A community bank in Norcross, Ga., recently reduced its number of shareholders by 78% - spending $1 million of its capital and ultimately dividing its board. One director quit in protest.
First Capital Bancorp achieved all of this by using a reverse stock split - 1-for-3,000, to be exact.
The rare technique was implemented not just to drive up the bank's share price - its most common use - but also to save costs by reducing the number of small shareholders and, most importantly, to deploy excess capital.
First Capital's controversial move is an example of how community banks are beginning to cope, often creatively, with a situation that until recent years most banks would have craved: too much capital.
"Excess capital would have been unheard of just a few short years ago," Walt Moeling, a lawyer with Powell, Goldstein, Frazier & Murphy in Atlanta said at the recent convention of the Georgia Bankers Association. "Today, it is a real strategic problem."
A scarce commodity just five years ago in many banks around the nation, capital is building to levels not seen since the boom of a decade ago. Equity capital industrywide has mushroomed by 41% since 1991, to $335 billion, according to Professional Bank Services, a Lousiville, Ky., bank consulting firm.
Among banks with under $1 billion of assets, the average Tier 1 risked- based capital ratio was 15.14% in 1994, a 25% jump from 1991, according to the Louisville firm.
Instead of sitting on their riches, however, community banks need to look for ways to put them to use, according to some industry experts. The primary reason is that the higher the capital level, the higher the returns needed to achieve a respectable return on equity.
ROE should be in the 12%-to-15% range, most financial consultants agree, and if it's not there, many of today's small-bank shareholders will demand a merger or take their money elsewhere.
But today's fat banks shouldn't rush too quickly to use up their capital, some said.
"It amazes me that we're talking about being overcapitalized, as if there won't be another downturn in the economy," said T. Stephen Johnson, who recently founded a $100 million fund in Atlanta to invest in southeastern banks. "It depends on whether you have a short-term view of shareholder value or a long-term view. If you're in it for the short haul, then you have a problem because an acquirer won't pay a premium for that capital."
Mr. Johnson said he is only just beginning to see the smaller banks attempt to lower their capital ratios and bring them in line with those of most of the larger banks.
The most common method of reducing capital is stock buybacks, which occur almost on a daily basis. The other obvious approach is to go shopping for another bank or branch. But with the Resolution Trust Corp.'s auction of failed institutions over, and with brick-and-mortar banking falling out of favor, this route is less appealing than before, observers said.
As for the relatively esoteric reverse stock split, most of those interviewed had not heard of it being used as a way to reduce capital. In fact, just 10 other financial institutions - four banks and six thrifts - have implemented a reverse stock split in the past two years.
Most of those splits were in the 1-for-5 to 1-for-20 range, however, a far cry from First Capital's 1-for-3,000 split.
"This is not a process for the faint of heart," said William R. Blantan, the $85 million-asset bank's president and chief executive.
Those with fewer than 3,000 First Capital shares - most of the 440 stockholders - had the option of buying more to reach that figure or being cashed out.
With the offering price at $4 a share, which represented an 8% premium, a stockholder with 1,000 shares, for example, had the choice of either paying $8,000 for another 2,000 shares or walking away with a check for $4,000.
Seventy-eight percent of the shareholders, many reluctantly, took the check, leaving a little over 100 shareholders.
The immediate result was a reduction in the cost of mailing materials to shareholders. Also, by having fewer than 300 shareholders, First Capital could deregister from the Securities and Exchange Commission, saving an estimated $35,000 to $50,000 in filing, accounting, and legal costs annually, Mr. Blantan said. The bank is now considered privately held.
The other primary goals were met as well: the capital ratio stands at 7.53%, down from 8.63%; earnings per share increased by 16% in the first quarter; and ROE is on target for 13%, up from 11%, according to Mr. Blantan.
"We sent out a memo on what we did to about 12 bank presidents," Mr. Blantan said. "Four called back and said, 'What the hell did you do, and how did you do it?' "
Not everyone can do a reverse stock split. After an appeals court prevented a national bank in Indiana from using the technique in 1991 - in Bloomington National Bank v. Telfer - the Comptroller's office barred national banks it regulates from the practice.
The court had ruled that the reverse stock split infringed on dissenters' rights. National banks owned by holding companies - which are regulated by the Federal Reserve - and most state banks can do reverse splits, but regulatory approval is required in some cases.