Sarbanes-Oxley was bad enough, but with today’s volatile market conditions, the negatives to going public outweigh the positives for many banks. In fact, a growing number are going private. Still, there are proponents who make the case for a listed stock.
By Orla O’Sullivan, contributing editor
Currently, for community banks, the gains of going public are eroded by the cost of SOX, subprime, and other deterrents
When people ask Earl McVicker can they buy stock in his bank—as they often do given its index-beating performance—the answer is no. And that’s how it will remain if McVicker, chairman and chief executive of Central Bank & Trust, Hutchinson, Kan., has his way.
Why go public when you have enjoyed, as McVicker describes, “a 16-year run of creating 24% compounded return to shareholders”? That’s double the long-term return of the S&P 500.
Like most banks, McVicker’s family-run bank issues privately-held stock through its bank holding company: “We can provide all the liquidity we want, and if we need capital it’s readily available.”
He’s not just saying the bank doesn’t need to go public; rather it’s doing so well because it’s not public.
“We can focus on our highest objectives rather than being concerned about quarterly performance reports,” says McVicker. “We have bought stock in a number of new banks,” he explains. “They typically take three years before they are profitable—sometimes ten. I think if we were public and our shareholders were not close to us, as they are now, they might not understand why earnings were not that high.”
Sins of a few visited upon all
Added to these arguments for staying private, developments over the past decade have brought things to the point where many suggest the benefits of being public have been eroded, at least for community banks. The biggest bane cited is compliance with the Sarbanes-Oxley Act—better known by the industry curse word SOX. Any company with over 500 shareholders is regulated by the Securities and Exchange Commission and subject to SOX, meaning filing and mailing reports, engaging internal and external auditors, etc.—at a cost claimed to reach 20% of smaller banks’ incomes.
Earlier regulations slashed margins for brokers making a market in small stocks and so made small-bank stocks less attractive to trade. Not only are the dot-com heydays of initial public offerings gone, now banks are indiscriminately tarred with the subprime-mortgage brush whether their results were sullied by such activity or not.
“The problem is the market’s not differentiating between big banks and community banks,” says Helen Sullivan, senior vice-president, financial and capital markets solutions with ABA. “Bank stocks have been hammered with the credit crunch,” she adds. (Citibank and Washington Mutual, for example, have lost half of their market value.)
Thirteen community banks went public since last summer, well down from 23 in the second half of 2006. However, annual flotations at 32 in 2007, were not radically below the 38 in 2006, so the trend is recent.
America’s Community Bankers NASDAQ Index (now part of ABA) includes all (502) domestic banks publicly traded on NASDAQ, minus the top 50, monoline and foreign banks, and banks traded on other exchanges. Like the S&P 500, the ACB NASDAQ Index (ticker symbol ACBQ), is down as bank stocks face what some have dubbed their worst time in 25 years. It has been enough to send some banks the other way: taking their banks private (see story on page 46).
[For information on the index, go to www.acb.us/about_acb/acbq_nasdaq_index/. The index itself can be seen at http://classic.NASDAQtrader.com/trader/aspx/index_main.aspx?ix=ACBQ.]
Theodore Kovaleff, senior bank and thrift analyst, Sky Capital, New York, says, “There have been several failed attempts [of banks] to go public recently.”
He attributes that partly to regulators “having forced too high a valuation on institutions,” in an unreceptive economy. Regulators can make banks going public or demutualising thrifts issue more shares, which reduces the possible earnings per share for prospective investors and makes that investment less attractive.
Bankers didn’t rate this as a big factor. One banker, who did not wish to be quoted, said regulators acted to take heat out of previously oversubscribed IPOs. He regretted his bank issued so many shares initially and then had to buy some back (something generally prohibited in year one) but blamed his underwriters.
Why go public? Deposits
Dan Hudson, president of nubank.com, a Dallas consultancy, is about the only commentator currently bullish on bank IPOs, which Nubank helps arrange. New banks need start-up capital and they uniquely enjoy the pluses of being public without the minuses of SOX, because start-ups are exempt in the first two years. Nubank has over a dozen de novo launches in the pipeline for this year, up from eight in 2006, Hudson says.
Hudson’s argument for going public is also contrarian: “It’s the only way to get core deposits.” If local residents get to invest in a bank, he argues, “chances are they’ll become customers.” The alternative way to generate capital is, as Hudson says, “to rent money from Wall St.”
Yet, he concedes that going—or remaining—public may not be for a “mature” bank, meaning “a community bank that’s seven to nine years old with $300-700 million in assets.” Then, curtailing shareholder numbers below the 500 SEC/SOX trigger may make sense, he agrees.
A necessary evil
ABA BJ spoke to a half-dozen banks. At one end of the private-to-public scale, McVicker and a recently ‘delisted’ bank have no regrets about being private, in the sense of not being SEC corporations. At the other end, the best cheerleader for going public admits his shareholders are “not particularly happy” to have shares worth substantially less if traded on NASDAQ today than if the bank were liquidated.
Two others, public and SEC regulated, represent it as a necessary evil, perhaps. We asked Steve Wilson, chairman and chief executive of $610 million Lebanon National Bank and its holding company in Lebanon, Ohio, how he would rate now as time to go public on a ten-point scale. “One,” he replied, without skipping a beat. “After SOX—a great cost and a great burden— we debated whether to delist, but we decided we would just grow to the point where we’d have to take that on again,”
Dan Blanton, vice-chairman of ABA’s America’s Community Bankers Council, advises others: “I wouldn’t even think about going public or opening a bank.” Given it all to do over, he’d probably keep his bank below 500 shareholders, but now it would be “politically incorrect” to disenfranchise community members who have stock in Georgia Bank & Trust, Augusta.
