Top 10 Issues Facing Financial Institutions: #8 – Capital Planning
As valuations and capital increase as a result of the improving economy, institutions are busy assessing and preparing for capital needs. Whether an institution is thinking about raising capital, using its stock as currency in an acquisition, or paying down or refinancing its outstanding debt, careful consideration should be given not only to capital opportunities of today, but also to planning ahead for future market changes.
A starting point for any institution’s capital planning strategy is ensuring compliance with applicable regulatory capital requirements, which varies depending on the institution’s regulators, size, and regulatory standing. The recent Basel III rules have also modified certain capital requirements, and some of these changes are still being phased in. Although understanding and planning for compliance with these regulatory capital requirements are essential to the capital planning process, this installment of our Top 10 Issues Facing Financial Institutions focuses on capital planning in connection with growth strategies and capital management.
As noted in some of our previous installments in this series—and as seen in the market generally, M&A and capital markets for financial institutions are active. To be a buyer or a capital raiser in this market, an institution’s capital plan needs to be in order. Planning for obtaining capital is critical for institutions that do not have a ready source of capital needed for its acquisition, its traditional capital raise, or its pay down of existing higher-cost debt or capital.
Various sources of capital exist, including through correspondent lending, subordinated debt issuances, or stock offerings. Fortunately, there is an active and competitive correspondent lending market eager to work with institutions on acquisition or traditional financing. Although less robust as in prior years, the subordinated debt market is still active and a viable source of capital.
With current market valuations on the rise, stock offerings are a very attractive alternative. Any institution considering a stock offering should identify not only its proposed group of offerees (e.g., existing shareholders, institutional investors, etc.), but also the offering structures available to it. While all institutions should evaluate their potential to have a successful private placement, a publicly traded institution should also consider its SEC-registered offering alternatives, including its eligibility to take advantage of the benefits of a shelf registration statement.
Each type of capital raise can have a different effect under regulatory capital requirements, tax treatment, and accounting standards. Additionally, the structure of each type of capital raise is unique.
Given the breadth of capital-raising alternatives, and the varying consequences each one can have on an institution, planning early is key. There is no one-size-fits-all approach, and each institution requires a plan specifically tailored to its individual needs and aspirations. As part of its planning, each institution should also look past the current strong market with an eye toward the potential for a future downturn.