Playing Their Cards Right

Texas Capital Bancshares first tried an initial public offering in 2002 and was stung by a lackluster market, having to withdraw its bid for better times. But the second go-around was a charm for the Dallas-based bank. Last August the bank went back to investors and raised $66 millionu00e2u20ac”capital it will use as currency for future acquisitions and to provide liquidity for existing shareholders.

“Having a public currency facilitates growth and makes valuation issues simpler,” says James R. Holland Jr., a board member and chairman of Texas Capital’s executive committee.

Other up-and-coming banks and thrifts are following suit. While the IPO market for financial institutions hasn’t been anything to jump up and down about in recent years, current market conditions point to a possible resurgence. For one, bank stocks have fared well since the war in Iraq, bouncing back from lows last year. The Philadelphia Stock Exchange/KBW bank stock index, a measure of the biggest U.S. banks, was up 38% in December from March, while the NASDAQ bank index, a barometer of community bank stock performance, was up 35% over the same period. Moreover, fourth-quarter data showed plenty of evidence of increased investment by businesses and a surge in manufacturing jobs.

“The economy is now beginning to rock,” says Joseph V. Ciaburri, chairman and chief executive of Southern Connecticut Bancorp, a financial institution that did an IPO two years ago in a harsher business climate and is now looking to do a secondary offering sometime during the first quarter. “Companies are spending. Loan demand is way up. There are a lot of plusses going with it. It’s a perfect time to get involved” in the markets, he says.

While not overwhelming, the appetite for IPOs has been increasing. There were 15 IPOs by banks and thrifts in the first 11 months of 2003, raising $1.9 billion, according to SNL Financial, a research firm in Charlottesville, Virginia. That compares with 18 deals and just $1 billion raised for all of 2002 (see chart). One big driver of late has been thrift conversions, such as Bank Mutual Corp. of Brown Deer, Wisconsin, which raised $411 million in a second-step offering that closed in October, and a $202 million offering by KNBT Bancorp of Bethlehem, Pennsylvania in November.

This year, the improving economic environment should send many more deals down the IPO pipeline, investment bankers say. “The market is very receptive to banks today,” says John Roddy, a senior vice president at Lehman Brothers in New York. “Banks will want to make sure they are adequately capitalized to take advantage of the market opportunity,” he says. “Having a public currency is also going to be very important for a number of banks as they expand.”

In particular, private financial institutions that are positioning themselves to grow rapidly in the coming years now have a window of opportunity. “There are not many boardrooms where this isn’t being discussed,” says Fred Price, a managing principal at Sandler O’Neill & Partners in New York. “They are saying, ‘Look, this is a good equity market. Do we want to become a public company and continue to grow, or do we want to remain a smaller private company?’ They are going to have to make that decision.”

Ante Up

Fueling the equity market are the growing cash coffers of big investors, as funds are starting once again to see inflows after the tumultuous years of a bear market. “The institutional equity funds today find themselves with a need to find investment ideas,” Price says.

Recent deals such as Bank of America Corp.’s announcement that it will buy FleetBoston Financial Corp. have fueled investor interest, generating the expectation that many banks that have recently gone public will eventually be sold at a premiumu00e2u20ac”especially those with strong franchises in growth markets. And banks on an acquisition path have more of a need for capital than they did when FASB allowed the pooling method of accounting. Under purchase accounting rules, acquirers must amortize goodwill, the difference between the book value of a company’s tangible assets and the price paid for the purchase. The amortization is an offset to tangible capital.

Factors holding back boards from taking the plunge include loss of ownership control and increased regulatory requirements, such as required filings with the Securities and Exchange Commission. Yet for banks that have gone the IPO route, there are enticements too good to pass up. In addition to the ability to use stock as a currency in acquisitions, going public provides more liquidity for shareholders, and banks can attract talent using employee stock ownership plans.

Moreover, with so many regulatory changes as a result of new laws such as the Sarbanes-Oxley Act, the effort to go public often won’t effectively cost a bank much more money, time, or effort. “It used to be, as a private company, people felt there was a little less scrutiny of their board and a little less scrutiny of everything else from their owners,” Price says. “But under Sarbanes-Oxley, that is not the case, especially for an insured depository. So they still have to meet the same independency tests and so forth. Why not give their shareholders the benefit of the public market if that really is going to be the case?”

Rolling the dice

Still, banks mulling over the option to go public are making a bet of sorts if they decide to do an IPO. A company going through an IPO is gambling that the market will still be strong in six to nine monthsu00e2u20ac”about the time it takes to complete the necessary filings and market the stock. While bank stock prices were good in late December, a downturn could quickly change the prospects for those seeking a big boost in capital. “Today you are betting on what the market is going to be like down the road,” says Michael Crowley Jr., chairman and chief executive officer at Bank Mutual, a thrift that sold 49% of itself to the public in 2000 and followed up with the other 51% in October. “I wouldn’t discourage anyone from making that decision, but they have to think through the risks and rewards.”

