Why Some Banks Purposefully Shun the Spotlight


strategy-8-9-19.pngFor as many banks that would love to be acquired, even more prefer to remain independent. Some within the second group have even taken steps to reduce their allure as acquisition targets.

I was reminded of this recently when I met with an executive at a mid-sized privately held community bank. We talked for a couple hours and then had lunch.

Ordinarily, I would go home after a conversation like that and write about the bank. In fact, that’s the expectation of most bank executives: If they’re going to give someone like me so much of their time, they expect something in return.

Most bank executives would welcome this type of attention as free advertising. It’s also a way to showcase a bank’s accomplishments to peers throughout the industry.

In this particular case, there was a lot to highlight. This is a well-run bank with talented executives, a unique culture, a growing balance sheet and a history of sound risk management.

But the executive specifically asked me not to write anything that could be used to identify the bank. The CEO and board believe that media attention — even if it’s laudatory — would serve as an invitation for unwanted offers to acquire the bank.

This bank in particular has a loan-to-deposit ratio that’s well below the average for its peer group. An acquiring bank could see that as a gold mine of liquidity that could be more profitably employed.

Because the board of this bank has no interest in selling, it also has no interest in fielding sufficiently lucrative offers that would make it hard for them to say “no.” This is why they avoid any unnecessary media exposure — thus the vague description.

This has come up for me on more than one occasion in the past few months. In each case, the bank executives aren’t worried about negative attention; it’s positive attention that worries them most.

The concern seems to stem from deeper, philosophical thoughts on banking.

In the case of the bank I recently visited, its executives and directors prioritize the bank’s customers over the other constituencies it serves. After that comes the bank’s communities, employees and regulators. Its shareholders, the biggest of which sit on the board, come last.

This is reflected in the bank’s loan-to-deposit ratio. If the bank focused on maximizing profits, it would lend out a larger share of deposits. But it wants to have liquidity when its customers and communities need it most – in times when credit is scarce.

Reading between the lines reveals an interesting way to gauge how a bank prioritizes between its customers and shareholders. One prioritization isn’t necessarily better than the other, as both constituencies must be appeased, but it’s indicative of an executive team’s philosophical approach to banking.

There are, of course, other ways to fend off unwanted acquisition attempts.

One is to run a highly efficient operation. That’s what Washington Federal does, as I wrote about in the latest issue of Bank Director magazine. In the two decades leading up to the financial crisis, it spent less than 20% of its revenue on expenses.

This may seem like it would make Washington Federal an attractive partner, given that efficiency tends to translate into profitability. From the perspective of a savvy acquirer, however, it means there are fewer cost saves that can be taken out to earn back any dilution.

Another way is to simply maintain a high concentration of ownership within the hands of a few shareholders. If a bank is closely held, the only way for it to sell is if its leading shareholders agree to do so. Widely dispersed ownership, on the other hand, can invite activists and proxy battles, bringing pressure to bear on the bank’s board of directors.

Other strategies are contractual in nature. “Poison pills” were in vogue during the hostile takeover frenzy of the 1980s. Change-of-control agreements for executives are another common approach. But neither of these are particularly savory ways to defend against unwanted acquisition offers. They’re a last line of defense; a shortcut in the face of a fait accompli.

Consequently, keeping a low media profile is one way that some top-performing banks choose to fend unwanted acquisition offers off at the proverbial pass.

While being acquired is certainly an attractive exit strategy for many banks, it isn’t for everyone. And for those banks that have earned their independence, there are things they can do to help sustain it.

Improving Shareholder Liquidity, Employee Performance through ESOPs


ESOP-6-18-19.pngMost banks face challenges to find, incentivize and retain their best employees in an increasing competitive market for talent. Often, smaller banks and banks structured as Subchapter S corporations have the added challenge of providing liquidity for their shareholders and founders. An employee stock ownership plan can be an excellent tool for addressing those issues.

An ESOP creates a buyer for the bank’s stock, generating liquidity for shareholders of private or thinly traded banks and providing market support for publicly traded ones. An ESOP’s buying activity can reduce shares outstanding and increase a bank’s earnings per share. It can also increase employee benefits and gives them a sense of ownership that can improve recruitment, retention and performance.

