NEW YORK -- Small U.S. banks will have to raise tens of billions of dollars this year to cover bad loans, and must choose from three unappetizing options: selling stock or bonds, selling assets — or selling themselves.
The need to raise capital comes as regulators clamp down on regional and community banks, many of which are heavily exposed to consumer mortgages, commercial real estate developers who can't make interest and principal payments, or both.
In recent days, investors have grown less worried about the banking sector, as announcements that Lehman Brothers Holdings Inc had raised $4 billion and UBS AG and Deutsche Bank AG had set big write-downs fueled optimism that the worst may be behind, at least for big banks.
Large banks have already raised more than $100 billion from sovereign wealth funds and public markets to shore up their balance sheets.
Regional banks have been much less assertive about raising capital and may find it harder to come by, especially those heavily exposed to mortgages and commercial real estate, analysts said.
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"It's just a matter of boards and management teams of these distressed institutions deciding that they have to throw in the towel and that they must raise capital," said Matthew Kelley, an analyst at Sterne Agee & Leach. "It's going to be painful."
Not every regional bank is in trouble. There are more than 8,500 banks in the United States, and more than 90 percent of them are regional. Many are well capitalized and have no trouble borrowing in financial markets or attracting deposits.
But some need help.
On Tuesday, National City Corp said it was looking at strategic alternatives, a move that often heralds a sale and which many analysts believe was encouraged by regulators. The Wall Street Journal said on Wednesday that KeyCorp was among the banks talking to National City.
Last week Fremont General Corp said regulators had declared its banking unit undercapitalized and had asked it to raise money or find a buyer in two months. Failure could result in the thrift, once a major subprime mortgage lender, being taken over by regulators.
The Federal Deposit Insurance Corp, a regulator that also insures many bank deposits, in mid-March alerted banks to the importance of managing commercial real estate exposure. Banks with high exposure to construction loans and commercial mortgages need strong capital and loan loss reserves, it said.
"Regulators, every time you hear them say something, they say, 'more capital,"' said Chip MacDonald, a partner at the law firm Jones Day. "You know the old adage, that FDIC stands for 'forever demanding increased capital."'
Banks with heavy exposure to real estate, especially in parts of the U.S. Southeast, Midwest, and West Coast hit hardest by the housing downturn, are likely to need the most capital, experts said.
FEWER OPTIONS
Regional banks have fewer options for raising funds than larger rivals such as Citigroup Inc, UBS and investment banks Merrill Lynch & Co and Morgan Stanley, which all have significant mortgage exposure. Sovereign wealth funds, for one, are likely to be less interested in financing small, low-profile banks, experts said.
Still, regional banks that don't want to be taken over by regulators can use a variety of methods to raise capital — including selling debt, selling preferred securities, offering common stock, and selling assets.
"A lot of offerings are still getting done," said Lee Calfo, an analyst at investment firm Boenning & Scattergood. "They are just getting done at higher prices."
Banks can also conserve capital by cutting dividends. Sovereign Bancorp Inc, Tennessee's First Horizon National Corp and Flint, Michigan's Citizens Republic Bancorp — as well as Citigroup — have done so in recent months.
But lower dividends can make shares appear to be worth less, hurting shareholders. The KBW Regional Bank Index was down 6.2 percent in the first quarter.
To persuade investors to supply them with capital, banks will have to find a way to manage their problem assets.
Fort Lauderdale, Florida-based BankAtlantic Bancorp Inc formed a new subsidiary last month to hold its bad loans, while selling some 1.9 million shares of Stifel Financial Corp to raise about $71.5 million.
Those needing capital shouldn't wait, experts said.
"There is going to be crowding," MacDonald said. "People who are first in line, all things else equal, are going to stand a better chance of raising capital on better terms than people who are late to the party."
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