The rewards seem ample for Texas Capital, which was the first Texas bank in five years to conduct an IPO. Spearheaded by Chairman Joseph M. Grant, the bank opened its doors in 1998 with the intention to go public after Grant identified a big hole to fill in Texas middle-market banking. Large banks in the state nearly went extinct after the last energy industry bust and following big acquisitions such as those by Chase Manhattan and Texas Commerce. Texas Capital, now with $2.1 billion in assets, competes with heavy hitters such as J.P. Morgan Chase & Co., Bank of America Corp., and Bank One Corp. and is targeting companies with annual revenue between $5 million and $250 million and clients with a net worth greater than $1 million.

“We were very cautious about going public,” says Holland, who chairs the executive committee on Texas Capital’s board and also serves as president and chief executive officer of Unity Hunt Inc., a private investment firm based in Dallas. “We wanted to be sure the bank was on firm footing to perform well going forward, that we would be able to sustain the performance in the aftermarket.”

So far, so good for Texas Capital’s performance. The bank reported earnings per share of 14 cents on a diluted basis in the third quarter, up 56% from the same period in 2002. Net loans grew 16% to $1.1 billion, and deposits grew 27% to $1.4 billion. Its stock in early December traded in the $14 range, up 27% from its offering price of $11.

Analysts say Texas Capital is, in part, using stock proceeds to spend more on infrastructure than it needs for its current size, in areas such as and personnel and data processing. It recently wooed away five seasoned lenders from Wells Fargo & Co. to open up its Houston branch as it deepens its penetration into energy lending. Much of its expansion has come by enticing experienced bankers in Texas, says Brock Vandervliet, an analyst at Lehman Brothers. “Texas Capital is growing largely by hiring very qualified loan officers that have 15 or 20 years’ experience and who are tired of working under the shackles of management outside the state or management that is in a much larger organization,” Vandervliet says. “By joining Texas Capital, [these new loan officers] can literally move the needle as they migrate their loan relationships.”

Ace in the hole

Still, boards need to consider how large infusions of capital can drive down return on equity. Texas Capital reported an ROE of 9.05% for the third quarter, well below the 15% range of its similarly sized competitors. “They have gone out and raised a whole slew of capital with the idea that they want to grow rapidly,” says Scott Alaniz, an analyst at Samco Capital Markets in Dallas. “The trick now is they have to grow the bank and do it in a very profitable manner so they can bring their ROE up to peer-group averages. That is what investors are betting on.”

One of the things the board can exercise a great deal of control over is how the shares are soldu00e2u20ac”if the institution is small enough. Community banks, for instance, can market offerings to their own constituency. This way, instead of using an underwriter and selling shares on a national basis, officers and directors of the company sell shares to a collective body of contacts that have ties to the local area. “A community offering is a more painstaking and lengthy process, but one that develops loyal shareholders,” explains John Carusone, president of Bank Analysis Center, a Hartford, Connecticut, investment bank and consulting firm. “Selling the stock through an underwritten offering is faster but less personal because of the unknown element of who the shareholders are and their absence of commitment to bringing business to the bank.”

Community offerings generally bring in less money than a national offering, and fund raising typically is measured in months rather than weeks. Connecticut Bank and Trust Co., which was scheduled to open for business in the first quarter [of 2004], raised $18.5 million in 76 days last summer, with about 500 shareholders. “When you do it yourself, you end up with local ownership,” says David Lentini, chairman, president, and chief executive officer of CBT. “In our case, we really wanted to have Connecticut people only.” The capital will allow the company to open three offices in Hartford, Glastonbury, and West Hartford.

CBT benefited from brand-name recognition from its days as an independent bank in the 1980s. The old CBT saw its demise after being bought by Bank of New England, which ran into real estate trouble in the 1990s, forcing the entire enterprise to liquidate. Capitalizing on the old CBT name recognition, the bank was fast to raise adequate money out of the gates. Its 40 foundersu00e2u20ac”prominent individuals from the Hartford areau00e2u20ac”pledged about $6 million of the total raised. “That really helped,” Lentini says. “It gave us a lot of confidence.” The offering also allowed the bank to avoid paying fees as high as 10% for the deal to be underwritten and sold nationally. “You save a lot of money if you can do it,” he says. “You end up with a shareholder base you design.”