ESOPs are tax-qualified defined contribution retirement plans for employees that primarily invest in employer securities. ESOPs offer accounts to employees, similar to 401(k) retirement plans. But unlike a 401(k), employees do not contribute anything to the plan; instead, the bank makes the contribution on their behalf.

ESOPs are an excellent employee benefit and a recruitment, retention and performance tool. ESOPs do not pay taxes on an annual basis, so taxes are deferred while the stock remains in a plan. When the employee retires or takes a distribution from the plan, the value of the distribution is taxed as ordinary income. Employees also have the ability to roll over the distribution to an individual retirement account.

Employees at companies that offer an ESOP have, on average, 2.6 times more in retirement assets than employees working at companies that do not have an ESOP, according to the National Center for Employee Ownership. Additionally, companies with broad-based stock option plans experienced an increase in productivity of 20 percent to 33 percent above comparable firms after plans were implemented. Medium-sized companies saw gains at the higher end of the scale. Employee ownership is also associated with higher rates of employee retention. According to a survey by the Rutgers University’s NJ/NY Center for Employee Ownership, workers at employee-owned companies are less likely to look for other jobs and more likely to take action when co-workers are not working well.

There are a couple of different ways that banks can establish ESOPs. The simplest and most efficient is called a non-leveraged ESOP, where the bank or holding company makes a tax-deductible cash contribution. The contribution can be in stock or cash and is recorded as compensation expense. If the bank contributes cash, those funds can be used to purchase stock directly from shareholders and create liquidity and demand in the stock. However, it can take years for a non-leveraged ESOP to accumulate a significant enough position to make a meaningful difference to a bank.

The other method, called a leveraged ESOP, uses a bank’s holding company to lend money directly to the ownership plan. The holding company is required because banks are not permitted to lend directly to the ESOP or guarantee a loan made to the ESOP. The holding company can use cash on its balance sheet, borrow it from a third-party lender or guarantee a third-party loan made directly to the ESOP. The ESOP uses the funds to purchase a large block of non-issued shares from the holding company or directly from shareholders. Although leveraged ESOPs have higher costs and complexity, they can make an immediate, meaningful difference in liquidity and employee benefits. This approach also has the benefit of increasing earnings per share upfront, since the shares underlying the ESOP loan to make the purchase are not considered outstanding. However, the repurchased shares negatively impact tangible common equity and tangible book value.

An ESOP can help the right bank accomplish many of its goals and objectives. Banks should carefully review their goals and objectives with qualified professionals that know and understand both the ESOP and commercial bank industries.

A Better Way to Value Deposit-Driven Deals


deposits-4-1-19.pngThere’s no doubt that the focus these days on acquisitions centers around deposits. When surveyed at the 2019 Acquire or Be Acquired conference, 71 percent of attendees said that a target’s deposit base was the most important factor in making the decision to acquire. This suggests that targets with excess liquidity (low loan-to-deposit ratios) will be highly valued in the market going forward.

This strategic objective is out of whack with traditional deal valuation metrics.

The two primary traditional deal metrics are tangible book value (TBV) payback period and earnings per share (EPS) accretion. Investors expect every deal to meet the benchmarks of a low TBV payback period (ideally less than three years) and be accretive to EPS, according to a presentation from Keefe Bruyette & Woods President and CEO Tom Michaud.

These are earnings-based metrics, and targets with low loan-to-deposit ratios have lower earnings because they have larger securities portfolios relative to loans. Therefore, traditional consolidation modeling will undervalue those targets with longer payback periods and lower accretion. Potential acquirers will struggle to justify competitive prices for these highly valued targets.

Why are deals that clearly create shareholder value by strengthening the buyer’s deposit base not reflected by the deal metrics du jour? Because those metrics are flawed. How can you justify a deposit-driven deal to an investor base that is focused on TBV payback and EPS accretion? By abandoning traditional valuation methods and using forward-looking, common sense analytics that capture the true value of an acquisition.

Traditional consolidation methodology projects the buyer and seller independently, then combines them with some purchase accounting and cost savings adjustments. Maybe the analyst will increase consolidated loan growth generated from the excess deposits acquired. This methodology does not capture the true value of the acquired deposits.

