The banking business

One of the many joys of being in the media business in a small community is the variety of opinions we hear on a broad range of issues. The latest stems from Sonoma Valley Bank’s proposal to increase its capital reserves through the issuance of preferred stock to be purchased by the U.S. government. Not surprisingly, we have an opinion, too.
Sonoma Valley Bank is an integral part of this community, as holder of our deposits, lender to our businesses and booster of our community projects. In turn, the bank’s stock is widely held by members of the community (including members of this board), and so the community rightly feels a little possessive about “the bank.” Here’s our take on various concerns gleaned from coffee-shop and e-mail discussions.
First, a bank’s capital is the support for all of its operations, and solid capitalization is especially important now, as businesses falter and home loans default. Capital is raised by selling stock, and with the common stock price down, issuing more shares of common stock would be expensive and would dilute the present ownership.
Second, drawing in more deposits by raising CD rates does not add to the capital of the bank; rather, it adds to the bank’s liabilities, as those new depositors have claim to the money. Plus, paying increased rates would hurt the bank’s profitability.
Third, the U.S. Congress, in its wisdom, is pushing a lot of capital out at attractive rates to the big banks, especially, to forestall closure of those with shaky balance sheets (that is, low capital reserves). Such capital is available to smaller banks, as well, including Sonoma Valley Bank, which has a strong balance sheet, thanks to its conservative lending practices over the years.
Fourth, Congress’ Capital Purchase Program (nick-named “TARP”) injects funds by purchasing preferred stock of the banks receiving the capital. Preferred stock is more like a bond than it is like common stock. Its payout is at a fixed rate (5 percent in this case), unlike common stock, which pays cash dividends that vary, depending on the bank’s profitability. Preferred stock is “preferred” only in that its fixed rate needs to be paid before dividends are distributed to the holders of common stock.
Fifth, Sonoma Valley Bank remains profitable and has consistently paid dividends to its common stock holders. Since the bank has a present capitalization of some $35 million, the $8 million additional capital from TARP represents an increase of less than a quarter, so its worst-case impact on profits is not large. In the more realistic case, of course, the bank would expect to leverage that new capital several times over and actually increase profits for its common stock holders.
Sixth, banks live in a weird world of government regulation and control; some do well, like Sonoma Valley Bank, and some don’t, like those making the news. But when the government changes the rules, as it does in many industries from time to time, businesses need to respond to remain competitive. That’s the case here, where other regional or national banks that already have the ability to issue preferred shares are taking the government infusion of capital. Sonoma Valley Bank needs to do the same.
So here’s the proverbial bottom line: Sonoma Valley Bank’s proposal strengthens its already solid capitalization position, helping to protect those who own the bank’s common stock and keeping it competitive. Issuing preferred stock for that purpose doesn’t dilute the common stock, and it needn’t impact the common stock cash dividend and certainly doesn’t end it. In our view, the bank’s proposal is a smart business move, which is what we expect from Sonoma Valley Bank.