A recent stock market rally may allow US banks to issue common shares to meet new capital requirements under stress tests, a possibility that was unthinkable just a few months ago. Those share offerings may be at discounts of 10 percent or more to current share prices.
-- Recent stocks rally enables banks to issue common shares
-- Offerings may be at discount of 10 percent or more
-- Some banks may have no other real options
For some banks, selling shares may be the only real option, even if others would rather sell assets or convert preferred shares into common stock.
Take Birmingham, Alabama-based regional lender Regions Financial Corp. Analysts at FBR Capital Markets & Co estimated, based on the publicly available information regarding the government's stress test, that the bank will have to raise $1.75 billion of new capital.
Regions could try to exchange some of its preferred shares for common stock, as many other banks will likely do, but the government is its main preferred shareholder, and an exchange could leave the government holding more than a quarter of Regions' equity. The government appears uninterested in holding such a large stake in most banks. Federal Deposit Insurance Corp Chairman Sheila Bair told Reuters in late April that banks found to need more capital under stress test should try to focus on raising funds from existing private investors.
That's where secondary offerings could come in. If the stress test is credible, and convinces investors that banks will not likely go back to the well for more capital, stock investors will likely be willing to buy bank shares, said Blake Howells, director of stock research at Becker Capital Management in Portland, Oregon.
"The financial sector was uninvestable for awhile because you just didn't know how much capital some of these banks were going to need," Howells said.
"Now, there's a little more certainty," he added. Howells said banks looking to sell shares may issue them at a 10 percent to 15 percent discount to current prices to ensure strong demand.
To be sure, some banks will likely convert preferred shares into common stock. Regulators said Bank of America has a $34 billion capital shortfall, and the bank has about $30 billion of privately held preferred shares outstanding, meaning an exchange of preferred for common would fill most of the gap without forcing the bank to tap capital markets. Investors seem to have grown more confident in bank stocks recently. The KBW Banks index has risen more than 90 percent since early March, and a number of banks have been able to sell shares recently, including Goldman Sachs Group, which sold $5 billion of shares last month, and City National Corp, which said on May 05 that it had raised $109.2 million in a share offering.
So far, the market seems to be splitting banks into the strong and the weak, said Adriaan van der Knapp, who helps banks raise capital at UBS. Strong banks have had no trouble issuing equity all along, but banks that are weaker could be able to sell shares now as investors increasingly view banks' losses as stabilising.
"The market believes Armageddon has been avoided, and so we should see some share offers from a handful of (stress-tested) banks," van der Knapp said.
So far, share issues have come at discounts, even for strong banks. Goldman priced its offering in mid-April at 5.5 percent below its prior close. HSBC last month raised $19 billion by selling shares at a roughly 40 percent discount.
Selling shares at a discount is a negative for current investors, portfolio managers said. "It will be bruising for existing shareholders. Much of that is reflected in bank stock prices already, but not all of it," said Walter Todd, portfolio manager at Greenwood Capital Associates, which owns Bank of America shares.