The U.S. economy is riding high. Bank stocks, while their valuations are down somewhat from their highs at the beginning of the year, are still enjoying a nice run. For most banks that want to raise new equity capital, the window is still open.
The banking industry is already well capitalized and bank profitability remains strong. According to the Federal Deposit Insurance Corp., the industry earned $60.2 billion in the second quarter of this year, a 25 percent gain over the same period last year, thanks in no small part to the Trump tax cut, which has also helped prop up bank stock valuations. The truth is, in the current environment, banks don’t need to raise new equity just to increase their capital base—they can do that through retained earnings. The industry is awash with capital and most banks don’t necessarily need even more of it.
“The industry overall is enjoying capital accretion,” says Bill Hickey, a principal and co-head of investment banking at Sandler O’Neill + Partners. “Capital ratios industry-wide have continued to increase as banks have earned money and obviously enjoyed the benefits of tax reform. … I think the need for equity capital has lessened slightly as a result of capital ratios continuing to increase.”
Over the last few years, banks have clearly taken advantage of the opportunity to repair their balance sheets, which were ravaged during the financial crisis. According to S&P Global Market Intelligence, there were 123 bank equity offerings in 2016, which raised nearly $6 billion in capital at a median offering price that was 125 percent of tangible book value (TBV) and 52.8 percent of the most recent quarter’s earnings per share (MRQ EPS). There were 146 equity offerings in 2017 that raised nearly $7.5 billion, with offering price medians of 66.3 percent of TBV and 16.6 percent of MRQ EPS. (The industry was much less profitable in 2016 than in 2017, which explains the wide disparity between the median values for the two years.) And through Sept. 26, 2018, there were just in 66 offerings—but they have raised $7.6 billion in equity capital, with a median offering price that was 175 percent of TBV and 13.3 percent of MRQ EPS.
As the median offering prices as a percentage of TBV have gone up over the last two and a half years, while also declining as a percentage of the most recent quarter’s earnings per share—which means that institutional investors are in effect paying more and getting less from a valuation perspective—you might think investor appetite for bank equity would begin to wane. But according to Hickey, you would be wrong.
“There is a lot of money out there looking to be deployed in financial services and banks,” he says. “So there are folks who need to deploy capital—pension funds, funds specifically focused on investing in financial institutions. They have cash positions they need to deploy into investments. So there is a great demand for equity, particularly bank equity at the current time.”
Hickey says most of this new equity was raised to fuel growth, either organic growth or acquisitions. But any bank considering doing so needs to provide investors with a detailed plan for how they intend to use it. “You have to be able to articulate a strategy for the use of the capital you intend to raise,” says Hickey. “That seems obvious, but it needs to be explained quite well to the investment community so they understand how the capital is going to be deployed and have a sense of what their return possibilities are.”
And if you’re going to tap the equity market to support your strategic growth plan, make sure you raise enough the first time around. “Arguably, a company [should] raise enough money that will allow it to fund their growth for at least 18 to 24 months,” Hickey explains. “Investors don’t like it when they’re investing today and then 12 months later the same company comes back looking for more capital. Investors would [prefer] to minimize the number of offerings so they’re not diluted in the out years.”