Is your bank board willing to do the math?

by | Aug 31, 2020 | Corporate Governance | 0 comments

One topic that typically comes up in recent bank management discussions is capital plans. A proactive and well thought out capital plan is among the best determinants of “management quality.”

Some banks have been increasing dividends. Some just hope to maintain dividends; some are issuing subordinated debt and some are repurchasing common stock.

Very few are issuing common stock, because common equity levels in US banks are the highest in the developed world, and should remain so after 3Q and 4Q increases in charge-offs at hospitality and retail etc.

But how do management teams optimize their capital in a changing backdrop? Many are lost. They need a helping hand, and here it is: if you are not issuing subordinated debt or preferred at 4-6% to get regulatory support, and using it to buy in stock at 9-15% earnings yield on forward estimates, you need to revisit your math.

It is very likely your bank has enough common equity. Regulators approve of sub debt as capital too, so use the system to your advantage. Sell the 5% capital and buy the 10% capital. Regulators will know their bases are covered assuming your risk exposure is at or better than industry average.

One other note – if you want to pay a 3-5%+ dividend, trade well under tangible book, and are not repurchasing, you are sending a message that the market has it right, you are worth under tangible book, and the company should, by extension, be liquidated. That’s what trading under tangible book value means – you are worth more being wound down than you are as a going concern. If you disagree on liquidation, you can buy the stock in, grow your tangible book per share, and engender shareholder goodwill assuming credit metrics are in check.