Building a Fortress Balance Sheet - Chase

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Insights for America’s Business Leaders

Building A Fortress Balance Sheet:
Protect Your Bank’s Financial Health While Positioning It For Growth

Executive Summary: - The Vauban Model - Current Market Overview - Stress Testing and the Fortress Balance Sheet - Capital-Raising Strategies

“Ultimately, market participants themselves must address the fundamental sources of financial strains – through deleveraging, raising new capital and improving risk management.”1 – Ben Bernanke

The Vauban Model
Throughout the remainder of the year, banks’ capital needs will accelerate as credit losses are expected to continue, despite easing monetary policies and government intervention. To weather the turbulence in an economy that shows no immediate signs of improving, bank management must simultaneously master the: • Offensive skills to raise capital and seize growth opportunities • Defensive skills to protect asset quality and fortify their balance sheets These requisite skills call to mind the exploits of Le Marechal de Vauban, the pre-eminent soldier and military engineer of 17th-century France. His genius for the offensive (capturing places) and the defensive (fortifying places) earned him a reputation as one of the great captains of his age. This white paper will provide insight into protecting your bank’s financial health and positioning it for growth, along with some offensive and defensive strategies for raising capital. The economic recovery is inevitable, so prepare to emerge from it with a roar instead of a whimper.

Cracks in the Dike
Many mid-sized banks with little or no sub-prime exposure and well-managed “capital cushions” were fortunate enough to avoid the burns of the sub-prime mortgage meltdown. However, many stood by nervously as the larger banks took the majority of the write-down body blows. While bankers and business leaders everywhere hope that the worst has passed, the aftershocks have left many with the premonition that the crisis is not quite over and there is still another shoe to drop. Already, the effects are starting to encroach on the broader economy as a number of small and mid-cap banks – having tried to grow too fast in the salad days of easy credit – have begun to see erosion in asset quality. Cracks are starting to appear in their “bread and butter” asset classes – from CRE and C&I to Home Equities and Credit Card loan portfolios. This spillover scenario is the new 800-pound gorilla in the conference room that is keeping CEOs and CFOs up at night.

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Many are asking whether their financial institutions have “the borrow” to raise adequate capital to hedge against any deterioration in asset quality and still: • Insulate against losses • Maintain liquidity • Protect the balance sheet • Return value to shareholders • Pursue growth opportunities While there has been no rash of bank failures, the current landscape for sourcing new capital still appears fairly barren. However, there are signs that the climate could be changing for the better as recent activity in the financial markets indicates. In its July 21, 2008 issue, Barron’s reported that “After a record-setting rally last Wednesday, the brutal sell-off in financial stocks – the worst for any major industry group since the technology bubble burst in 2000 – could be over”2 and that it’s time to consider buying. This may be a good omen for banks interested in raising common equity, but many traditional, large investors continue to exhibit a reluctance to pump money into the mid-sized banking segment in this sluggish economy. To compound matters, banks face: • Increased pressure from regulators to get more deeply involved in raising capital to what is considered to be “above well capitalized”; and • A paucity of available capital from sovereign wealth funds and private equity investors In addition, investors are causing waves in the market as they try to get their arms around potential credit losses at banks and predict...
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