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Raising Equity Capital in a Difficult Market

By: James C. Olson

Most banking organizations continue to face regulatory and market pressures to improve and augment their capital. Many institutions have raised funds through sales of senior preferred stock to the U.S. Treasury under the federal government’s TARP Capital Purchase Program and more will be able to do so as the government has extended the time to access the program for smaller banking organizations. TARP is a short-term solution, however, and banks that participated in the CPP will eventually need to replace capital without further assistance from the Treasury.

While the senior preferred remains a relatively inexpensive and non-dilutive source of capital, early repayment offers various benefits. Repurchase of the stock offers a bank the opportunity to demonstrate its strength relative to non-repurchasing peers and a full repurchase lifts the restrictions that come with TARP, including the compensation limitations.

Unfortunately, raising other forms of capital has proven to be a more daunting challenge due to market conditions during the last year and many of the usual alternatives may not be available. The IPO market for private banks is not currently an option and while the secondary market for public institutions appears to be improving, many banks are locked out or face prohibitively expensive terms. The trust preferred market, so successful in years past, is still suffering the effects of the credit crisis and is effectively closed.

What is a well-run, well-positioned bank to do? Companies across many industries are considering alternative sources and methods to seek capital, focusing on structures that have not been as widely used historically. While each institution’s circumstances will determine what options are available, banking organizations should consider these structures as well. Some of the alternatives include accessing the private equity market, private placements of public equity, registered direct offerings, at-the-market offerings and rights offerings to current shareholders.

Accessing the Private Equity Market

There has been an increase in private investor interest in well-run banking organizations, as well as turnaround situations. In September 2008, the Federal Reserve announced a shift in policy easing the limitations on investors of all types, but aimed at private equity and hedge funds, in taking non-controlling stakes in bank holding companies. Under the revised policy an investor may, without becoming subject to regulation as a bank holding company, own as much as 33 percent of the equity of a bank or bank holding company. Up to 14.9 percent may be in the form of voting securities. In addition, the investor may appoint two directors under certain conditions.

The new rights come with various restrictions, including passivity commitments from the investor, and the Federal Reserve retains discretionary authority to review all such investments to monitor whether the investor might have an otherwise controlling influence over the banking organization. Nevertheless, properly structured, the process affords access to a source of capital without prior regulatory approval.

PIPEs and Registered Direct Offerings

For non-public banking companies, private placements are a common method to offer securities to investors. Private investments in public equity, or PIPES, and registered direct offerings are effective methods for publicly held banking companies to raise capital from private equity funds and other investors. A PIPE is a private placement of securities by a publicly traded issuer to a small number of institutional investors, often through a placement agent. The offering usually includes registration rights that enable the new holders to eventually sell their securities freely.

The technique can be used to offer common stock, preferred stock, debt, warrants and combinations of these. A registered direct offering is similar to a PIPE, except that the offering is registered under federal and state securities laws at the time of its initial placement. In most cases a placement agent is used as well.

Banking companies with shelf registrations filed with the Securities and Exchange Commission can benefit most from the registered direct structure because the transactions can be completed quickly with no advance announcement to the public. Banking companies with no shelf statements on file with the SEC will generally benefit from the timing advantages offered under the PIPE structure. A common stock PIPE or registered direct offering is the simplest option and is generally offered at a discount to current market price.

These transactions contain few provisions to negotiate and can be done quickly, although one disadvantage is that they can result in greater dilution to existing shareholders than other alternatives. Other factors that may be applicable and should be considered include stock exchange requirements, which may require a shareholder vote if a company issues 20 percent or more of its outstanding stock at a discount and, in the case of a PIPE, the possibility of downward pressure on the company’s stock price due to the registration rights issued along with the new common shares.

At-the-Market Offerings

An “at-the-market” offering is a registered offering by an issuer of its securities directly into the market over time, typically through a broker dealer engaged to act as placement agent. This structure enables the issuer to review market conditions and timing opportunities and issue shares at its discretion at intervals over an extended period of time. The issuer determines the timing of any issuance, the amount of securities offered, the floor price and the duration of the offering period.

Under SEC rules, this alternative is available only to a public company with a public float of at least $75 million. In addition, this can be a more expensive alternative, as it requires more substantial involvement by counsel and accountants in the initial offering of securities, as well as in subsequent sales during the term of the program.

Rights Offerings

A common type of offering in foreign countries, rights offerings are now being looked at closely by many companies in the United States. This type of transaction involves the issuance to each existing shareholder of a right to participate ratably in an equity offering of new shares by the issuer. The offering price is typically set at a discount to the current market price of the security and the offer typically remains open for a period of 15 to 30 days. This technique enables an issuer to give all existing shareholders an opportunity to participate in the offering, thereby avoiding the dilution that might otherwise result from other offering structures with third parties, particularly where securities are offered at a discount.

In many cases, a degree of certainty can also be added through the engagement of a backstop purchaser who, prior to the commencement of the rights offering, agrees to buy any shares that are not taken up in the offering by existing shareholders.

What Makes Sense?

The recent conditions in the capital markets have forced many banking organizations to make hard choices. While the market for common stock offerings appears to be improving, the various alternative methods to raise capital should be considered as a part of an overall strategy. One size does not fit all. Whether a banking organization is a public or private issuer, how widely its shares are held and the business priorities of the organization will in large measure determine what is possible and preferable. Consultation with counsel and other advisers can be helpful in this process and any offering of securities requires careful review and proper structuring to ensure compliance with federal and state securities laws and other legal requirements.

James C. Olson is a partner in the San Francisco office of the Jones Day law firm. Contact him at 415-875-5749.

Copyright © July-August 2009 Western Banking (BankNews Publications) 


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