When a shareholder wants to sell…

As I travel around the country visiting my community bank clients, I’m regularly asked (by outside directors in particular): “How does the bank holding company facilitate increasing the trading volume for its shares?” 

My general answer is “It doesn’t.” 

Let me back up a little bit. The real issue is, does the community bank holding company have an obligation to create share liquidity for its shareholders? 

Liquidity for rarely, barely traded shares

In this context, share liquidity is defined as the ability of a shareholder to sell a share or many shares of the holding company at the time he or she desires at a price that is “fair.”

Within this context, the answer to the question of whether the holding company has an obligation to provide share liquidity is “yes.”  It is part and parcel of the directors’ obligation to enhance shareholder value.

According to recent statistics, only 7% of community banks are publicly traded. This means fewer than one in ten community banks in the nation are SEC reporting and presumably listed on some market exchange or at least trading its shares over the counter.

I suggest that even those banks that are “trading” are not really trading. If you look at banks that are listed on any of the OTC markets (OTCQX, OTCQB, or OTCPink), you will find that there is very little actual trading going on.

Keep in mind as well that when the number of shares traded is reported, it is reported both for the buyer and the seller. So, for example, if 200 shares are reported as having “traded,” that means 100 shares have been sold and the same 100 shares have been purchased. So don’t forget to divide by 2.

Literally making a market

In reality, for most community banks, there is no public market for their shares. Therefore, it is incumbent upon the board of directors to create that market and provide share liquidity for the shareholders.

After all, what good is it to the shareholders who have held onto an investment for a long period of time if they cannot get out of the investment because there is no one to purchase the shares at a reasonable price? 

For most community bank holding companies that, by definition, are not public SEC-reporting companies, the solution to share liquidity is that the holding company itself serves as the source of that liquidity. The decision to be made: Does the board want to reactively provide for share liquidity or do so on a proactive basis? 

• If the board wants to be reactive, then, at a minimum, the board should establish a “walk in” policy for share repurchases.

This simply means the board authorizes holding company management to purchase stock from those shareholders who approach the holding company seeking to sell. The company does not keep a list of buying shareholders nor seek to match buyers and sellers. The holding company and its management team does not want to serve as a non-licensed broker. (After all, no one wants to go to jail.)

To put it more simply, the holding company’s job is to make a market in its own stock. The board sets the price, the amount of capital it wants to spend on a quarterly basis, and authorizes management to redeem shares as they become available (i.e., when a shareholder walks in the front door seeking to sell its shares).

• The second approach involves the holding company being more proactive with respect to redeeming its outstanding shares.

This seems to be a growing trend these days. The reason for this trend is that the Great Recession has waned in most parts of the country resulting in many community banks being “over capitalized.” (I say “most” out of respect for all of my oil and gas friends in the industry.)

In other words, they have excess capital to allocate.

What to do with spare capital

As we like to say in our firm, you need to provide your shareholders with a return on equity or return of equity.

If an overcapitalized community bank has no other alternative uses for its capital—such as growing the balance sheet, acquiring another bank, acquiring another line of business, such as an insurance agency or trust department, etc.—then the bank should consider returning that capital back to its shareholders. This would be through a dividend in a C corporation, a distribution in an S corporation, or possibly the redemption of shares.

Community banks that find themselves overcapitalized often allocate a certain specific amount of capital to redeem shares. For example, the bank may allocate $2 million of capital to a stock repurchase program in order to consolidate ownership into a more core group. These redemption programs are often targeted at smaller shareholders, out-of-state shareholders, or shareholders who do not do business with the bank.

A board that knows exactly which shareholders it would like to retain can structure a “forced” program requiring certain subgroups of shareholders to sell their shares. Otherwise, these programs are typically “voluntary,” allowing shareholders that meet certain criteria to sell shares if they desire to do so. Which one is better ultimately depends on the goals of the organization.

Whether pursuant to a reactive or proactive plan, the impact of a holding company repurchasing its own shares is generally positive for everyone involved.

• The selling shareholder gets cash out of their investment, pays the taxes, and gets to spend the money as he or she wishes.

• The non-selling shareholders will generally see an increase in earnings per share; an increase in return on equity; an increase in dividends (assuming the bank pays a percentage of earnings in dividends); and the illusion of share liquidity—all conducted within a safe and sound framework.

That is the definition of “enhancing shareholder value.”

If your community bank holding company has excess capital, consider either cleaning up or consolidating your shareholder base. It is an excellent use of capital for community bank holding companies.