The intelligent acquirer should first project its own financials under realistic scenarios, given current market trends. Industry deposit growth has already begun to slow, and the big banks are taking more and more market share. If the bank were to grow loans organically, it must be determined:

  • How much of the funding would come from core deposits and how much would require brokered deposits or other borrowings like Federal Home Loan Bank advances and repurchase agreements? This change in funding mix will drive up incremental interest expense.
  • How many of the bank’s existing depositors will shift their funds from low cost checking and savings accounts to higher cost CDs to capture higher market rates? This process will increase the bank’s existing cost of funds.
  • What will happen to my deposit rates when my competitors start advertising higher rates in a desperate play to attract deposits? This will put more pressure on the bank’s existing cost of funds.
  • How many of my existing loans will reprice at higher rates and help overcome increasing funding costs? Invictus’ BankGenome™ intelligence system suggests that, while the average fixed/floating mix for all banks in the US is 60/40, the percentage of floating rate loans actually repricing at higher rates in the next 12 months is much lower because the weighted average time between loan reset dates is more than six quarters.

Standalone projections for the buyer must adequately reflect the risks inherent in the current operating environment. These risks will affect a bank’s bottom line and, therefore, shareholder value. This process will create a true baseline against which to measure the impact of the acquisition. Management must educate its investors on the flaws in legacy analytics, so they can understand a deal’s true value.

In the acquisition scenario, the bank is acquiring loan growth with existing core deposit funding attached. And if the target has excess deposits, the acquirer can deploy those funds into additional loans grown organically without the funding risks due to current market trends. The cost differential between the organic growth and acquisition scenarios creates real, tangible savings. These savings translate to higher incremental earnings from the acquisition, which alleviate TBV payback periods and EPS accretion issues. Traditional deal metrics may be used as guideposts in evaluating an acquisition, but a misguided reliance on them can obscure the true strategic and financial shareholder value created in a transaction.

Every target should be analyzed in depth, with prices customized to the acquirer’s unique balance sheet and footprint. Don’t pass on a great deal because of flawed traditional methodologies.

Rodge Cohen: Are We Preparing to Fight the Last War?


risk-3-1-19.pngHis name might not command the same recognition on the world stage as the mononymous Irish singer and song-writer known simply as Bono, but in banking and financial services just about everyone knows who “Rodge” is.

H. Rodgin Cohen–referred to simply as Rodge—is the unrivaled dean of U.S. bank attorneys. At 75, Cohen, who is the senior chairman at the New York City law firm Sullivan & Cromwell, is still actively involved in the industry, having recently advised SunTrust Banks on its pending merger with BB&T Corp.

Cohen has long been considered a valued advisor within the industry.

In the financial crisis a decade ago, he represented corporate clients like Lehman Brothers and worked closely with the federal government’s principal players, including Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke. His character even made an appearance in the movie “Too Big To Fail,” based on a popular book about the crisis by Andrew Ross Sorkin.

Eleven years later, Cohen says the risk to the banking industry is no longer excessive leverage or insufficient liquidity—major contributing factors to the last crisis.

The Dodd-Frank Act of 2010, passed nearly a decade ago, raised bank capitalization levels substantially compared to pre-crisis levels. In fact, bank capitalization levels have been rising for 40 years, going back to the thrift crisis in the late 1980s. Dodd-Frank also requires large banks to hold a higher percentage of their assets in cash to insure they have enough liquidity to weather another financial storm.

The lesson from the last crisis, says Cohen, revolves around the importance of having a fortress balance sheet. “I think that was the lesson which has been thoroughly learned not merely by the regulators, but by the banks themselves, so that banks today have exponentially more capital, and the differential is even greater in terms of having more liquidity,” says Cohen.

But does anyone know if these changes will be enough to help banks survive the next crisis?

“I don’t think it is possible to calculate this precisely, but if you look at the banks that did get into trouble, none of them had anywhere near the level of capital and liquidity that is required now,” says Cohen. “Although you can’t say with certainty that this is enough, because it’s almost unprovable, there’s enough evidence that suggests that we are at levels where no more is required.”

It is often said that generals have a tendency to fight the last war even though advances in weaponry—driven by technology—can render that war’s tactics and strategies obsolete. Think of the English cavalry on horseback in World War I charging into German machine guns.

It can be argued that regulators, policymakers and even customers in the United States still bear the emotional scars of the last financial crisis, so we all find comfort in the fact that banks are less leveraged today than they have been in recent history, particularly in the lead up to the last crisis.

But what if a strong balance sheet isn’t enough to fight the next war?

