More than ever, small banks are turning to special loans from correspondent banks to satisfy their appetite for growth.
In the last year, some large regional banks, particularly in the Midwest, have seen a 20% surge in bank stock loans as community institutions seek financing for costly cash purchases or branch expansion.
"For the smaller banks, it's absolutely essential to their expansion efforts," said James W. Kratzer, vice president for correspondent banking at Boatmen's National Bank in St. Louis.
Mimicking the feeding frenzy among the large banks this past year, community banks are seeking to bulk up their size in a race for survival and a search for efficiencies.
But many of the smallest community banks, whether in big cities or rural towns, aren't likely to have a stock strong enough to exchange in a deal and probably lack the visibility needed to go to the market for capital.
That leaves the bank stock loan as one of the few options. In a typical bank stock loan, a community bank holding company borrows money from a correspondent bank, pledging as collateral the wholly owned stock of its subsidiary. Dividends are then sent upstream from the subsidiary to the holding company to pay the interest.
Such lending tends to be more significant in the Midwest, where the landscape is dotted with tiny institutions. By contrast, bank stock loans are rarer elsewhere. In fact, at least one northeastern community banker had never heard of the product.
Currently, Boatmen's has about 35 such loans for about $100 million on its books. That's down a bit from previous years, Mr. Kratzer said, but that total also represents many new customers. They replaced previous bank borrowers, who were able to prepay their loans either because they were bought in turn or because of strong earnings.
"Our portfolio has essentially been replaced in the last two years," Mr. Kratzer said. "We have seen so many mergers that a lot of these loans represent new opportunities. I wish there was more activity, but there's definitely been an increase."
Another major correspondent bank, LaSalle National Bank in Chicago, has about 80 bank stock loans, averaging about $5 million each.
"It's a real neat phenomenon that's going on, where small banks are trying to grow in the same way as large banks are," said Mark A. Hoppe, executive vice president for correspondent banking at LaSalle, a unit of ABN Amro. "It's perpetuating the community bank industry that the market wants."
And because the institutions are performing so well, bank stock credits are viewed as good investments for lenders and are attracting more players, although it's still not for everyone. As a result, correspondent bankers have also witnessed a tightening of pricing and margins comparable to what many are seeing with other types of lending.
"Bank stock lending is not immune from the other types of loan pricing competition that we've witnessed over the last three or four years," Mr. Kratzer said.