Privately Held Banks Get New Liquidity Option After SecondMarket's Exit

Privately held banks are getting another option to provide an exit strategy for investors.

OTC Markets Group, which has been focusing on small, publicly traded banks for a specialized marketplace, has started courting privately held financial institutions. The group is pitching prospects a chance to provide shareholders with liquidity without going through the headache of an initial public offering.

The new forum should also fill a void left last year when New York broker-dealer SecondMarket discontinued its marketplace for privately held banks.

FirstAtlantic Bank in Jacksonville, Fla., is expected to become the first privately held bank to join the marketplace, and the OTC is reviewing applications from two other banks that have not traded on public exchanges. Plans are also in place for a formal sales campaign for private banks, featuring a May conference in Atlanta designed to educate smaller banks about ways to boost liquidity.

"We're starting to see a significant increase in private banks that weren't contemplating going public," Jason Paltrowitz, an executive vice president at OTC Markets Group, said. Interested banks view the marketplace as a way "to meet the needs of their shareholders."

The marketplace — OTCQX Banks — launched last spring. It has about 50 banks, with assets ranging from $110 million to $2.4 billion. Most of those banks moved their stock from OTCQB, the OTC's lower-profile bulletin board. Others left the Nasdaq after voluntarily delisting under the Jumpstart Our Business Startups Act.

Over-the-counter markets have become an attractive option for banks that have "gone dark" under the JOBS Act, which provided exemptions from certain Securities and Exchange Commission reporting requirements.

Many banks that voluntarily delisted have migrated to the OTC exchanges to maintain trading volumes, said Beth Sims, a securities lawyer at Butler Snow. "It's an option for entities that want some liquidity vehicle for their shareholders without the significant cost" of filing with the SEC, she said.

The QX marketplace aims to provide more luster than other over-the-counter exchanges. It is being marketed, in part, to small banks looking to distinguish themselves from exchanges that include financially distressed companies and penny stocks.

"It's a step up from the [OTC's bulletin board], but not all the way to the Nasdaq," said Barbara Britenriker, chief financial officer at the $910 million-asset Farmers and Merchants Bank in Archbold, Ohio, which joined the marketplace this month. "Hopefully investors will look there and realize there's a difference."

Some deterrents could exist. The OTC's QX marketplace, compared to its bulletin board exchange, has heightened disclosure requirements and requires regular earnings reports. It also mandates that participating banks designate a corporate broker-dealer.

A labyrinth of state securities laws could also create headaches. Such complexity led SecondMarket, which piloted its exchange in 2012, to discontinue its marketplace.

"We explored the private community bank market in great depth, and found that the patchwork of non-standardized state-level blue sky laws was prohibitive towards the development of marketplaces for secondary trading," SecondMarket spokesman Anil Sharma said.

Despite some initial skepticism from bankers, the OTC expects to sign up to 200 banks by the end of this year, Paltrowitz said. And SecondMarket's exit could provide the group with a longer runway for growth.

"To the extent that a well-known player like SecondMarket is no longer in the field, I think that certainly would benefit OTC," said Jeff Adams, managing director at Banks Street Partners in Atlanta, which is co-sponsoring the marketplace's small-bank conference. 

Banks that qualify for the OTC marketplace should benefit from having higher visibility to potential investors, while providing existing shareholders with an opportunity to monetize their holdings without having to sell the institution, Adams said.

Additionally, banks that were formed and expanded during the de novo boom that ran from the late 1990s to the financial crisis have begun to express interest alternative exchanges, Sims said.

Roughly 500 banks were formed in the past decade, with the lion's share opening up from 2005 to 2007, according to data from the Federal Deposit Insurance Corp.

"We've seen a lot of interest in de novos wanting to give their shareholders options to move their stock," Sims said. "Those shareholders are ready for a liquidity event."

Alerus Financial in Grand Forks, N.D., joined the QX marketplace earlier this month. Alerus switched to make sure its shares wouldn't "get lost" on the OTC's bulletin board, said Jay Kim, the $1.5 billion-asset company's general counsel.

Alerus began providing "more robust" disclosures to shareholders a few years ago, Kim said. Moving to the QX will allow the company to attract attention from potential investors.