Time for a bank stock loan?

It is no surprise that capital is still king for community banks, particularly those desiring to stay in good stead with the regulators.

I have recently been with a number of community banks that are working on transactions, or at least contemplating them, that will require additional capital for their bank.

Acquisitions under today’s rule, with today’s money

As an example, let's say your community bank holding company determines to make an acquisition. It is going to use cash as a currency, stock as a currency, or some mix of cash and stock as a currency.

Of course, if you are mixing the two, you need to make sure you issue at least 40% of the purchase price in stock to make the stock received tax-free, but that’s another blog. 

If your community bank holding company is in an acquisition transaction and you can convince the seller to take the stock of the holding company, that is generally a good thing.

If you cannot, and the holding company has to come up with cash, then it really becomes a question for the community bank holding company board—how do you raise that cash? 

Raising cash today

For bank holding companies, under the recent legislation, leveraging of the holding company is still a very real possibility, particularly if your holding company is under $1 billion in consolidated assets. As you may recall, the Small Bank Holding Company Policy Statement was recently changed from applying only to banks with less than $500 million in consolidated assets to applying to banks with less than $1 billion.

So what are the board’s choices when they need to come up with the cash for an acquisition transaction, a large redemption of shares, or growth of the bank? 

There are basically two ways to generate cash for the community bank holding company under $1 billion: sale of equity or sale of debt.

• Equity. The sale of equity is pretty straightforward. It generally means you pass the hat around the board table, then go to your existing shareholders, then go out to non-shareholders, and finally, consider equity investments by private equity firms.

• Debt. Debt is a little bit different. Debt is often thought to be derived from a rich, smart director who may have sold his or her business recently and is sitting on a lot of cash and would just as soon lend it to the community bank holding company as put it someplace in a CD. The board member will obtain a much better rate for the loan.

Exploring the rebooted bank stock loan

The other most traditional way of leveraging the company is through a typical bank stock loan, which the community bank holding company board should be happy to know is back in vogue.

A bank stock loan is just what it sounds like. It is a borrowing by the holding company from an independent third party institutional lender who accepts the holding company’s primary asset, the bank stock, as collateral. Post-recession, bank stock lenders (primarily bankers’ banks, other correspondents, and some of your community bank friends) have been the sources of bank stock loans.

Thinking about this from the lender’s standpoint, it is really a pretty good deal. The lender loans the holding company a certain amount of money. The holding company injects it into the bank to do an acquisition transaction or to grow capital. As collateral, the lender gets the bank stock—which includes the amount of money the lender just lent, since it has now been contributed to the bank’s equity.

Terms on bank stock loans have changed over the last several years. During the Great Recession, just like equity, a holding company could not get a bank stock loan unless it did not need one (or it could simply not get one at all).

Now the bank stock lenders are back, but the deals all vary. You can get a short fixed rate, you can get a longer-term variable rate, you can get a 10 or 12 year amortization … the list goes on. You must be mindful of the Small Bank Holding Company Policy Statement, though, which says that the debt to equity must be reduced to at least 30% by the end of 12 years.

The best way to get a bank stock loan on good terms is to go to the bank stock lender (again, who may be your fellow community banker) with a set of projections that shows how the loan is going to be paid back.

Keep in mind, bank stock loans are similar to other large commercial loans. They have covenants. These include payment covenants, i.e., you have to pay it back on a scheduled basis. Bank stock loans also contain nonpayment covenants, such as minimum capital ratios, asset quality ratios, and the like).

All in all, however, bank stock loans make a lot of sense.

Don’t forget the “internal bank stock loan”

As a final thought, when you are considering raising capital at your holding company, do not forget about your employee stock ownership plan or your 401(k) employee stock ownership plan.

These are also vehicles that can leverage directly from an institutional lender or individual or simply take a mirror loan from the holding company as part of their bank stock loans. The benefit of ESOP leverage is that an ESOP loan is paid back with tax-deductible dollars (i.e. compensation expense), so as a practical matter, both principal and interest are tax-deductible.

Strategizing for capital growth

As you are contemplating mechanisms to raise capital for the holding company, consider bank stock loans.

My general preference for our clients is to have them use leverage first, followed by equity generated from passing the hat around the board table, followed by equity from the existing shareholders, followed by equity from new shareholders, followed by, as a last resort, equity from private equity funds.

The source of capital is really a question of whether you want to keep your bank independent, which is something I will cover in a separate blog.