Shareholder Interest


The capital market investors take a fresh look at community bank stock offerings

By Karen Epper Hoffman

When it comes to accessing the capital markets, community banks have historically had trouble getting a seat at the table. However, new capital standards of Basel III and stronger market pricing means that for community banks looking to boost their capital in the new year, there may be a relative feast of opportunities.

“The capital markets for community banks are reviving,” says Peter Weinstock, co-practice group leader for the financial institutions section at Hunton & Williams LLP in Dallas. The markets tended to be “white hot prior to the downturn,” he explains, “and then virtually dead from 2008 through 2010.
“As market pricing for bank stocks has rebounded, there is more willingness of investors to buy into community banks.”

Likewise, James A. Sheriff, partner and senior attorney at the financial institutions practice group at Godfrey & Kahn of Milwaukee, which counsels clients on capital formation strategies, says that in recent months he has talked to at least half a dozen community banks about doing capital planning. “Banks finally have a better story to tell when they want to raise capital,” he says.

Also, while the credit crisis “put a halt to people wanting to invest in banks,” says Stephen Clinton, president of Capital Market Securities Inc. in Kent, Ohio, “now [investors] are seeing these banks as undervalued.”

Charles W. Ingram, managing director for the bank capital group at Commerce Street Capital LLC in Dallas, sees two tiers of interest developing as the markets warm “considerably” to community banks. The first group, as he puts it, is the “still wounded banks” that have resisted change, have failed to address their problems aggressively, or simply did not have the capital to address resolving their issues.

Raising capital for these banks is difficult, Ingram says. Small amounts of capital can be raised from investors to fix workable problems, but factors such as a bank’s geographic location, the perceived strength of its local economy and the capability of its management will influence the story a bank can successfully tell to potential shareholders.

From after the financial crash in late 2007 through 2012, Ingram says, this represented the vast majority of the types of banks for which his company was raising capital. Commerce Street Capital raised more than $600 million for more than 45 community banks during that time.

But, he points out, a new cluster of capital-raising wannabes is emerging in the community bank sector. “This second tier are those who have aggressively resolved their problems, are in good shape now and only require capital to take advantage of opportunities for growth and acquisition. We are now seeing many more of these and these are making up the bulk of our current pipeline.”

What it takes to make it

But, while the market is improving, many community banks may still struggle with how to present themselves in their best light to investors. Investors largely want to see that “credit quality problems or other issues [if any] are behind the bank,” Clinton says. Having a good management team in place and a plan for making money in the future are essential to winning capital, he adds.

Weinstock advises that the best way to raise capital is to “be able to tell a story.” While investors are reluctant, even when they are existing shareholders or directors, to support a plan that does not provide a market return on their money, he says, local investors, existing shareholders and board members tend to look for lower returns on investment than outside investors.

“Even close supporters of a bank, however, want to understand how the strategic plan, if successful, will make it worth the risk to make the investment. Investors first and foremost want to be sure they are backing a capable management team,” he adds. “Then, investors like to see that the executive officers and directors support the capital raise.”

Weinstock’s firm has had “extremely good success” in offerings in which the insiders take 25 percent or more, or $2.5 million or more, of the offering, depending on the size of the overall offering.

Patrick Murphy, an attorney in the financial institutions practice group at Godfrey & Kahn, agrees that “it boils down to having a good story to tell. Investors are fatigued over the volume of diluted offerings out there.” Murphy’s colleague, Sheriff, points out the example of a community bank in the Milwaukee area that was able to attract investment recently by repackaging itself as a bank that came back from the brink and is now moving into geographic areas where it would likely gain more market share.

“A lot of community banks may be stuck if they don’t have a story like that to tell,” Sheriff says. Investors also want to see a well-run organization with a good plan for the future, including new avenues for creating revenues and prospects for giving investors the ability to liquidate their investment in the future, Murphy adds.

“As market pricing for bank stocks has rebounded, there is more willingness of investors to buy into community banks.”
—Peter Weinstock,
capital markets consultant

As Ingram points out, capital markets investments in community banks are “a little different than institutional or remote out-of-market investors. Yes, they want complete financial disclosure, but most are more concerned with the overall needs and health and belief in the community.” Investors want to believe in the ability and experience of the senior management and the board of directors, as well as the bank’s plan for success and how any investment will result in making money, he says. “Since the regulators have stepped in and stopped dividend payments for most small banks, they want to know when and how they will either get back to a position to pay dividends, or what the term and viability of their exit plan is.”

With that in mind, much of community banks’ capital base still comes from the community in which it does business, Ingram points out. “If the investor doesn’t know the community and the bankers involved or has no other special tie to the community or the bankers involved, they are much less likely to buy the story,” he says. “Unlike most other companies, a community bank can’t easily sell its services too far from home.”

