The deadline for deciding to participate in the Treasury’s Capital Purchase Plan looms (11/14/08).  The mood of the industry is clearly unsettled, and many possible participants are on the fence on this issue.  On the one hand, how do you pass up “cheap” capital?  On the other hand, how do you really feel about having the Treasury Department as a partner? 

First, for those without great familiarity with the program, here’s the basic plan.

The Capital Purchase Plan allows participating institutions to issue preferred stock to be purchased by the Treasury Department at a dividend rate of 5% for the first five years, with the rate reverting to 9% thereafter. Those institutions that want to participate in the program must submit their application by November 14.  This Capital Purchase Plan was designed to be the initial thrust in the Treasury’s plan to restore liquidity and confidence in the banking industry, to be followed by the asset purchase program, whereby the Treasury actually would buy troubled assets from financial institutions.  However, the Treasury has now decided not to implement the asset purchase program.

Here are a few of the reasons you should be thinking about participating in the Capital Purchase Plan: 

• Can you find less expensive capital than this?  With a dividend rate of 5% for the first five years and 9% after that, you will be hard pressed to find a cheaper source of capital than this program provides. 
• Cheap capital can be used to fuel expansion.  As was seen with the PNC acquisition of National City, this capital provides a means to fund aggressive growth, either through acquisition or through site or market expansion.
• With Treasury abandoning the asset purchase program, the Capital Purchase Program may be the only relief that is available to you.  If you have been impacted in the current economic environment, don’t count on the Treasury buying your non-performing assets. 

On the other hand, what are the reasons that you should be wary of the Capital Purchase Plan?

• If you participate, how you will you be viewed by customers and investors?  Does participation indicate that you are “troubled?”  Will non-participating competitors use this to their advantage in competing against you?
• Does participation dilute your return to your existing shareholders?  While the cost of this capital is cheap, if you cannot effectively employ it, the return to your existing shareholders is reduced.
• What encumbrances are likely to be put on you as a result of participation in this program?  This may be the most significant concern.  The fact of the matter is that the provisions of this program are not clearly defined, and more importantly, can be changed at any time.  If you participate in this program, you will be subject to any such changes in the provisions.  Many bankers do not like CRA as it is; it’s possible that a participating bank could be subject to “CRA on steroids” as a result of Congress’ intrusion in the program. 

Given these considerations, on what basis should you make your decision to participate in the Capital Purchase Program?  We believe that you should examine the following factors: 

1. How strong is your current capital position?  If your capital position has deteriorated as a result of economic conditions or rapid growth, the Capital Purchase Program may make sense for you.  It is alternative to raising capital in the private markets and is a very inexpensive alternative.
2. What is your share of market in the markets in which you compete?  This is an important consideration because it is an indicator of the growth opportunities you have.  Low market share means great opportunity for growth, and inexpensive capital can help you in this regard.
3. What is your historical rate of growth?  If your past history indicates that you have been able to generate consistent double-digit growth rates, then another source of inexpensive capital makes more sense in your case.
4. What is your expectation in regard to future losses in your loan portfolios?  If you anticipate you will experience significant future losses in your loan portfolios, then the Capital Purchase Plan may be an appropriate means to prepare for future earnings imbroglios that could impact your capital position. 
5. Do you have viable loan growth opportunities in your markets and will you continue to lend to consumers and businesses.  This is a critical consideration in that one of the future requirements of the Capital Purchase Program may be a required growth in loan volumes for participating institutions.  If your markets do not present viable lending opportunities, then you may be forced to lend to less-than-optimal businesses or consumers just to meet these loan growth requirements.
6. Could you repay within five years?  This is a significant consideration because the first five years is where capital is actually least expensive.  The longer you anticipate needing this infusion of new capital, the better off you may be seeking private sources of capital.
7. Do you anticipate you will be looking at acquisitions within the next five years?  If your strategic planning process suggests an opportunity for expansion through acquisition, the Capital Purchase Program is an opportunity to fund this acquisition inexpensively.  

It is apparent that the Capital Purchase Program represents an opportunity for financial institutions to grow their capital in an inexpensive manner.  But beware of the strings that may be attached to this program in the future, and opt for this source of capital only if your strategic business conditions dictate that capital growth is a high priority.  Your greatest consideration should be that participation makes the Treasury Department, and by extension, Congress, a partner in your business.

 

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