NorCal Community Bancorp in Alameda, Calif., has opened a branch in Oakland that Stephen G. Andrews, its president and chief executive, thinks can bring in $15 million of deposits within 15 months.
The bait? Common stock.
The $263 million-asset NorCal is issuing preferred stock to about 40 wealthy investors in the hopes they will put their deposits in the branch and encourage their friends, family, and business contacts to do the same.
If the branch hits its deposit target by next summer, each share of preferred stock issued to new investors will be converted to 1.5 shares of common stock.
"If you have 37 investors at $40,000 apiece, and they brought in 10 times their investment, that's your nut right there of $15 million, without the bank doing a damned thing," Mr. Andrews said in an interview last week.
The parent company of Bank of Alameda is the latest to borrow a little-known deposit-gathering strategy that Sterling Bancshares Inc. of Houston has been using for about 15 years: a private placement of preferred stock with a conversion feature tied to the success of the new branch.
Many bankers are struggling to attract and retain deposits in the face of fierce competition from traditional banks, online banks, brokerage houses, and credit unions. Bankers and other observers say that deposits gathered in this way tend to stick, because the depositors, as shareholders, have an incentive for the bank to succeed.
Mr. Andrews said the strategy is more attractive than offering high-yield certificates of deposit that would erode NorCal's net interest margin, which was 5.89% in the first quarter. Likewise, he prefers the private placement path to relying on commercial bankers to build the deposit base "the old-fashioned way."
Richard Hartnack, an industry veteran and the head of retail banking at the $221 billion-asset U.S. Bancorp of Minneapolis, said that he had not heard of the strategy, but "it sounds like a clever economic response to the need to make new branches pay off quick and engage people locally in the success of that branch."
The $316 million-asset Greater Sacramento Bancorp completed its third private placement this spring. The $515,000 offering was tied to the April 2 opening of a Bank of Sacramento branch in Roseville, on the outskirts of Sacramento. The company made a similar offering in 2005 for a Rancho Cordova branch that now has $28 million of deposits, and another last year for a downtown Sacramento branch that now has $30 million of deposits.
"I think we would probably have about half the growth we've had in those two offices if we hadn't gone this way," William J. Martin, the CEO of Greater Sacramento, said in an interview Monday.
He and other bankers said the strategy attracts deposits by turning the investors into ambassadors for the new branch.
"It's been very, very successful. People stay engaged. They don't just buy it and go away," Mr. Martin said.
The $4.3 billion-asset Sterling has used the strategy for more than a decade to help fill the vaults of all its new branches.
The approach is designed "to recreate the feel of a brand-new, de novo chartered community bank," said J. Downey Bridgwater, Sterling's chairman, president, and CEO, said last week.
Mr. Bridgwater said each share of preferred stock Sterling offers depositors converts to 1.25 common shares if a branch has $25 million of core deposits after two years. If the target is not hit in two years, the investors are given 12 months more to hit the goal, and the conversion premium drops to 10%. If the deposit goal is not met after three years, the preferred shares convert 1 to 1 to common stock.
"It's helped us get our branches to profitability a lot faster, due to the incentive these people have to drive deposits from their business, their vendors, their customers to the bank, as if they were a director of the bank," Mr. Bridgwater said.
Sterling has opened about 10 branches using this strategy, he said; all have hit their deposit target by the third year, and most have hit it in two years.
"It's not a barn burner, but it helps, and it creates a greater awareness, especially if we are moving into a new part of town or new markets like Dallas and San Antonio," Mr. Bridgwater said.
Bankers and observers said the downsides of the strategy appear to be modest compared to the benefits of rapid growth in core deposits.
Daniel Bass, a managing director in the Houston office of the investment bank Carson Medlin Co., said limiting the influence of the investors can be an issue in such offerings.
Sterling has been "very successful" achieving growth with the private placements, but it has had to cope with the challenges of reining in branches that operate like "little kingdoms or fiefdoms," Mr. Bass said. "At some point you get to where you have to centralize things," and investors "can't have the autonomy that they had to build it."
Mr. Bridgwater said it issues preferred shares to 30 to 50 individuals for every branch it opens, so individual investors "have no control at all." Typically, eight to 10 of the investors serve as advisers on the branch's business development board.
Dilution to common shareholders, another possible drawback, is negligible, bankers and observers said because the number of new shares is relatively small.
"You don't want the offering to be so big that all of a sudden the common people get diluted, but you want it to be meaningful enough to the investor that they get a good return to move their deposits over," Mr. Andrews said.
NorCal expects to issue $1 million to $1.5 million of preferred stock to 25 to 40 investors by the end of this month. In 15 months each share will convert to 1.5 common shares if core deposits at the branch (which has $11 million of deposits from a prior location) averages more than $26 million in months 13, 14, and 15. Each share will convert to 1.25 common shares if deposits average $20 million to $26 million in those months. If the average does not top $20 million, the shares will convert at a ratio of 1 to 1.
"If you attract some good core deposits out of this and attract those customers and cross-sell them, it's a lot more valuable than what they would be paying out on the conversion to shares," said Ramsey Gregg, an analyst in San Francisco with FIG Partners LLC.
Bankers and observers say the risk of the investors' taking their deposits elsewhere following the conversion is minimal, because they are sophisticated investors who likely will be customers or will become customers of the bank.
If the investors leave, "then shame on you, because what did you do to retain them?" Mr. Andrews said. "Either services are missing or something is missing, so I don't view that as a risk."
The alternative of CD sales is far less attractive, he said. "I view a deposit sale as a risk, because you have to keep offering that narcotic to them of really high rates, or they are going to go."