That said, what marketing stories are successful?

Experts say that, not surprisingly, the markets like to hear stories of rebirth and growth. “The most successful offerings provide for a transformative story,” says Weinstock. “Ideally, they would be tied to an existing acquisition. Regardless, the management team needs to be able to demonstrate that they will be able to put the new capital to work and they have the capability of doing so.”

Ingram points out that “the story hasn’t changed, the country and the economy has. Growth is still the story that travels well. Pre-2007, every market seemed to be showing growth opportunity, which is the ideal climate for banks. The problem was it was all built on real estate ‘speculation.’ Today, the high-level numbers look much better, but the reality is that the ‘growth’ opportunity is much more granular and regionalized.”

Once a community bank has its own story straight, what can a community expect in terms of stock offerings? The answer depends largely on the bank, its size and reach, and the price of its stock relative to book value, Ingram says. According to Weinstock, community bank stock offerings can be “as low as a couple of million dollars and as high as $20 million to $25 million. It is very difficult to raise more than $5 million unless a combination of debt and equity is offered.”

For offerings above $15 million, Weinstock adds, such levels are difficult to reach without a placement agent or investment banker assisting. The last couple of community bank capital-raising deals for Godfrey & Kahn have been in the $5 million to $10 million range, according to Murphy.

Ingram says banks with less than $500 million in assets can typically raise between $10 million and $20 million from stock sales, as long as those banks are “healthy and growing” and can demonstrate the opportunity for continued growth. Larger community banks, he says, can potentially raise more money from investors if they don’t overprice their stock. He points out the example of $300 million-asset Spirit of Texas Bank, for which Commerce Street Capital recently helped raise $23 million (and more than $41 million over the past three years). “They were aggressively making good quality loans and growing so fast and earning so much that by the time we closed the price to book, value had declined below book value,” Ingram says. “In addition, their management had a well-defined three- to five-year exit plan.”

Changing markets

While much of the approach to capital raising is the same, changes are shaping the way that community banks should view soliciting investment. For starters, emerging regulations and legal requirements may present some as-yet-unknown concerns. Ingram says that because smaller community bank offerings are not terribly lucrative and because they require so much more work to be successful, “most of them need specialized help like we provide, but we are becoming increasingly reluctant to do anything other than a 506(b) offering that still allows up to 35 nonaccredited investors and still allows accredited investors to self-affirm their status.

“Getting an individual investor to provide tax returns or certified balance sheets to prove their accredited status is a dead horse at the gate.”

Clinton adds that “the [Securities and Exchange Commission] is a monster. … This is another regulatory world that community banks are often unfamiliar with.” Issues from the development of marketing material to critical disclosures require community banks to be careful and seek expert outside support, he adds.

“Getting an individual investor to provide tax returns or certified balance sheets to prove their accredited status is a dead horse at the gate.”
—Charles W. Ingram, capital markets consultant

The types of stock investors community banks are attracting are different too. Community bank stock investors generally are willing to accept a return on an investment of 8 percent to 10 percent in the current environment, rather than the 15 percent plus that outside-of-the-market investors might require, Weinstock says. As Ingram describes it, “These are generally professionals and entrepreneurs and investors in the community being served or with close ties to the community, board members, management. It would be too simple to say the country club set, but it is.” The good news is that there are steps community banks can take to succeed in seeking capital in a stock offering.

Weinstock advises a seven-step plan that includes:

  1. developing the strategic plan for the bank itself—for example, how it will leverage the capital;
  2. confirming that the management team has the ability to execute the strategic plan;
  3. obtaining board consensus behind the strategic plan and the need for the offering;
  4. appointing a person to oversee the capital effort, which could be an outside placement agent;
  5. pooling the list of all of the contacts of the insiders;
  6. interviewing investment bankers regarding the possibility of an institutional offering; and
  7. arranging opportunities for the bank management to get in front of those insiders to tell the bank’s story.

Ingram, who steers clear of public offerings in favor of private placement of public stock, says it can take two to three months just to get offering documentation written and signed off on. “Invariably most banks want to use year-end financial data so that can affect timing,” he adds. He also recommends engaging a broker-dealer to get involved very early in the process for a variety of reasons: If the method of distribution requests approvals from the SEC or FINRA or both, the process can take a minimum of six to 10 weeks. Meanwhile, the actual private capital raising process itself for banks with $2 billion or less in assets can take six months in a best-case scenario.

As Murphy points out, “A lot of community banks don’t have a good grasp of the time and effort this takes. Stock doesn’t sell itself. It requires a tremendous amount of effort on the directors and executives at the institution.”

Karen Epper Hoffman is a writer currently working in Europe.