“I think the biggest risk in the [financial] system today is a successful cyberattack,” says Cohen. While a lot of attention is paid to the dangers of a broad attack on critical infrastructure that poses a systemic risk, Cohen worries about something different.

“That is a very serious risk, but I think the more likely [danger] is that a single bank—or a group of banks—are hit with a massive denial of service for a period of time, or a massive scrambling of records,” he says. This contagion could destabilize the financial system if depositors begin to worry about the safety of their money.

Cohen believes that financial contagion, where risk spreads from one bank to another like an infectious disease, played a bigger role in the financial crisis than most people appreciate. And he worries that the same scenario could play out in a crippling cyberattack on a major bank.

“Until we really understand what role contagion played in 2008, I don’t think we’re going to appreciate fully the risk of contagion with cyber,” he says. “But to me, that is clearly the principal risk.”

And herein lays the irony of the industry’s higher capital and liquidity requirements. They were designed to protect against the risk of credit bubbles, such as the one that precipitated the last crisis, but they will do little to protect against the bigger risk faced by banks today: a crippling cyberattack.

“That’s why I regard [cyber] as the greatest threat,” says Cohen, “because a fortress balance sheet won’t necessarily help.”

More Banks Want To Sell For This Reason


liquidity-1-14-19.pngPeople often ask what are the main factors that are motivating banks to sell. Not surprisingly, sellers frequently cite a lack of succession planning, a lack of scale and increasing costs for technology and compliance.

But one surprising area that is becoming more influential is shareholder liquidity, now more often the primary factor we see pushing institutions to sell.

For many banks, the age of their average shareholder is approaching or exceeds 70. This leads to three primary challenges:

  • As shareholders pass away, the personal representative often needs to liquidate shares in order to settle the estate. If the issuer can’t provide a source of liquidity, the estate will “dump” the shares, sometimes at a steep discount.
  • Other shareholders are engaged in estate planning and seeking to sell shares.
  • Local shareholders are bequeathing shares to children and grandchildren spread all over the country who have no commitment to the community or desire to hold shares in the local bank.

There are also de novo banks whose investors bought in during the late 1990s and early 2000s with the promise of a 10- to 15-year time horizon. They are 20 years older and eager for a liquidity event.

There are many tools institutions can use to provide shareholders with increased liquidity, including:

1. Matching Programs. Some of our clients keep “interested purchaser” and “interested sellers” lists, in order to help match prospective buyers and sellers. This can be a simple way to help shareholders find an avenue for sale. If a shareholder asks for help in selling their shares, you can provide them with a list including the contact information of interested purchasers.

There are important considerations when administering a matching program. You will want to (1) avoid activity that would require registration with the SEC as a broker-dealer, and (2) make sure you, as the issuer, are not seen as “offering” the shares. To mitigate those risks, you should play a very limited role in any matching transaction. You should not negotiate, offer opinions, handle transaction money, or actively promote the service or solicit customers. You may, however, provide certain limited information and make shareholders aware of the service.

2. Repurchase Programs. Repurchase programs can take many forms, but the two most common are buyback programs and tender offers. With a buyback program, the board adopts a policy authorizing the company to repurchase shares within certain parameters. You may then inform shareholders of the program, but you may not actively solicit shareholders to participate in the program. Alternatively, a tender offer is an active solicitation whereby you ask a shareholder to make an investment decision in a limited amount of time. Furthermore, a tender offer is often more successful because it is “easy.” A shareholder simply needs to accept the issuer’s offer and doesn’t need to engage in negotiations with the company or other unfamiliar shareholders. Tender offers also allow the issuer to target strategic goals, such as offering redemption to small shareholders or out-of-state shareholders.

There are certain bank regulatory considerations involved with any share buyback or redemption transaction. In addition, specific securities laws and requirements apply to tender offers.

3. Transfer Services. Legislation enacted in recent years (the JOBS Act and the FAST Act) allows the use of a third-party online platform to implement certain securities transactions. By using a third-party platform, you can remain involved and offload most of the compliance risk to the vendor. Such platforms can often act as a white-labeled bulletin board for your shareholders to interact.

4. Listing. There are always the options of listing your securities over-the-counter (or OTC), on the recently-created bank-specific OTCQX, or going public and listing your shares on NASDAQ or NYSE.

