Recently I received a phone call from a client, the president of a profitable $100 million-asset community bank. Though normally a cheerful fellow, on this occasion he called to express two complaints.
"Every day I work very hard for the benefit of other people," he said. "I want to work for myself."
He also complained that he was tired of hearing from self-styled shareholder activists who call from time to time but can't come up with any advice better than "implement a stock repurchase program" or "sell the bank."
Community bank managers are voicing this complaint with increasing frequency.
Here's my client's problem. His bank is well run and profitable, but the bank's stock is thinly traded, making it more difficult for a stockholder to sell. Also, the market perceives that this bank is unlikely to be acquired anytime soon, given the high level of insider control and the relatively young management.
As a result, the stock price is languishing far below the bank's true value. Growth opportunities at this bank are also limited. The economy in its market area is stable but not expanding, and acquisition opportunities are limited because of the bank's relatively small size and illiquid stock.
Like many community bank managers, my client simply cannot do much to expand operations and meet reasonable shareholder expectations for growth. But he continues to devote substantial time and effort to this goal.
If reasonable shareholder growth expectations cannot be achieved, should a bank continue to be a public company?
For many community banks, the answer is "no." Instead, it may make more sense to take advantage of the low stock price to take stock out of shareholders' hands.
There are many good reasons why my client would want to reduce the amount of stock held. For starters, more of the earnings would accrue to the benefit of the remaining shareholders, and insiders would benefit more directly from their own efforts.
Also, fewer or no outside shareholders means less potential for shareholder activism.
There are other potential benefits as well. If the number of owners is reduced to below 300, the bank could deregister its stock. This would relieve it of the obligation to file Forms 10-K, Forms 10-Q, and other reports with the Securities and Exchange Commission. If the number of stockholders is reduced to below 75, the bank might qualify as an S corporation.
Also, if my client doesn't have to answer to outside shareholders, he is free to pursue strategies that may be beneficial to the bank in the long term but that shareholders don't like. Investors like to see banks post improved earnings on a steady basis each quarter, which often discourages management from pursuing any strategy that temporarily disrupts earnings growth.
There are many ways to go private. One technique is an issuer self- tender. An issuer self-tender lets a bank buy more stock than it otherwise could through simple open market purchases. This involves an offer to stockholders to purchase up to a specified number of shares at a specified price.
Issuer self-tenders also may be made by means of a dutch auction. The bank contacts all its stockholders and announces its desire to buy a specified number of shares within a specified price range.
The offer is held open for a specified period of time, and stockholders may tender their shares and specify the minimum price within the range that they would be willing to accept. The bank then selects the lowest price within the range that lets it purchase the desired number of shares.
If an issuer self-tender would not work, bankers might want to consider what is known as a "going private" transaction.
There are numerous ways to do this. One example is called a "freeze-out merger." This is where the bank merges with an entity controlled by the acquiring group of stockholders, and all stockholders not part of the control group are forced to sell their shares.
Another possibility is a reverse stock split. A reverse stock split has the effect of reducing rather than increasing the number of outstanding shares.
For example, every 500 shares would become a single share. In the reverse stock split, stockholders would receive cash in lieu of fractional shares, so that any stockholder who owned less than 500 shares would be cashed out.
Before undertaking this type of transaction, the bank would need to address corporate issues, such as stockholder voting requirements and whether the insiders satisfied their fiduciary duties to minority stockholders by offering a reasonable price.
The purchase price per share is likely to be at a high premium to the market price and may even approach the price that might be obtained in a sale of the bank. The bank would also have to review the tax and accounting implications of the proposed transaction, as well as the required regulatory application process.
To avoid potential conflicts of interest, it may be necessary to appoint a committee of disinterested directors to review the terms of the transaction or to obtain independent financial advice.
If a bank decides to pursue an issuer self-tender or going private transaction, it will need cash, and lots of it. Depending on the scope of the transaction, the bank may need to find an outside source of cash.
The good news is that cash for this purpose is readily available to many banks in our current economic climate. If the bank chooses one of these alternatives, it has not foreclosed its options. It can always seek out a sale to another entity. Or it could later go public, by selling additional shares in the bank to the public, allowing remaining stockholders to sell their shares to the public, or a combination of the two.
This approach is not for everyone. However, for community bank managers who want to work for themselves, an issuer self-tender or a going-private transaction just may be the answer. Mr. Rappoport is a partner in the Washington, D.C., law firm of Housley Kantarian & Bronstein P.C.