The bank is 50% owned by Blanton’s family, but—as Societe Generale and Bear Stearns know—no stock corporation is immune from a takeover, especially if performance falters.
Dealing with big blocks of shares
Another banker suggested it’s a risk to have too much stock held by locals in aging communities, exposing the bank to shares flooding the market if descendants cash out inheritances: often substantial blocks of stock that grew over time through stock splits of the deceased’s original holdings.
Earl McVicker’s family owns 85% of the $600 million bank holding company for $225 million-asset Central Bank, so relatively few people own relatively large blocks of bank stock. If a shareholder wants to sell, the BHC buys the stock back or connects the seller with a buyer within the known circle of shareholders. Share values aren’t listed on some public database, and with less than 500 shareholders the bank is not subject to SEC/SOX. “We don’t keep an official list [of prospects] and we don’t set the price—that’s important,” McVicker says. When buyer and seller reach agreement, the company records the exchange price.
Case for listing on an exchange
That wouldn’t work for $1.8 billion-asset Great Florida Bank, says chief financial officer Gary Laurash: it has too many shareholders for personal introductions. On day one, June 30, 2004, the Coral Gables bank had more than 500.
There was little to lose and theoretically something to gain by upping Great Florida’s level last December from Over The Counter (OTC) Bulletin Board trading to trading on the NASDAQ Global Market exchange.
The bulletin board, owned and operated by NASDAQ, is free, but companies pay to be on the exchanges (currently at least $5,000 a year), which offer greater visibility and usually more liquidity. Certain institutional investors, for example, will only invest in companies trading on an exchange.
Smaller banks’ stocks may be so thinly traded on a NASDAQ exchange that the returns are no better than the bulletin boards. Laurash agrees that Great Florida’s stock is “somewhat thinly” and erratically traded, with anywhere from a few 100 to a few thousand shares trading hands daily.
However, he says, “If you’re not on an exchange there’s no way of knowing where your shares are at. On the bulletin board, a broker puts a price on a screen, but there’s nothing to say whether they actually bought or sold shares at that price.”
Not that he considers the bank’s current share price fair. Great Florida is “probably one of the strongest institutions in the country… we have $90 million in capital against $1.3 billion in loans,” he says. The bank has barely had bad mortgage loans, but Florida is one of the three worst hit states for foreclosures. The upshot? “Our stock is now trading at $8 or $9 a share while our book value is over $13.50 a share,” Laurash said in March.
Traditionally, banks floated to get capital to acquire other banks using their stock as the currency to purchase. Target institutions, however, have sometimes refused to sell except for cash. That might be more likely now with bank stocks devalued.
What is the advantage for Great Florida of being listed on NASDAQ? Laurash says, “It’s hard to say we have achieved our goal of building liquidity,” but by increasing visibility and contacts now, he says “we’re going to be in a good position down the road.” BJ
The case for going private
Thirteen community banks went public in the last six months of 2007—essentially matching the six that moved to go back ‘private’ in about half that period. ABABJ found data only through mid-Oct. 2007 on banks that filed to quit being ‘public’ companies, in the commonly understood sense of being SEC-regulated corporations.
Almost 30 of 100 banks that switched back in the past 15 years did so in the past two years, extrapolating from bank client and SEC filing data collected by Powell Goldstein LLP, an Atlanta law firm specializing in legal ways out of SOX.
When it comes to engineering shareholder numbers below the 500 trigger for SEC/SOX compliance, “Bankers don’t understand the latitude they have,” says partner Walt Moeling, IV.
Tender offers are best known, but shareholders rarely respond to requests to sell stock back to the bank, he says. Reclassification is the most popular of three main alternatives in that it doesn’t force shareholders to give up their shares or force the bank to find cash to buy them out, as reverse stock splits and cash-out mergers entail. The bank must reclassify shareholders into new groups each with fewer than 500 members, but “they must have substantive differences,” says Moeling. For instance, smaller shareholders might lose voting rights but gain extra dividends.
The one-time exit cost (for legal and other advisers) often is less than what is saved annually on SOX, according to banks’ public filings. Most dramatically, First Citizens Bancorp, Columbia, S.C., reported saving $1.35 million annually—most of it management time—and paid $150,000 to get out.
Most banks are “shocked” when they tally the cost of time spent promoting the bank’s stock in analyst calls, on road-shows, etc. Moeling says.
“A $30 million bank that is SEC regulated probably loses 20% of its income on SOX,” he claims.
Asked if there’s any downside to having come off Nasdaq, Lawrence Safarek, president of First Niles Financial, Inc., a $100 million-bank in Niles, Ohio, is emphatic: “No, absolutely not.” Since ‘downgrading’ to the bulletin board from Nasdaq, First Niles (FINI) has maintained the trading volumes it had on the exchange, more than held its own on share price relative to its depressed bank-stock peers, done its first buy-back since reverting to ‘private’ ownership, and saved itself close to $100,000 a year in expenses associated with being an SEC regulated company.
“For a bank our size, SOX was just way out of line,” says Safarek. “The banking industry is already regulated.”
The electronic version of this article available at: http://lb.ec2.nxtbook.com/nxtbooks/sb/ababj0408/index.php?startid=42
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