Don't Make Your Capital Plan on Account of Us, Bank Investors Say

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Do what's right for your bank, not what you think investors want.

That is the common message from community bank shareholders who otherwise have a wide range of views on what management teams should do to build and deploy capital.

For some big shareholders, organic growth and acquisitions take center stage. Others prefer that their investments return capital over time in the form of stock splits and buybacks.

But the overall view from investors at a recent panel discussion in Atlanta is that banks must determine where they want to go before pursuing a specific course of action for raising capital and providing liquidity for shareholders.

"I don't think there is one right way" to manage capital, Scott Reed, co-founder of BankCap Partners in Dallas, said at a liquidity conference for privately held banks. "Banks should not start by thinking about what investors want. They should start with their own markets and strategy and go from there."

A bank in Dallas, for example, might be focused on organic growth, Reed said. In contrast, institutions in rural markets might be better served looking at repurchasing stock or paying dividends.

Still, investors at the conference — hosted by Banks Street Partners, the Bryan Cave law firm, OTC Markets and StockCross Financial Services — said they have their own preferences for how management teams handle capital. They said those preferences are largely shaped by the banks in their portfolios and the stakes they hold in those institutions.

Most of the panelists said they want their banks to achieve a return on tangible common equity of 10%, though their timetables for such performance vary.

"Our investment horizon can stretch out a long time … maybe because I reach a little more into the scratch-and-dent bin," said Ken Lehman, a former banking lawyer who now makes large investments in banks with promising turnaround stories.

"It takes longer but the goal is a sustainable community bank," added Lehman, whose portfolio includes Four Oaks Fincorp in Four Oaks, N.C.; First Capital Bancorp in Glen Allen, Va.; and Liberty Bell Bank in Marlton, N.J. "I identify management that have the same vision."

Lehman said he is an advocate for banks' pursuing stock buybacks. They are great way to improve an institution's book value, by reducing shares outstanding, he said.

"It eventually opens up opportunities for M&A," Lehman said.

M3 Funds in Salt Lake City also prefers to see its investments focus on repurchases, Jason Stock, the firm's founding partner, said.

For Stock, buybacks make more sense than overextending and making risky loans in a low-rate, hypercompetitive environment. "There are a lot of overcapitalized banks," he warned.

"We're not optimistic right now because banks are taking on too much risk," Stock said, pointing to an increasing number of instances were banks are making 10-year, fixed-rate commercial loans at 3.5%. "I'd rather see banks make [fewer] loans right now."

By contrast, Fred Cummings, president of Elizabeth Park Capital Management in Pepper Pike, Ohio, said he doesn't like banks with big dividend ratios. It "signals to the market that a bank doesn't have other ways to use capital," he said.

Rather, "I want banks to focus on organic growth first," Cummings said.

Elizabeth Park tends to invest in banks located in markets deemed attractive to consolidators, and about a third of its portfolio consists of banks with market capitalizations below $200 million, Cummings said. The firm meets with potential acquirers, finds out where they want to expand and then scouts out banks in those markets. Cummings avoids privately held firms, because they are difficult to value, and is willing to cash out of a stock if his firm is unable to build its stake over time.

Lehman tends to buy controlling stakes, while working with existing management to find a way to purge bad assets, absorbing the hit with the capital he is investing.

"We develop a challenging, but achievable, business plan," he said, noting that the plan is then used to establish the restricted stock targets for management.

Stock and Lehman highlighted the underlying value of banks with high levels of core deposits. "Anyone can make a loan, but community banks know how to sell FDIC-insured deposit products," Lehman said.

Liquidity is important to BankCap, which has sizable stakes and board seats at Atlantic Capital Bank in Atlanta, Silvergate Bank in San Diego and Xenith Bankshares in Richmond, Va. The company focuses on banks with $1 billion to $10 billion in assets.

"We like to have a path to liquidity that is not dependent on an acquisition because [deals] are hard to predict," Reed said. "We like banks that can get to $2 billion or more in assets with organic growth and [making] acquisitions."

While Stock expressed reservations about making big investments in community banks, Reed said he thinks there are ample opportunities to put money into the financial sector.

"I believe the banking industry is on sale," Reed said. "I feel very excited about investing in community banks."

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