A Wisconsin thrift company has found a resourceful way to raise some badly needed capital, one that institutions across the country could replicate: unwinding its employee stock ownership plan.
Citizens Community Bancorp Inc. in Eau Claire was able to return its thrift to well-capitalized status by terminating its ESOP, it said late last week in Securities and Exchange Commission filings. Impairments of its securities portfolio had left the thrift merely adequately capitalized by regulatory standards.
Industry watchers applauded the move — especially as the company's employees won't lose any of their money — as a prime example of the old adage about necessity being the mother of invention.
"In turnarounds, the first question we ask is: Where can I find capital?" said Christopher J. Zinski, a partner at Schiff Hardin LLP in Chicago. "You have to turn over every single rock on the balance sheet as you look for those opportunities, and you have to do it fast in order to get more room to maneuver."
Citizens Community's strategy could have broad implications for the banking industry, where industry experts estimate as much as one quarter of companies have ESOPs.
This employee benefit is especially common in mutual thrifts that have converted to stock organizations. Many created an ESOP as a way to absorb some of the cash raised in an initial stock offering. Such thrifts could follow Citizens Community's example as they consider their capital needs.
"I don't know exactly how prevalent it will become, but I could see others doing this," said Charles Crowley, a managing director in investment banking at Stifel, Nicolaus & Co. Inc.
"I think some might be reluctant to unwind them, unless they feel that is their best option to raise capital. It definitely fits under the umbrella of creativity."
In an interview, Edward H. Schaefer, the chief executive officer of the $566 million-asset Citizens Community, would not provide details of the transaction that unwound the ESOP. But he said his company was prompted to take action after writedowns on its mortgage-backed securities left the thrift adequately capitalized and it entered into a memorandum of understanding with the Office of Thrift Supervision.
"We took into consideration ways to raise capital and this was the best option for the company and to preserve shareholder value," Schaefer said. "The $3.1 million puts us above where we need to be."
Lawyers who specialize in handling ESOPs said Citizens Community likely had a leveraged ESOP, meaning one that was funded through a loan.
Typically, the loan comes from a third party, but an SEC filing from February 2005 shows Citizens Community loaned its ESOP $1.2 million of the $9.1 million it raised through its initial public offering.
The company would have had to treat the loan as a liability; paying off the loan and terminating the ESOP would result in shares that had not yet been allocated to any employees flowing back to the company in the form of equity.
"It is a pretty complicated accounting, but it appears to be a really creative strategy," said Gregory K. Brown, a partner at Katten Muchin Rosenman LLP in Chicago, who specializes in ESOPs.
According to a Feb. 12 SEC filing, Citizens Community's ESOP accounts will be transferred to the company's 401(k), meaning its employees won't lose the money already invested in the ESOP.
"That money continues to exist. Nothing has been done with those shares," Brown said. "Arguably, they are better off." This strategy at least for now shores up the company's capital problems, which should improve its long-term value, Brown said. The approach also allows employees to diversify their investments through the 401(k) plan, while the ESOP contained only company shares.
The $3.1 million raised was enough to move the thrift's total risk-based capital ratio from 9.6% at Sept. 30 to 10.8% at Dec. 31.
Citizens Community's problems largely stem from its exposure to mortgage-backed securities. Although the securities were rated triple-A at the time they were purchased, nearly half were downgraded by rating agencies to below investment grade, according to SEC filings.
As a result, the company booked $7.8 million of other-than-temporary impairment charges on the $50 million portfolio in 2009. Such impairments drive losses and eat away at capital. Also, when securities are downgraded, their risk-weighting increases, making the denominator of the capital equation larger.
Michael Iannaccone, president of MDI Investments Inc. in Chicago, said the company could be hit with further impairments on those securities in 2010. Yet data from the company shows the securities, particularly the ones without federal guarantees, moving off the balance sheet at a brisk pace, meaning its exposure is dwindling each quarter.
"It appears to either be a well-seasoned or short-term pool, but if it continues at the same speed, it will take six quarters to wind it down," Iannaccone said. "Will they need another impairment charge between now and then? That is the part we don't know."
Still, Iannaccone said it would be wise for Citizens Community to boost its risk-based capital by $21 million, which would give the thrift a total risk-based capital ratio of 15%. In addition to the threat of further writedowns, 45% of its loan portfolio is comprised of consumer loans.
"Given where the economy and unemployment is, I would be concerned about that," he said.
So far, the company's credit quality has remained fair. It reported nonperforming assets of $8.4 million at the end of the fourth quarter, making up 1.48% of total assets. Schaefer noted that "having more capital than 10% in today's environment is favorable," but would not discuss other efforts to raise capital.
Schaefer became CEO in January. He had been a director of the company and served as a consultant since Oct. 1.
He succeeded James G. Cooley, who was removed as CEO in October. In a securities filing, the company described Schaefer as someone skilled at fixing ailing banks.
"This is a company that grew dramatically following going public," Schaefer said in the interview. "My goal is to put the right people in the right places so we can focus on getting back to our core profitability."
By focusing on profitability, the company will be able to absorb writedowns on the securities portfolio should further impairment charges be needed, Schaefer said.
"Some companies are being forced to sell these, we have decided to let these run off," he said. "But the plan is to be able to offset those charges with earnings."
Schaefer pointed to the company's first-quarter earnings as an example. Despite impairment charges of $583,000, Citizens Community made $175,000, down 34% from a year earlier.