Centrix Bank & Trust, a $150 million company in Bedford, New Hampshire, has also maintained a tight rein on its investor base. It first tapped the market in 1999 and then followed up in October 2003 with a secondary offering to boost its capital ratios and fund growth. It raised $8 million in each offering, yet still only has about 320 shareholders. In the IPO round, “we were adamant against taking in any sort of institutional money,” says Joe Reilly, president and chief executive officer of Centrix. “Local people who have business connections are our best advocates in driving business to the bank, and they have a more vested interest.” Centrix’s recent secondary offering was oversubscribed, but wording in the offering circular was crafted to allow the bank to choose those investors it felt would best serve the growth of the bank.

Dealer’s choice

Still, using an underwriter has its advantages. In another de novo IPO, Southern Connecticut Bancorp, a New Haven-based Connecticut bank with $57.5 million in assets, opened its doors in October 2001 after raising $11.7 million in August that year. Using Tucker Anthonyu00e2u20ac”now RBC Dain Rauscheru00e2u20ac”as its investment bank, Southern Connecticut was able to raise the money in 17 days and accumulate a base of 1,000 shareholders at a time when money was tight.

“To do it ourselves, it would have taken a year,” says CEO Joseph V. Ciaburri. “We did it in 17 days. It was worth the effort of paying what we had to pay because it really was organized very quickly and gave us the manpower to do it.”
While the bank got off to a rough startu00e2u20ac”the stock first sold for $12 then dropped to $6 after the terrorist attacksu00e2u20ac”its stock had regained some of its ground by December when it traded near $9. In the process, the bank has succeeded in tapping the middle market in New Haven. The company works more like a private bank, pricing out retail customers such as Yale University students and focusing on small business. The bank’s sole branch last fall had one teller, though the bank had 500 business customers, typically those with $3 million to $5 million in annual sales. The bank generated its first profit in October, has $41 million in loans, and its staff has grown to 28, up from eight at its inception. It started a company that helps find capital for businesses in November, and will open a mortgage company in the first quarter of 2004.

That growth has prompted Southern Connecticut to go back to the markets for more capital. The bank plans to tap the markets again in the first quarter of 2004 to fund expansion of two more branches. Southern Connecticut will undergo a secondary offering with the goal of raising $15 million to start up another bank in New London, under the name Bank of Southeastern Connecticut. No doubt, the issuance of stock should be a simpler sell in today’s capital markets than in those just before 9/11. “It will be easier now,” Ciaburri says. “Plus, we have credibility.”

Winning Strategies

In the IPO market, mutual thrifts have a little more flexibility than their commercial banking brethren. Thrifts can go public in steps, allowing as much ownership control in the hands of officers and directors as possible. Under Office of Thrift Supervision regulations, mutual thrifts can recognize ownership transactions where companies sell less than 100% to the public. (National commercial banking charters do not allow this, along with most state banking charters.)

The aforementioned Bank Mutual, a federally chartered Wisconsin institution with $3.2 billion in assets, sold 49% of the company to the public in November 2000, raising $110 million in the process, then followed up by selling the other 51%u00e2u20ac”yielding the $411 millionu00e2u20ac”in October 2003. The first phase helped the company purchase First Northern Capital Corp. to help it compete against formidable competition for the consumer market from the likes of Wells Fargo & Co., U.S. Bancorp, and Bank One Corp. “The need for capital to do that acquisition was not great enough to require that we sell 100% of the company to the public,” says chairman and chief executive officer Crowley. “If you don’t have to give up control, why give up control?”

Financial institutions often raise funds to meet Tier 1 capital requirements or to finance acquisitions but in Bank Mutual’s case, selling off the other 51% was driven by a desire to best represent the needs of shareholders. “We perceived it was in the best interest of shareholders, from a market timing and market strength perspective in bank stocks, to offer the second step,” Crowley says. “We felt that the receptivity was strong.”

That receptivity has allowed the thrift’s mutual owners to capture the value of its stock price since going public. When it went public in 2000, shares were sold at $10 per share and were trading at $42.40 before the second step IPO in October 2003. In the offering, the company did a 3.6-for-one stock split, and issued the new shares at $10 per share.

Aside from the proceeds, the second step provided Bank Mutual with additional liquidity. The offering increased outstanding shares to 78 million, up from 11 million. Average daily volume in the first week of December was 530,000 shares, up from about 62,000 in the first five trading days of October, approximately four weeks before the second step took place. That kind of newfound traffic will make it more marketable to large investors. “Before, some institutional investors wouldn’t get involved because there wasn’t liquidity in the stocks,” Crowley says. “They would never know if they could get out of a position.”

Industrywide, the increased activity in the IPO market might be just the beginning, as many privately held banks consider their options. “There will be a significant increase in the number of banks that are filing to go public over the short term,” says Roddy of Lehman Brothers. “The market environment is conducive today, yet it’s not always going to be there. It’s hard to say how long it will last.”

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