Pumping Up Short Interest Gains Sway As Way of Speeding Share

No company wants to see the short interest in its stock rise, because that commonly indicates investors are betting against the company.

But earlier this year, Banc One Corp. surprised the industry by engineering a big increase in its own short interest. In fact, it was the largest increase in short interest among all companies traded on the New York Stock Exchange during that period.

Banc One, it turns out, is not alone. More than 20 banking companies have quietly turned to the strategy over the past two years as a way to speed up large share repurchase programs, traders and investment bankers say.

"This is the most important new development in share repurchases, whether for banks or industrial clients," said Joseph Elmlinger, a senior member of Salomon Brothers' equity derivatives group, which is credited with inventing the method - known as block share repurchases - in late 1994.

Share repurchases are increasingly prevalent in banking, as the industry tries to boost returns to shareholders. Share repurchases boost earnings per share and reduce capital ratios at a time when most banks are overcapitalized.

In a block share repurchase, an investment bank borrows shares in the market, creating the short position.

The commercial bank then pays the investment bank for the shares, often at the average price of the stock over an agreed-upon period of time.

The upshot: the bank accomplishes in a single transaction what could have taken a year or more in open market trading.

Banks that have used block share repurchases include Southern National Corp., Amsouth Bancorp., Mercantile Bancorp., and Banc One, whose short interest rose 354% in the month through March 15 after Salomon completed the Ohio company's block repurchase.

Amsouth has done three block share repurchases totaling 3.25 million shares, including one of the first ones in late 1994, said List Underwood, executive vice president of corporate finance at the Birmingham, Ala.-based bank.

While the program limits the flexibility of a company to enter the markets when the price of its stock is more advantageous to buy, Mr. Underwood said the final price paid is similar.

"Because the investment banker executing the transaction is buying back shares from time to time in the market, it is not unlike regular systematic repurchase of stock," he said.

After the bank receives the shares, the investment bank then has a designated period to buy the bank's shares in the market to cover the short position.

The bank and the investment bank usually agree to share some risk over that period. But after that span ends, the investment bank, if it has not covered the short position, bears the financial burden if the stock price rises.

Short-sellers traditionally borrow shares and sell them immediately, in hopes of replacing them with cheaper ones when the stock price falls.

The danger is that the share price might rise, forcing the borrower to replace the shares with pricier stock.

"It is not for the weak of heart," said Mr. Elmlinger of Salomon Brothers. "You do take risks as an investment bank that you are not going to be able to cover your short (position) at the right price," he said.

Investment banks with large trading operations are better equipped to handle block share repurchases, he said, because their traders can time the purchases more adeptly and seamlessly.

There is risk nonetheless, so the credit rating of the investment banks is important.

UBS Securities is touting its ability to compete with other Wall Street firms on block share repurchases because its parent, Union Bank of Switzerland, has a triple-A rating.

"We are very active in this arena, and view overall bank capital management as a broad product line," said Tod Perkins, a vice president with UBS' financial institutions group.

"We are continually developing tools that will create just-in-time capital for banks," he said. UBS was the short-seller in the Amsouth repurchases.

But Salomon Brothers still remains the leader, having performed nearly two dozen block share repurchases since late 1994.

After reviewing several investment bankers, Southern National Corp. chose Salomon to short 4.3 million of the bank's shares in February, said the bank's chief financial officer, Scott Reed.

The effect: the bank's high 8.2% equity-to-assets ratio fell to 7.7%.

Just as the method is gaining sway, however, Mr. Perkins suggests the time for block share repurchases may have come and gone.

Because so many banks now have steady earnings, there is little need to juice up the balance sheet with speedy disposal of capital. And there are other ways of reducing capital ratios, he said.

At this point, he added, all major brokerage firms offer this service. "It is nothing but a commodity now," he concluded.

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