34 MAY / JUNE 2021 Michael J. Messaglia Managing Partner Krieg DeVault LLP mmessaglia@kdlegal.com Krieg DeVault LLP is a Diamond Associate Member of the Indiana Bankers Association. DIRECTORS / SENIOR MANAGEMENT Capital Raising for Community Banks Impact of the COVID-19 pandemic The COVID-19 pandemic drove capital raising efforts for community banks in 2020. Initially it was to raise defensive capital due to the uncertainties created by the pandemic and its potential negative impact on the economy and loan portfolios. Later these efforts were opportunistic to take advantage of lower rates in 2020 and the access to growth capital. Opportunistic capital raises continue in 2021. Early in the pandemic, banking regulators encouraged banks to use their capital buffers to lend and undertake other supportive actions to benefit borrowers. Further, the CARES Act reduced the leverage ratio under the community bank leverage ratio (CBLR) from 9% to 8% in 2020 – and increasing it to 8.5% in 2021 and to 9% in 2022. Banks electing CBLR may need to raise capital to stay in compliance with CBLR in 2021 and thereafter, if they managed to the 8% leverage ratio in 2020. Banks need to continue to address their current and long-term capital plans in light of the changes in the economy in general and to specific changes at their institutions. These plans are developed by management and then reviewed with and approved by the board of directors at least annually. Banking regulators will continue to focus on these plans during their regulatory exams. Need for Capital The need for capital generally results from balance sheet growth, stock repurchases, or an opportunity or need to refinance existing capital, absent a bank being in a troubled condition. The considerations of how much and what type of capital differ, depending upon whether the bank has elected CBLR or is subject to riskbased capital ratios. Modeling capital projections and different scenarios will assist in coming to the proper determinations. Both capital calculations consider Tier 1 capital, but CBLR does not take into consideration any Tier 2 capital. Types of Capital The type of capital required depends upon the needs of the bank. Capital is divided between Tier 1 capital (also referred to as core capital) and Tier 2 capital (a.k.a. supplementary capital). Tier 1 capital is permanent capital, while Tier 2 capital is permitted under banking regulations to have a maturity date and provide for cumulative dividends. Tier 1 capital consists of common stock, noncumulative perpetual preferred stock, and minority interests in consolidated subsidiaries, subject to certain deductions. The bank must have the right under the preferred stock designations to waive the payment of dividends and not cumulate undeclared and unpaid dividends in order for the capital to qualify for Tier 1 status. Banks subject to risk-based capital ratios or electing CBLR make a similar calculation of Tier 1 capital. Tier 2 capital consists of subordinated debt, cumulative preferred stock, hybrid capital instruments including mandatory convertible debt, allowances for loan and lease losses, and net unrealized holding gains on equity securities. Recognition of Tier 2 capital is limited to 100% of Tier 1 capital and, in some cases such as subordinated debt, limited to 50% of Tier 1 capital. In 2020, subordinated debt was the capital choice for community banks with less than $10 billion in assets, with subordinated debt offerings accounting for over 80% of reported capital offerings. As there was greater demand from banks focused on investing in bank-issued subordinated debt, this segment of the capital markets became accessible to more community banks.
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