To fund some of the repurchase initiatives identified above, some banks have successfully raised new capital from community members and customers, many of whom have not had the opportunity to invest in the bank. When a repurchase program is coupled with an offering, several banks have successfully “recycled” their shareholder base, buying time to execute their strategy without the added pressure of liquidity concerns.

There are a lot of options to consider, but community bank executives and boards should be aware of the increasing challenge shareholder liquidity is presenting to their peers and how to manage it proactively.

Five Reasons Why You Should Reconsider Short-Term Loans


lending-7-16-18.pngFor the better part of a decade, regulatory agencies have placed obstacles in front of banks that all but prohibited them from offering short-term, small-dollar lending options for their customers. Now, at least one major regulator has signaled a shift in its opinion about those products, which should inspire banks to reconsider those options.

Here are five reasons banks often cite when discussing why they don’t offer short-term, small-dollar options, and a case why they should rethink those ideas.

You don’t think your customers need it
Perhaps many of your branches are in affluent areas, or you believe that your customers have access to other types of short-term liquidity. But the statistics regarding American personal finances may surprise you:

Nearly 50 percent of American consumers lack the necessary savings to cover a $400 emergency, according to the Federal Reserve.
The personal savings rate dipped to 2.8 percent in April 2018, the lowest rate in over a decade, according to the St. Louis Fed.
Each year 12 million Americans take out payday loans, spending $9 billion on loan fees, according to the Pew Charitable Trusts.

Based on these statistics, it’s likely that a portion of your customer base is affected by the lack of savings, or has a need for better access to liquidity, and chances are good that they’d be receptive to a small-dollar, short-term loan solution.

It’s Cost and Resource Prohibitive
For most financial institutions, introducing a traditional small-dollar loan program is cost-prohibitive–operationally, and from a staffing standpoint. From the cost of loan officers and underwriters to the overhead, the reality is it would take time and resources many banks do not have.

Enter fintech firms, bringing proprietary technology and the application of big data. The right fintech partner can manage the time, human and financial resources you may not have, such as application, underwriting and loan signing processes. In some cases, the whole thing can be automated, resulting in a “self-service” program for your customers, eliminating the human resource need.

Underwriting Challenges and Charge-Off Concerns
Another challenge is the loan approval process and how to underwrite these unique loans. A determination of creditworthiness by a traditional credit check does not adequately predict the consumer’s current ability to repay using recent behavior instead of a period of many years. Today’s fintech firms use proprietary technology to underwrite the loans, incorporating a variety of factors to mitigate charge-offs.

The OCC recently released a bulletin outlining “reasonable policies and practices specific to short-term, small-dollar installment lending.” It stated such policies would generally include “analysis that uses internal and external data sources, including deposit activity, to assess a consumer’s creditworthiness and to effectively manage credit risk.” The right fintech partner will apply big data solutions to assess creditworthiness using the OCC’s criteria and other factors.

Compliance Burdens
There’s no question short-term loan options have been heavily regulated over the past eight years. The CFPB placed predatory lending and payday loans under scrutiny. In 2013, the OCC and FDIC effectively ended banks’ payday loan alternative, the deposit advance. The CFPB cracked down even harder in October 2017 with their final payday lending rule, which had the potential to devastate the storefront payday loan industry, forcing consumers to seek alternative sources of quick liquidity.

The pressure is easing. The OCC was the first agency to encourage banks to make responsible and efficient small-dollar loans. If history has taught us anything, it’s that the other regulatory agencies likely will soon follow suit.

Concern About Cannibalizing Overdraft Revenue
Exclusive data collected by fintech firms experienced with overdraft management has shown there are two distinct groups of consumers managing their liquidity needs in different ways:

The Overdrafters
These are consumers that struggle with transaction timing and incur overdraft or NSF fees. A significant portion of this group might have irregular income streams, such as small business owners or commissioned salespeople. In many cases, these consumers are aware of their heavy overdraft activity, and will continue to overdraft, because for them, it makes financial sense.

The Loan-Seekers
A second group includes those consumers who simply lack the cash to promptly pay their bills, and either can’t obtain adequate overdraft limits or failed to opt-in to overdraft services. These consumers are actively seeking small-dollar loans to avoid the double whammy of hefty late fees and negative hits to their credit score for late payments.

Savvy financial institutions will ensure they have the programs in place to serve both groups of consumers, and fill the gap for the second category by using an automated small-dollar lending program with sound underwriting from a trusted fintech vendor.

