Could Small Banks Use Speculators To Their Advantage Soon?

If market conditions get any rockier for financial services firms, it is possible that we may see a spate of share sales by the end of the year.

In small-cap circles, it is common practice for firms to raise money whenever they stand the most chance doing so, at the highest possible valuation they can get the funds. Companies do this in order to avoid suffering a cash squeeze in the times when they are busy conducting the research and development (R&D) of their products.

While banks and lenders can hardly be considered as having to undergo lengthy R&D procedures, there is a substantial chance that for the next 12 to 18 months they may have to weather a series of revenue and profit storms. That would have the net effect of putting pressure on cashflow.

Take for example CIT Group, which said today that it won’t be able to make a September 15 interest payment due to its bondholders. With almost $10 billion of debt maturing through 2010, the company has been staving off bankruptcy for nearly two months now, and will continue to suffer pressure on the bottom line.

Then there is E*Trade, an online broker. Even though it showed a positive net change in cash of $1.3 billion in the six months ending on June 30 this year, by far the bulk of that was not in operational revenue but in hedge fund Citadel’s continued funding of the broker. E*Trade suffered a short-term crisis of confidence last month when its largest shareholder announced it would sell up to 120 million shares in the broker. While that decision was revoked on Friday, such a massive share sale would have endangered E*Trade’s ability to compete effectively with larger TARP-funded rivals.

There are another 416 institutions out there with similar headaches right now, according to the Federal Deposit Insurance Corporation (FDIC). According to one panel study, if economic conditions became 20 percent worse than the FDIC expects, 719 banks with between $600 million and $100 billion in assets would be forced to raise a total of $21 billion from investors.

Turning The Jungle Into An Opportunity

These kinds of wild economic conditions tend to make for equally nutty market ones, sending share prices leaping and tumbling in the space of months as short-term speculators seek to drive up the value of dead money and sell out quickly. For example, in the past 3 months, CIT Group has gone from $3.80 a share to a low of around 40 cents a share, and has slowly travelled back up to $1.60 lately. E*Trade jumped 25 percent in June, before slumping back to around $1.20 a share. The stock hit a high in the $1.80’s yesterday.

No example is better than that of AIG. After a 20 for 1 reverse stock split in July, shares in the insurer surged 500 percent, before falling back 20 percent in the last 2 days after a critical article in Barron’s.

When combined with tight cashflow, these types of equity conditions frequently encourage companies to raise money when their share price hits one of the high points. In the case of small and medium-sized banks — which either face being gobbled up by a larger rival or struggling to prove their creditworthiness in a lengthy process of application for government aid — riding share sales on the back of speculator-created stock gains might be the most desirable solution over the next 12 months.