How Investment Banks Plan to Play TARP

What opportunity does the Treasury Department’s TARP recapitalization program offer to investment banks?

On the surface, it would seem that TARP undermines the investment banks. After all, presumably hundreds of banks will obtain capital infusions without the assistance of investment banks. Additionally, these TARP capital infusions are intended to restore banks to health, so TARP might potentially diminish the need for future capitalization efforts for banks. Both dynamics appear to be detrimental to investment banks.

But don’t tell that to Eric Billings, chairman and CEO of FBR Capital Markets Corp. (FBCM). Billings offered a concise TARP action plan for investment banks during FBR’s third-quarter earnings call yesterday, and it bears analyzing.

Essentially, Billings sees an opportunity for FBR and other investment banks to recapitalize financial institutions after they tap TARP.

“From my perspective, I think [TARP] will probably in some ways enhance the ability to raise capital for many of these companies, and the reason I say that is two-fold,” Billings said. “Number one, this capital remember is trust preferred, or a preferred capital. It is long-term financing. It is not common tangible equity. When these companies … lose money, they lose money through their common tangible equity.”

Billings then explained why that was important.

“So, in point of fact, what the government is doing with the TARP program is increasing the funding of long-term debt on these balance sheets. It is not, in fact, increasing the tangible common equity. And this is paramount. I think there are going to be opportunities to talk to many of these companies and to potentially do transactions that can be simultaneous ‘take downs’ of the government plan and simultaneously … raise equity capital at prices that are maybe half [what Treasury is charging] … and still enhance the value of the franchise and create a great investment opportunity.”

TARP also offers banks — and investment banks — an opportunity for more M&A.

“There are going to be many hundreds of sales of banks,” Billings said. “The TARP program is not going to prevent that under any circumstances from our perspective, and the opportunity to capitalize and recapitalize financial institutions will … be very, very significant.”