In April of last year, Congress enacted the JOBS (Jumpstart Our Business Startups) Act with the purpose of easing the capital raising process for small and growing companies. While only some of the provisions have been put into effect, many small banks have already taken advantage of the new registration and deregistration threshold. According to the latest numbers released by SNL Financial, more than 100 banks have deregistered with the Securities and Exchange Commission (SEC) following the passage of the enactment of the JOBS Act. Most of the attention has been placed on the amount of money and resources banks save as a result of deregistration, but what has not been addressed is the flip side, the new threshold that will require registration. Going forward, banks won’t need to register until they have 2,000 shareholders of record. This change opens the door for small to mid-sized banks that in the past were reluctant to raise capital or merge in fear of increasing their regulatory burdens. What’s important to note is that for non-bank and non-bank holding companies, the statutory shareholder threshold remains the same. In writing the new laws, Congress purposefully carved out banks, acknowledging not only the need for banks to access capital but also the highly regulated environment that banks already face.
SEC Registration Versus Public Markets
Even with this statutory easing, many banks still view the capital markets with caution and often the hesitation comes from a dearth of information and misunderstanding of how the public markets function for small companies. The common perception is that a bank must undergo a costly and time-consuming process to become public, one that requires underwriting, SEC registration, and compliance with Sarbanes-Oxley. While that process still exists, it only applies to banks seeking to do an Initial Public Offering (IPO) and trade on a registered national securities exchange such as NASDAQ. As long as there are freely tradable shares, banks can have broker-dealers quote and trade those shares on OTC Markets without filing with the SEC.
With greater demand and regulatory pressure to hold more capital, it is no longer efficient for banks to sell stocks by pulling out a list of interested buyers from desk drawers. However, as a company enters the capital markets, the information gap also begins to widen and it becomes infeasible for companies to know each shareholder and conversely, investors become removed from the daily ins and outs of the companies they are investing in. The classical definition of markets assumes that information is widely available, allowing buyers to make informed decisions, and sellers to have access to the capital they need to grow and expand their businesses. Yet, information is not always widely accessible, or the information availability is asymmetric, meaning that one side has more information than the other, making a marketplace inefficient.
An Efficient Marketplace
There are three elements that make a stock market efficient:
- Access for investors with widespread pricing and the ability to easily trade through any broker
- Availability of publicly disclosed information to allow for fair valuation of the stock
- Confidence from investors that companies are reputable and information is trustworthy
All three elements above address the problem of asymmetric information in a marketplace by bridging the knowledge gap between company management and investors. Transparent pricing facilitates the assessment process, letting companies and investors determine whether the valuation is fair and actionable. Markets are self-regulating, and when information is widely available, prices will adjust to reflect a combination of company performance, investor demand, and overall economic conditions. Intrinsically, SEC filings are meant to eliminate the discrepancy of information between companies and their investors, yet the high cost associated with registration doesn’t always seem to match the intended benefits. Banks on a quarterly basis already produce call reports to their regulators, and many of them also publish additional financials and disclosures to their shareholders via public portals such as www.OTCMarkets.com, through SNL, or on their own shareholder relations page. For a small bank, the cost of SEC reporting typically ranges from $150,000 to $200,000 per year, and on annual net income of $1 million, that’s a very significant amount.
In the U.S., there are roughly 7,000 banks, a majority of which are small community banks with under $1 billion in assets. Of the 7,000, about 15 percent are publicly traded, around 450 on registered national securities exchanges such as New York Stock Exchange and NASDAQ, and 600 over-the-counter, primarily on the OTCQB marketplace operated by OTC Markets Group. Fifteen percent is a relatively small fraction, especially given the current economic climate and disposition towards mergers and acquisitions. In general, banks are viewed more favorably and are in better positions to be acquired when the bank’s stock is publicly traded. There is always going to be greater confidence in a deal when valuation is publicly derived (even if the price/book is less than 100 percent).
However, should banks become publicly traded solely for the fact that they would be “more attractive” in an acquisition? Without a doubt being traded on a public market exposes the company to potential market volatility, and there are inherent risks and costs associated with being publicly traded, even with the recent changes outlined in the JOBS Act. A common impediment delaying and preventing companies from going public is the fear that the public valuation will be less than the management’s internally perceived price. A parent will believe that his or her child is the best, but unfortunately we live in society where individuals are subject to comparison and ability is often determined by some form of standardized testing or arbitrary measurements. Public scrutiny is hard to swallow, but public acknowledgement can be equally, if not more, gratifying.
Since the financial crisis in 2008, markets have been perceived as the big bad wolf, the visible scapegoat for why companies go bankrupt and why shareholders lose millions of dollars in their investments. However, despite the recent ups and downs, they still remain the best indicator of good investments and the most efficient way to access capital. If the company has a sustainable and profitable business, if a bank’s loan portfolio has consistently provided high returns with minimal default risks, then the well-informed markets should adjust to reflect those successes.