Bank Recapitalization through SEOs: Why Is This Time Different?

Abstract:     
Expeditious bank recapitalization is a key macroprudential regulatory concern in financial crises because prolonged undercapitalization has debilitating macroeconomic consequences. When common equity capital is eroded, banks face a debt overhang problem that makes a voluntary SEO unattractive from their common shareholders’ perspective. Consistent with this, we find that in the aftermath of the recent financial crisis banks replenished only 12% of crisis-related losses through SEOs in 2009 and 2010. However, we also find that SEOs are disproportionately conducted by Capital Purchase Program (CPP) recipients, and this is not explained by CPP recipients’ economic and regulatory capital needs. SEOs in 2009 and 2010 by CPP recipients alone account for 27% by number, and 52% by dollar amount, of all SEOs by U.S. banks between 1994 and 2010, indicating the CPP is the most influential event in the history of U.S. bank SEOs. Controlling for economic and regulatory determinants of SEOs, CPP recipients were 43% more likely than non-recipients to have an SEO within the four quarters subsequent to CPP receipt. SEO proceeds were used to repay CPP receipts without jeopardizing loan growth. Collectively, the results suggest restrictions and political costs associated with CPP funds were an impetus for CPP recipients to issue equity expeditiously in order to relieve these costs.

Number of Pages in PDF File: 51

Keywords: Financial crisis, Banking crisis, SEO, CPP, TARP, Bank Capital, Macroprudential perspective

JEL Classification: E4, E5, E6, G21, G28, G32, G38, M41

working papers series