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Regionals Get a Clue on Capital Ratios

The recent equity raise by PNC Financial as part of its plan to repay bailout funds potentially provides a valuable clue about what capital standards regulators will eventually adopt.



) -- The recent equity raise by

PNC Financial Services

(PNC) - Get Free Report

as part of its plan to repay bailout funds potentially provides a valuable clue about what capital standards regulators will eventually adopt.

PNC is the highest profile name to pay its Troubled Asset Relief Program, or TARP, tab of late as the Pittsburgh-based company disclosed its arrangement to make good on nearly $8 billion in bailout funds last week. PNC was the largest of the remaining banks with outstanding preferred shares owned by the U.S. Treasury after

Bank of America

(BAC) - Get Free Report


Wells Fargo

(WFC) - Get Free Report



(C) - Get Free Report

each used large equity offerings to repay funds in December.

What's interesting about PNC's plan is that, likely on the recommendation of regulators, the company cushioned itself with the $3 billion equity raise. This was in addition to announcing a number of other steps to improve liquidity, including an agreement to divest its global fund processing unit to

Bank of New York Mellon

(BK) - Get Free Report

for $2.3 billion, and plans to sell between $1.5 billion and $2 billion worth of senior notes.

Factoring in these moves, PNC says its Tier 1 common equity ratio would have stood at 8% as of Dec. 31 on a pro forma basis, compared to the 6% level it reported on Jan. 21 when it released its fourth-quarter results.

Banks of ranging sizes continue to look to the capital markets to provide fresh ammunition for their coffers, with many doing it primarily to repay bailout funds. But the actions of PNC this week sent a message to other regional banks about what capital ratios could be targeted by regulators in the future.

TARP paybacks were few and far between in the final three months of 2009 until the flurry of big banks that took the plunge in December, and the standards for the money-center names wouldn't be expected to necessarily apply to the majority of the industry anyway. PNC's TARP payback deal, however, may represent a step by regulators toward setting the 8% ratio up as a benchmark of sorts for the remaining regionals and other smaller institutions.

In general, the higher the ratio favored by regulators, more banks will likely have to sell additional stock to shore up their balance sheets. Lifting the standard in relation to historical levels also impacts ongoing expectations of profitability for the group, as the sector would have less capital available, on a relative basis, to put to work than it did in the past. It could also affect M&A activity, and other capital-intensive initiatives, like expansion and infrastructure investment.

"In our view the top question on investors' minds will be how much capital does a bank need under precedence set by PNC ... and others in recent months," analysts at FBR Capital Markets said in a research note last week.

The FBR note goes on to say that two schools of thought exist on how much capital is needed to be raised in order to repay TARP funds.

The first requires banks to undergo a common equity raise equal to half the amount of outstanding TARP funds minus half of the capital released from any deleveraging or business divestments, FBR analysts say.

Or it could be that regulators are gravitating that 8% common ratio, even though there have been exceptions, including Bank of America and

U.S. Bancorp

(USB) - Get Free Report

, according to the FBR analysts.

SunTrust Banks

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Regions Financial

(RF) - Get Free Report



(KEY) - Get Free Report


Fifth Third Bancorp

(FITB) - Get Free Report

all bolstered their balance sheets last May following the stress tests that found capital deficiencies. Yet the FBR analysts say these banks

may have to raise extra capital

if they want to repay the government's capital injections. "

The blueprint so far suggests that additional raises may be necessary at some point in the future," the note says.


Earnings and credit quality are not enough to get out of TARP," said FBR Capital analyst Bob Ramsey during a follow-up interview. "You absolutely do need to have strong capital levels."

Ramsey covers banks primarily in the Northeast, which have held up typically better than banks located in harder hit areas of the country. But one bank under his coverage that may need to raise capital to repay TARP is

M&T Bank

(MTB) - Get Free Report

. "They are a healthy bank, but they do have thin capital," he says.

As of Dec, 31, the relevant common equity ratios of some of the more prominent regionals that still have TARP tabs were 8.5% for Regions Financial, which owes $3.5 billion; 7.5% for KeyCorp, which owes $2.5 billion; 8.8% for SunTrust, which owes $2.5 billion; and 7% for Fifth Third, which owes $3.4 billion.

Even well-capitalized institutions are looking to raise equity these days either to repay TARP or so that they can pounce on opportunistic and/or FDIC-assisted M&A in the sector.

Umpqua Holdings

(UMPQ) - Get Free Report

, the parent company of Umpqua Bank, also announced plans last week to sell $264 million worth of stock to raise capital to repay TARP funds totaling $214.2 million, and to do more FDIC-assisted deals, it said.

Umpqua's tangible common equity ratio was 8.27% at Dec. 31, while its total risk-based capital stood at 17.07%, the company said on Jan. 28 when it reported its fourth-quarter results. This was Umpqua's second visit to the public markets in less than six months as the company had already raised nearly $260 million through a public offering in August.

The uncertainty surrounding the final decision by regulators is clearly confusing for banks, but for the most part observers largely expect to see increased levels going forward. And already at least one bank CEO is wondering how much is too much.

First Niagara Financial

(PNC) - Get Free Report

is another small bank that has been to the public markets several times to raise opportunistic capital. The company paid its TARP tab of $184 million in late May 2009, and it ended 2009 with a tangible equity ratio of 10.5%. But CEO John Koelmel says future onerous regulation on capital levels will hinder growth in the industry and subsequently shareholder interest.

"You can't raise capital requirements and expect the industry to be able to produce the type of returns that are necessary to attract the higher levels of capital they want us to have," Koelmel said in an interview last month with


. "Higher capital levels, fewer loans; fewer loans, lower earnings; lower earnings, lower returns, investors move to other sectors. That's what I get concerned about."

Gary Townsend, a former bank regulator and sell-side analyst now at private investment management firm, Hill-Townsend Capital, says it isn't realistic to incorporate capital levels that reflect frequent panic-like disasters into businesses.

"We've had a whole lot of failures only some of which were in these companies," he says.

For example, one large contributing factor to the housing bubble and subsequent crisis was mortgage fraud. Regulators and banks have since clamped down on lending standards going forward and a lot of the exotic loan products such as so-called low-doc mortgages and no-doc mortgages and other abuses are no longer allowed.

"To dial up capital requirements when everyone is so risk adverse seems foolish, Townsend says. But when the markets are "humming along and credit seems to be superb, maybe that's when capital standards need to be dialed up somewhat," Townsend suggested.

One silver lining in the wake of outsized capital levels at the banks is the potential to use the excess capital for dividend raises and share repurchases.

"My sense is that we'll find that the banking system overcapitalized significantly so by the end of this year," Townsend adds. "If I am right we'll see resumption of dividends and in 2011 a resumption of capital management through the repurchase of shares."

--Written by Laurie Kulikowski in New York.