Are the Ducks Quacking?


IPO-5-17-18.pngAn initial public offering isn’t the only path to listing your bank’s shares on the Nasdaq or New York Stock Exchange, and gaining greater liquidity and more efficient access to capital via the public markets.

Business First Bancshares, based in Baton Rouge, Louisiana, opted for a direct listing on the Nasdaq exchange on April 9, over the more traditional IPO. Coincidentally, this was the same route taken a few days prior—with greater fanfare and media attention—by Swedish entertainment company Spotify. A direct listing forgoes the selling of shares, and provides an instant and public price for potential buyers and sellers of a company’s stock.

Business First’s direct listing could be seen as an IPO in slow motion. The $1.2 billion asset company registered with the Securities and Exchange Commission in late 2014, ahead of its April 2015 acquisition of American Gateway Bank. Business First then completed a $66 million private capital raise in October—$60 million of which was raised from institutional investors—before acquiring MBL Bank in January. The institutional investors that invested in Business First last fall did so with the understanding that the bank would be listing soon. “We actually raised money from the same people as we would have in an IPO process,” says Chief Executive Officer Jude Melville.

Melville says his bank took this slow route so it could be flexible and take advantage of opportunities to acquire other banks, which is a part of the its long-term strategy. Also, bank stocks in 2015 and 2016 had not yet hit the peak levels the industry began to see in 2017. The number of banks that completed an IPO in 2017 more than doubled from the prior year, from eight to 19, according to data obtained from S&P Global Market Intelligence.

“The stars aligned in 2017” for bank stocks, says Jeff Davis, a managing director at Mercer Capital. The Federal Reserve continued increasing interest rates, which had a positive impact on margins for most banks. Bank M&A activity was expected to pick up, and the Trump administration has appointed regulators who are viewed as being friendlier to the industry. “There’s a saying on Wall Street: When the ducks are quacking, feed them, and institutional investors wanted bank stocks. One way to feed the ducks is to undergo an IPO,” Davis says. Bank stock valuations are still high, and so far, 2018 looks to be on track for another good year for new bank offerings, with four completed as of mid-April.

The more recent wave of bank IPOs, which had trailed off in 2015 and 2016, was largely a result of post-crisis private equity investors looking for an exit. As those investors sought liquidity, several banks opted for life as a public company rather than sell the bank. That backlog has cleared, says Davis. “It’s still a great environment for a bank to undergo an IPO,” he says. “Particularly for a bank with a good story as it relates to growth.”

The goals for Business First’s public listing are tied to the bank’s goals for growth via acquisition. Private banks can be at a disadvantage in M&A, having to rely on all-cash deals. A more liquid currency, in the form of an actively-traded stock, is attractive to potential sellers, and the markets offer better access to capital to fuel growth. Melville also believes that most potential employees would prefer to work for a public versus a private company. “Being publicly traded gives you a certain stability and credibility that I think the best employees find attractive,” he says.

Business First’s delayed listing was a result of leadership’s understanding of the seriousness of being a public bank, and the management team focused on integrating its acquisitions first to be better prepared for the listing.

“You really have to want to be a public company and make the sacrifices necessary to make that possible,” says Scott Studwell, managing director at the investment bank Stephens, who worked with Business First on its pre-public capital raise but not its direct listing. “There has to be a lot of support for doing so in the boardroom.” The direct preparation for an IPO takes four to six months, according to Studwell, but the typical bank will spend years getting its infrastructure, personnel, policies and procedures up to speed, says Lowell Harrison, a partner at Fenimore, Kay, Harrison & Ford. The law firm serves as legal counsel for Business First. Roadshows to talk up the IPO and tell the company’s story can have executives traveling across the country and even internationally.

And the bank will be subject to Wall Street’s more frequent assessment of its performance. If a bank hits a road bump, “it can be a rough go for management in terms of looking at the stock being graded by the Street every day, not to mention all the compliance costs that go with being an SEC registrant,” says Davis. All of this adds more to the management team’s plate.

Considering a public path is an important discussion for boards and management teams, and is ultimately a strategic decision that should be driven by the bank’s goals, says Harrison. “What is the problem you’re trying to solve? Do you need the capital? Are you trying to become a player in the acquisition market? Are you just simply trying to create some liquidity for your shares?” Filing an IPO, or opting for a direct listing, should check at least two of these boxes. If the bank just wants to provide liquidity to its shareholders, a listing on an over-the-counter market such as the OTCQX may achieve that goal without the additional burden on the institution.

