Buy a few prized horses at a premium, or buy a whole stable on the cheap?
First Security Inc. in Owensboro, Ky., decided on the latter last week when it decided to call off a deal to buy three Indiana branches and a pool of loans from the struggling, $3 billion-asset Integra Bank Corp.
M. Lynn Cooper, the president and chief executive of the $334 million-asset First Security, said that after completing one deal with Integra for a handful of branches, the company decided to look elsewhere to deploy its growth capital.
"The capital constraints in branch deals are pretty strong," Cooper said in an interview last week. "We increased our assets by 60% with the first deal but feel that the capital we are raising is better used elsewhere."
And that, to Cooper, means acquisitions, failed-bank deals and organic growth — not branch purchases.
Community bank branch sales have been strong in recent years, with 81 deals announced in 2009 and 47 so far this year. Struggling banks view them as a quick and efficient way to reduce assets and harvest some capital.
Yet experts say that, for healthy banks with a menu full of expansion options, branch purchases are not always such a good deal.
"Buying branches is an expensive way to grow," said Kenneth Pickering, a partner in Pickering & Cotogno in New Orleans. "You're better off buying a failed bank or a distressed bank and getting a heck of a deal."
First Security's Cooper said the deals are more "cash-intensive" than expensive. His company had agreed to buy eight branches in Kentucky and Indiana, including $188.2 million of deposits and $172.1 million of loans. It paid $6 million, or a 5% premium, for the Kentucky deposits and would have paid $2 million, or a 3.5% premium, for the Indiana deposits.
Those are steep premiums, especially as the Federal Deposit Insurance Corp. strikes whole-bank deals with low or no premiums, said Ken Thomas, an independent bank consultant and economist in Miami. "Branch deals really have to improve your franchise value to work right now," he said.
Beyond the cash premium, branch deals do not include equity from the seller, so the buyer must have the liquidity and capital to support them. First Security has added $18 million of capital through debt and equity since May 1, Cooper said, and probably would have needed to raise another $10 million to $20 million to take on the Indiana branches while retaining potential to grow.
The Indiana branch deal was to have closed by the end of September. Cooper said he was not sure whether his company would have been able to raise the capital in time. Not wanting to waste Integra's time, it called off the deal.
Though Integra's executives called the deal's collapse disappointing, they said it has had little effect on the wounded company.
Integra is in a negative equity position, with a tangible common equity ratio of 1.5% at June 30. Its Integra Bank unit is adequately capitalized, though last week the company announced that the Office of the Comptroller of the Currency had issued a capital directive giving it 90 days to boost its leverage ratio to 8% and its total risk-based capital ratio to 11.5%. Those are the same ratios set forth in an informal agreement, with which the bank has not complied since March 31.
"It is no surprise; they've been working with us and have been supportive of our efforts, but at a certain point they have to go through the proper protocols," said Mike Alley, who has been Integra's chief executive since May 2009, referring to the directive. "They needed to put a precise time frame on us."
So far, Integra's capital strategy has been to sell clusters of branches. Including the Kentucky branch sale to First Security, it has completed three branch deals this year and has two pending. Though the branch deals marginally moved the capital needle, Alley acknowledged that Integra needs a big shot of capital.
Alley said branch sales have two purposes: They help with capital-raising and also can condense a far-flung franchise, which he hopes will make the company more palatable to would-be investors.
"We are trying to get rid of offices that are geographically the farthest from us and really focus on a franchise within 100 miles of our headquarters," he said.
Alley said the Indiana branches fall within its targeted area, so it will keep them. Integra's Chicago branches — where many of its problems are concentrated — are all that are on the market now.
He would not comment on the exact amount of capital the company is seeking. Analysts said the number is hard to estimate, given the branch divestitures and the growing trend of other banks to convert their Troubled Asset Relief Program funding into common equity. Integra has $84 million in Tarp funds. A ballpark estimate would be that Integra must raise about $150 million, said Ross Demmerle, an analyst at Hilliard Lyons.
"It sounds like they have a plan in place to put themselves in the best possible condition for investors," Demmerle said. "But they need to start moving forward with it. That's the bottom line. They need some money."
