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By Ronald Fink
Lloyds Banking Group's plans to raise $2 billion in fresh capital shows that even bailed-out institutions need to do more to fix their balance sheets. And contrary to what much of the press has been reporting recently, repayments of bailout funds from the Troubled Asset Relief Program do not demonstrate that large U.S. banks are out of the woods.
Citigroup's problems were amply illustrated late last week when the Treasury postponed plans to begin selling its stake. The delay was prompted by a selloff in the bank's shares as a result of its plans to raise capital and pay back its TARP funds. Citi investors obviously feared dilution from the issuance of new shares, despite a pronouncement of support from Saudi Arabian Prince Alwaleed bil Talal, Citi's largest individual shareholder.
Now comes word that Lloyds, which is considered in better shape than other banks that have required government bailouts, is paying a significant premium for the hybrid securities it is selling. According to Bloomberg, the cost of the $2 billion in capital is expected to reach $3.6 billion.
Part of the problem, of course, is that these securities are riskier for investors than bonds, since issuers can fail to pay interest on hybrids without defaulting on their obligations. On the other hand, investors in hybrids are paid before holders of common equity, so they're safer for investors than equity.
That added safety has made the capital cheaper than equity for issuers. Yet because they're riskier for investors than bonds, hybrids require a premium over straight debt, and that premium has become larger as the financial crisis has underscored their difference from bonds.
In addition, issuers are increasingly likely to exchange hybrids for equity, especially if bank regulators stick to their guns. Under proposed new rules issued by a group of international regulators known as the Basel Committee, even the least restrictive measure of capital that must be kept in reserve will get tighter. Starting next year, so-called Tier One capital would have to include less in the way of hybrid securities and other types of non-equity capital, including so-called deferred tax assets such as net operating losses.
As CFOZone reported on Monday, Citigroup's deal with the Treasury to waive IRS rules for $38 billion of the bank's NOLs looks suspiciously like an effort to get in under the wire on the new Basel rules, or at least their announcement.
Granted, Citi's Tier One ratio of capital reserves to assets stood at 12.7 percent on Sept. 30, compared with 8.2 percent a year earlier. And its ratio of tangible common equity, which excludes hybrid securities and other forms of capital besides equity, improved to 10.3 percent from well under half of that based on a range of analyst estimates (the company doesn't disclose a figure for the earlier period).
The improvement in Citi's tangible common equity ratio reflects exchange offers that substituted a significant amount of common shares for outstanding hybrids. Even so, capital other than common equity still accounts for fully 2.4 percentage points of Citi's Tier One ratio.
Other U.S. banks also have Tier One ratios that still include a significant amount of such capital. And some observers contend they'll all have to face up to that fact sooner or later even if, as is possible, the Basel rules are significantly watered down before they take effect due to pressure from the banks.
"Beyond Basel, U.S. banks have a lot of goodwill and intangibles to deal with, including tax assets, purchased goodwill for deposits, etc.," wrote Christopher Whalen, a banking analyst who runs the website, Institutional Risk Analyst, in an email on Monday to CFOZone.
In fact, banks have been reducing their provisions for loan losses despite the likelihood that those losses will increase. As analysts for Annaly Capital Management wrote earlier this month, "Credit performance continues to deteriorate and the coverage ratio is certainly not what we'd call adequate for any scenario other than a rosy one."
No wonder Treasury Secretary Tim Geithner has postponed the scheduled expiration of the TARP until next October.
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