With a compelling need for capital and the usual open-market routes to it in gridlock, a growing number of firms are turning to insiders for fresh funds.
At least five banking companies have arranged securities sales to insiders or affiliated entities in recent months, and others are expected to follow suit soon.
Before the financial crisis, bankers seeking funds would almost always turn to the open markets, issuing stock or bonds. But with such capital scarce, small banking companies especially are increasingly pursuing alternatives, such as stake sales to private-equity investors, the uncertain Troubled Asset Relief Program, and now private placements.
Michael O'Boyle, an investment banker at Sterne, Agee & Leach Inc., said in an interview that he has held numerous discussions with bankers interested in selling securities to insiders.
The companies fall into two camps, Mr. O'Boyle said. For some, the "boards want to shore up their balance sheets by talking about what can be raised around the table first." For others, "it is the only option left."
Laurence Pettit 3rd, who oversees the community bank portfolio at Anderson & Strudwick Inc., said the trend indicates the urgent need to raise capital.
"I think everything is on the table, and you find buyers where you can," Mr. Pettit said. "I think you'll see a lot more private placements with insiders. They can't be selective."
Observers said a majority of recent private placements have involved small banking companies.
First Mid-Illinois Bancshares Inc. is looking to sell $25 million of convertible preferred stock this month. William S. Rowland, the $1.05 billion-asset Mattoon company's chairman and chief executive, said in an e-mail that it will sell securities to "a small group of accredited investors" that could include executives and directors.
"I cannot talk about the intentions of others," Mr. Rowland said. "I will participate in this offering and make an additional personal investment."
First Mid-Illinois earned $2.1 million in the fourth quarter.
Flagstar Bancorp Inc. sold $5.3 million of common stock to executives last week to complement the $500 million of capital the $14.2 billion-asset Flint, Mich., thrift company received from the Treasury Department and private-equity investors.
Calls to Flagstar were not returned, though Mark Hammond, its CEO, said during a Jan. 30 earnings conference call that the funds "will provide us with both the considerable capital base to sustain future losses and to allow us to prudently increase our asset base and income strength."
Flagstar posted a fourth-quarter loss of $200.3 million.
Habersham Bancorp sold $7 million of preferred stock last month to an entity with ties to its chairman, Thomas A. Arrendale 3rd. The $500 million Cornelia, Ga., company plans to sell the entity another $3 million at dates to be determined, according to regulatory filings.
David Stovall, Habersham's CEO, did not return a call for comment. His company has taken aggressive steps to save capital, including a dividend suspension in November. It said it will post its fourth-quarter results this week or next.
Raising capital by selling securities to executives and directors, rather than to outside investors, can create a tricky balancing act. Though it can be a quick and relatively inexpensive way of infusing cash into a company, it also runs the risk of irritating shareholders who are shut out and have their stakes diluted.
"To outsiders, the practice can seem somewhat egregious," Mr. O'Boyle said. "The message you have to deliver to shareholders is that we're in a tough environment, and there is a need to be original in thought to get to good capital levels. But you are going to alienate some people who would want to invest, because the feeling may stick with them in the future."
Other banking companies have raised cash from insiders in recent months, including Superior Bancorp of Birmingham, Ala., which sold $10 million of subordinated debt in mid-September to an entity tied to a former director, and Virginia Commerce Bancorp Inc., which sold $25 million of trust-preferred securities in the same month with warrants to directors and executives.
Peter Converse, the $2.7 billion-asset Virginia Commerce's CEO, did not return a call for comment. His in Arlington company earned $1.3 million in the fourth quarter.
C. Stanley Bailey, the executive chairman and CEO at Superior, said in an interview that he fielded a few calls about the $3.2 billion-asset company's subordinated debt issue, which included warrants for common stock. Most of the inquiries from investors were about the deal's structure, he said.
On Monday, Superior said it expected to report a $1.1 million profit for the fourth quarter, excluding the results of a possible goodwill charge that would not affect capital levels.
Mr. Bailey drew a distinction between companies that have raised capital to absorb large credit losses and Superior, which he said is using its capital primarily to expand its balance sheet in response to consolidation around Birmingham. Superior's loan book grew 15% last year.
"Any capital raise … is dilutive in this environment," he said. "We have the ability to leverage the capital, so it will be accretive over the long term. It is just a question of when."
Jacqueline Reeves, the managing director of Bell Rock Capital LLC, said in an interview that an ability to show that capital is being leveraged should be sufficient justification for raising more funds in the future.
"If you successfully deploy the capital you've raised from individuals and institutions, you can go back to them into perpetuity," Ms. Reeves said. "It also depends to a degree on the management team's track record and credibility."
Mr. Bailey, who has overseen three similar fund-raising efforts in his career, said he would be open to another one if the need arose.
"If we need to do it again, we have that in our repertoire," he said, quickly dismissing the notion of turning to common stock. "Not in this environment."
Analysts distinguished between instances where companies issued securities to insiders and recent examples of executives buying common stock in the open market. In the past month several large-bank CEOs, including Kenneth D. Lewis of Bank of America Corp., James Dimon of JPMorgan Chase & Co., and C. Dowd Ritter of Regions Financial Corp., have bought outstanding shares in moves that many read as a psychological show of confidence in their companies.
"In those instances, the executives were buying already issued shares that do not help the company's capital position in any form, shape, or fashion," Mr. Pettit said.
When it comes to private placements with insiders, he said he was comfortable with the dilution, because it is better than having a company cited for dwindling capital. "An insider is no different than any other person, and they know the risks of investing in a bank's stock."