruments had hit a market clearing price. However, were that to occur, mark to market rules mean that financial institutions would have to revalue their holidngs at those prices, which would render some (many?) firms technically bankrupt.
Tett argued later in March that if the credit market continued to deteriorate, the Federal government would have to recapitalize banks via subterfuge, since bailouts are unpopular. She anticipated that the folks in DC would resort to under-the-radar mechanisms such as greater reliance on Freddie, Fannie, and the Federal Home Loan Banks.
Tett has maintained an anodyne tone, while her fellow FT writer John Dizard has been far more blunt. Witness this comment from January:
At the beginning of the year I floated a deliberately heretical thought: that it would be impossible to recapitalise adequately the US banking system with new investments of actual cash. Instead, I suggested, it would be necessary to return to a discarded 1980s concept. Not padded shoulders for power suits, though that might help as well, but “supervisory goodwill”. That was an accounting tool used by US regulators to allow weak and reorganising depository institutions to meet their capital requirements by using a sort of pretend equity. By the end of the decade, supervisory goodwill, at least under that name, was prohibited by an act of Congress.
I was hoping for a blast of angry mail from readers, particularly those at regulatory agencies and central banks. It never appeared, since it turned out that there was a lot of re-thinking about bank capital adequacy being done by the official and semi-official world. Heresy and irresponsible suggestions were, at least for a moment, allowed.
In March, Dizard argued that bank recapitalizatiion would require government support:
We don’t, however, have a lot of time to avoid the self-reinforcing contraction of the financial system that is the precursor of a depression. So while the philosophical and legal arguments over the next bank regulatory regime are being worked out, the American and European banking systems have to raise a lot of new capital, and raise it now.
It would appear that the scale of new capital issuance required for the banks is so large that some form of official sponsorship is required to make the effort work. The longer the capital-raising exercise is put off, the larger it will have to be, and the greater the degree of government sponsorship….
It does not, therefore, take much of a leap in imagination to suggest that the US banks need to raise well over $100bn in new Tier One capital, and perhaps more than $200bn. They also need to do it quickly, so as to avoid that spiralling destruction of capital.
Those are big numbers. Given that the mark-to-market theology would, without much of a stretch in interpretation, tell you that some major institutions would already have something less than the capital they need to support their business, one might reasonably ask why the investing public would give them more money. After all, you can buy big piles of mouldering securitised paper on the open market, without the management value subtracted offered by the Citigroup board.
The answer is the franchise value of the banks. Because they will be given positive yield curves, effective monopolies for making markets in government-sponsored securities, and will be cossetted with easier accounting rules in future, they are gigantic rent-paying machines in a risky age.
However, that point has to be driven home by the central bankers and regulators. So the hundred billion, or hundreds of billions, in new equity issues will need to be effectively co-sponsored by the Fed, along with a row of other eminent suits from the government.
Also, the issues will be so large that some queuing will have to be administered, or at least sanctioned, by someone with apparent independent authority.
Or consider Dizard in April:
It is not fair to say the Fed does not have a plan. It does. The plan is for the banking system to recapitalise for a new on-balance sheet world by raising a minimum of $200bn in a short period of time, not longer than two quarters. That way, there is no credit crunch, according to the model. A credit crunch, in Fed chairman Ben Bernanke’s own language, is: “A significant leftward shift in the supply curve for bank loans, holding constant both the safe real interest rate and the quality of potential borrowers.” ( The Credit Crunch , Brookings Institution, 1991) That means you can have a decline in the demand for credit as part of a business cycle without a “crunch”.
Let us put the Fed’s plan in the context of the world of the capital markets. Consider Washington Mutual’s $7bn recapitalisation of last week. We would have to have a Washington Mutual recap a week for the next six months to get the Fed’s plan done. All the uncommitted capital available to the private equity funds could be dedicated to this purpose.
All of it? I do not think so. The private equity people have other ideas. To raise anything like the bank capital the Fed and the other authorities such as the Treasury want, it would be necessary to have a series of road shows for the investing public that would be the size of theme parks. That could be done with difficulty and with great dilution for shareholders and, more seriously, career damage for senior management. The Fed itself would have to be a co-sponsor in some form.
Quietly arranged deals, first with sovereign wealth funds, then with private equity partnerships, are not enough. It is a bit like attacking militias in Basra without adequate forces or preparation. Some investors might throw down their arms and defect to the short-selling side.
Perhaps I missed it, but I don’t recall seeing anything so blunt in the US business media.
Thus, the Wall Street Journal story, “Investors Hide as Banks Come Knocking,” is useful reporting as to where things stand, but seems a bit overdue in highlighting this problem. In addition, it focuses on the woes of regional and community banks, suggesting that the bigger end of town is having a better time in the markets. Narrowly, that may be correct, but the real difference in the long run may not be market access, but degree of official intervention.
From the Wall Street Journal:
In the past several weeks, bank executives have encountered unexpected resistance from investors…. Already bruised by big losses and fearing that bank shares haven’t yet hit bottom, some of these investors are choosing to tighten their purse strings.
“The window for capital-raising is closing,” says Brad Evans, a portfolio manager for Heartland Advisors Inc., a money-management firm in Milwaukee that invests in small, regional banks. “Investing in a bank right now means investing in a large portfolio of loans that are essentially a black box.”…
Before announcing plans earlier this month to raise $1.5 billion, KeyCorp, of Cleveland, quietly reached out to more than a dozen of its largest institutional shareholders to gauge their interest in participating in a transaction, according to people familiar with the matter. A number of those investors rebuffed the offer….
Dozens of Wall Street firms and commercial banks have raised capital, and many more financial institutions are expected to follow the same path in coming months…That is particularly the case for small, regional banks and mom-and-pop lenders just starting to be hit hard by losses in their real-estate and construction-loan portfolios. With so many banks already having gone hat in hand to shareholders, these financial institutions ultimately may be forced to deal with a limited pool of investors who still would be willing to pump in money….
“Investors are tired of trying to catch a falling knife,” says one investment banker who specializes in the financial-services industry…
Growing queasiness could force some banks to downsize their capital-raising ambitions. That is how some analysts and investors interpreted the actions of Fifth Third Bancorp, which on Tuesday said it would raise $1 billion through an offering of convertible preferred stock and sell $1 billion in assets. The Cincinnati bank also cut its dividend for the first time in three decades.
“The decision we made speaks for itself,” a Fifth Third spokesman said.