In considering the bank’s capital needs, a private equity investor—which would allow the bank to remain private, at least in the near term—may suit the bank. Institutional investors favor short-term liquidity through the public markets, which is why Business First was able to obtain capital in that manner, given its near-term direct listing. Private equity investors are willing to invest for a longer period of time, though they will eventually seek liquidity. These investors are also more actively engaged, and may seek a board seat or rights to observe board meetings, says Studwell. But they can be a good option for a private bank that’s not ready for a public listing, or doesn’t see strategic value in it.

Though Business First’s less-common path to its public listing is one that could be replicated under the right circumstances, the majority of institutions that choose to go public are more likely to opt for a traditional IPO. “The reality is that direct listings are very rare, and it takes a unique set of circumstances for it to make sense for a company,” says Harrison. While a direct listing provides more liquidity than private ownership, be advised that the liquidity may not be as robust as seen in an IPO, which tends to capture the attention of institutional shareholders. “Usually, it’s the actual function of the IPO that helps kickstart your public market activity,” he adds. And if the bank needs an injection of capital—and determines that a public listing is the way to do it—then an IPO is the best strategic choice.

Creating Liquidity: Alternatives To Selling The Bank



Executives and boards of private banks have to think outside the box if they want to create a path to liquidity for shareholders that doesn’t require selling the bank. In this video, Eric Corrigan of Commerce Street Capital outlines three liquidity alternatives to consider, and shares why a proactive approach can help a bank control its own destiny.

  • Challenges in Creating Liquidity
  • Three Liquidity Alternatives
  • Benefits and Drawbacks to Each Solution
  • Questions Boards Should Be Asking

Understanding the Attributes of Core Deposits


deposits-9-27-17.pngAs loan growth materializes, it is important to renew the focus on liquidity management, have an overall liquidity plan and a contingency funding plan. In order to create and implement such plans, it is important to understand the attributes of deposits. Even if a bank is not experiencing stronger loan growth, it is necessary to understand the elasticity of core deposits in order to make accurate modeling assumptions.

Anyone who experienced a higher interest rate environment remembers depository institutions having to compete with money market funds and other non-bank investment instruments that paid comparatively high rates. As the economy emerges from the bottom of a 10-year interest rate trough, depositors are starving for interest income. Institutions are finding that customers are willing to buy longer term CDs in exchange for yield. We simply do not know how long deposits will remain on books in a higher rate environment or how much we will have to pay to keep them.

The primary core deposit assumptions used for interest rate simulation models are beta and decay. Deposit beta is an indication of how rates correlate to the market. For example, if you use a beta of 0.25 on your savings rate, for every projected market rate move of 100 basis points, the savings account rate will move 25 basis points.

Decay is the measure of deposit attrition, or how long deposit accounts will likely remain open. If you decay a savings account over a 60-month period, you make the assumption that the savings account will have a 60-month maximum life. The normal range for decay is 24 months for sensitive deposits and 84 months for more static accounts.

Historically these numbers have been typically supplied by market averages, vendors, the Office of Thrift Supervision (which was merged with the Office of the Comptroller of the Currency in 2011) and management estimates. Various forms of deposit studies are gaining popularity but remain the least common means of obtaining core deposit assumptions. Meanwhile other modeling assumptions utilize prepayment rates, discount rates and spreads and are much more precise. The higher degree of precision for these non-deposit modeling assumptions helps reduce simulation risk. The irony here is that even though non–deposit assumptions are much more precise, they have a lesser impact on simulation results. This means that the greatest amount of simulation risk comes from assumptions with the least amount of basis!

In order to demonstrate the impact of these core deposit assumptions, we can take a typical Bank asset/liability management simulation and compare the results of the Economic Value of Equity (EVE shock/stress both with and without these beta and decay assumptions.) This serves as a stress test of the deposit assumptions. To stress the assumptions, we will simply set all betas to one and all maturities to one month. Then we can compare the results. To keep it simple, we will look at it graphically:

EVE-chart.png

Note how the EVE variance is between +7 percent and -14 percent when the betas and decays are utilized in the simulation. Once they are removed, this variance is between +10 percent and -30 percent, showing that it almost doubles in a rising rate scenario. In this case, removing the assumptions or making material changes to them can cause a financial institution to approach or exceed prudent risk limits. Additionally, this will also impact the net interest income shock as well, but a complete simulation will need to be performed to assess the impact.

