Since the Sarbanes-Oxley Act became law in 2002, dozens of small publicly traded banks have gone private to rid themselves of the costs and compliance burdens of registering with the Securities and Exchange Commission.
Most have done so through stock buybacks, but a growing number took a less-known and more cost-effective route: stock reclassification.
Rather than buy back their common stock, these banks reclassified it as preferred stock. The chief benefit is not having to spend large sums to cash out investors.
Of the 40 community banks that have filed with the SEC since January 2004 to deregister, 15 chose stock reclassification, according to Walter G. Moeling 4th, a lawyer with Powell Goldstein LLP in Atlanta who specializes in the tactic.
"We've seen it grow over the past two years, and we think that the reclassification method will be the method of choice for most community banks that opt to go private in the future," Mr. Moeling said.
There are drawbacks, chief among them that shareholders whose stock is reclassified as preferred have limited voting rights. The tradeoff is that they are generally paid higher dividends than common-stock shareholders.
Georgia Bancshares Inc. in Peachtree City is one of several banking companies awaiting SEC and shareholder approval of stock reclassification plans. The $269 million-asset company said in a Nov. 21 SEC filing that it had considered the traditional reverse stock split or even selling itself to escape SEC registration requirements.
"We rejected these alternatives because we believed the reclassification would be the simplest and most cost-effective manner" in which to go private, the company said in the filing.
A prerequisite of SEC deregistration is reducing the number of common-stock shareholders to fewer than 300. To do so, Georgia Bancshares plans to convert about 157,000 shares of common stock to preferred.
Mr. Moeling said reclassified shares are generally owned by small, local investors who do not mind losing their right to vote for directors or routine issues that come up at shareholder meetings.
Besides, he said, these shareholders still have a say on the big issues, such as sale or liquidation of the bank. In Georgia Bancshares' case, preferred shareholders would have equal voting rights with common-stock shareholders on those issues and would share in the proceeds. (Mr. Moeling's firm is advising Georgia Bancshares in its reclassification.)
The banking company estimates that going private will save it $240,000 a year - and that doing so through reclassification will save it from paying about $2 million to repurchase 157,000 shares of common stock.
Big Lake Financial Corp. in Okeechobee, Fla., which delisted its stock in 2004, pioneered the stock reclassification method. Its management, like many community bankers, had concluded that the burdens of being publicly traded outweighed the benefits.
Jack Greeley, a senior partner at the Orlando law firm Smith Mackinnon PA, worked on the deal. "The problem was, we didn't want to cash [shareholders] out," he said.
"Many of these shareholders were good customers and supporters of the bank, and we didn't think it would be fair that if there was a sale of the bank in the future, they would have lost the increased value of the stock," Mr. Greeley said.
And in fact the company announced Nov. 22 that it had agreed to sell itself to the $2.1 billion-asset Seacoast Banking Corp. of Stuart, Fla., for $43 million.
Last year Big Lake created a preferred class of stock to go private without irritating shareholders. After the SEC reviewed the plan to ensure that it was both legal and fair to investors, Big Lake's shareholders unanimously approved the plan.
"It worked out great for us," said Joe G. Mullins, the president of its $307 million-asset Big Lake National Bank. "The shareholders really weren't giving up anything, and they were gaining the ability of the company to add to its bottom line."
Mr. Moeling said other banks are discovering those advantages. "The biggest drawback of going private, for many community banks, has been the community reaction to forcing out small shareholders," he said. "The stock-reclassification method avoids this issue and has received nearly unanimous shareholder support where it has been used."
But the management of Cherokee Bank in Canton, Ga., was not convinced. It took a hard look at stock reclassification before deciding to use a traditional stock buyback this year.
"We decided that it would be too complicated to say to shareholders, 'We're going to take your voting common stock and create nonvoting common stock," said Dennis W. Burnette, the president and CEO of the $187 million-asset bank.
He worried that the move "would have created a lot of ill will," and confuse investors, who might not understand the difference between the two stock classes.
Also, he said, because reclassification was a relatively new method of privatization, regulatory approval was uncertain. "We did not want to be trailblazers."
Mr. Moeling does not claim that reclassification is always the best way for all community banks to go private. "It's not one-size-fits-all," he said.
For those with actively traded stock and aggressive investors, a traditional stock buyback is still the best choice, Mr. Moeling said. But for smaller banks with thinly traded stock and a more passive shareholder base of customers and others in the community, reclassification is the way to go, Mr. Moeling said.
"It allows the bank to achieve the most significant benefit of deregistration while allowing the board of directors to feel very good about the treatment of its shareholders," he said.