The graph shows that core deposit assumptions are an important variable in the modelling results, especially if used as a management tool. As mentioned, this can be also used as a regulatory stress test. Stress tests are good but they do not serve the purpose of creating valid assumptions for management purposes. This can be accomplished by a core deposit study. A detailed core deposit study is a fairly involved and costly project but it will produce the most accurate assumptions. An abbreviated core deposit study can be used to understand the correlation of deposit line items to market rates and back into decay rates. There are a number of companies offering such services for institutions without in house expertise. It is worth exploring such options as the regulators are most likely to focus on core deposits as interest rates rise.

Four Reasons Why Waiting to Sell May Be a Bad Idea


bank-strategy-2-5-16.pngMost community banks have a timeframe for liquidity in mind. Strategic plans for these institutions are often developed with this timeframe as a key consideration, driven by the timing of when the leader of the bank is ready to retire.

We meet with a lot of bank CEOs, and we regularly hear some version of the following: “I’m in my early 60s and will retire by 70, so I’m looking to buy not sell.” When we ask these CEOs to describe their ideal acquisition target, the answer often involves size, market served, operating characteristics and, most importantly, talent. After all, banking is a relationship business and great bankers are needed to build those relationships with customers. Buyers will undoubtedly pay a higher premium for a bank with great talent that still has “fire in the belly.” It is hard to recall a time when a buyer was looking for a tired management team ready to retire. So, it seems ironic that a buyer cites talent as the key component to a desirable acquisition candidate, but that same buyer is planning to wait until retirement to sell. Put differently, they’re planning to sell at the point their bank will become less desirable.

We have highlighted four key items for boards and management teams to consider when evaluating the timing of a liquidity event as part of the strategic planning process: the timing of management succession, likely buyers or merger partners, shareholders and the overall economy and market for community banks.

Management Succession
Timing of management succession is critical to maximize price for shareholders. As referenced above, if the leadership of an organization would like to retire within the next five years, and there isn’t a logical successor as part of senior management, the board should begin evaluating its options. Waiting until the CEO wants to retire may not be the best way to maximize shareholder value.

Likely Buyers/Merger Partners
The banking industry is consolidating, which means fewer sellers and buyers will exist in the future. While there may be a dozen or more banks that would be interested in a good community bank, once price is considered, there may only be one or two banks that are both willing and able to pay the seller’s desired price. These buyers are often looking at multiple targets. Will a buyer be ready to act at the exact time your management is ready to sell? In fact, there are a number of logical reasons that your best buyer may disappear in the future. For example, they could be tied up with other deals or they may have outgrown the target so it no longer “moves the needle” in terms of economic benefit.

Shareholder Pressure
Shareholders of most banks require liquidity at some point. While the timing of liquidity can range from years to decades, it is worthwhile for a bank to understand its shareholders’ liquidity expectations. And liquidity can be provided in many ways, including from other investors, buybacks, listing on a public exchange, or a sale of the whole organization. As time stretches on, pressure for a liquidity event begins to mount on management and, in some cases, a passive investor will become an activist.

Overall Economy and Markets
With the Great Recession fresh in mind, virtually every bank investor is aware the market for bank stocks can go up or down. Before the Great Recession, managers who were typically in their mid-50s to early 60s  raised capital with a strategic plan to provide liquidity through a sale in approximately 10 years, which would correspond with management’s planned retirement age. We visited with a number of bankers in their early 60s from 2005 to 2007 and indicated that the markets and bank valuations were robust and it was an opportune time to pursue a sale. Many of these bankers decided to wait, as they were not quite ready to retire. We all know what happened in the years to follow, and many found themselves working several years beyond their desired retirement age once the market fell out from under them.

Over the past two years, we had very similar conversations with a lot of bankers and once again we see some who are holding out. While bankers and their boards generally can control the timing of when they would like to pursue a deal, the timing of their best buyer(s), the overall market and shareholder concerns are beyond their control. Thorough strategic planning takes all of these issues into account and will produce the best results for all stakeholders.