Community bankers are rushing to use a capital-raising tool that did not even exist three years ago.
Almost $3.5 billion of pooled trust-preferred securities securities backed by multiple, rather than individual, institutions were offered by roughly 300 banks and thrifts last year.
Since 1996, when the Federal Reserve Board first permitted it, dozens of institutions have issued trust-preferred securities on their own. But the pooled securities, introduced in late 1999, have allowed many smaller banks to get into the game.
For small banks, [single-issue] transactions are just not economically feasible, said Peter Wirth, an associate director of corporate finance at Keefe, Bruyette & Woods Inc. in New York. If youre doing a $5 million issue, the transaction costs will eat you up.
But affordability is not the pools only appeal.
First Sentinel Bancorp, a $2 billion-asset thrift holding company that could easily justify the cost of issuing trust-preferred stock on its own, was one of 53 participants in a $766 million offering that closed last month and was co-managed by Sandler ONeill & Partners and Citigroup Inc.s Salomon Smith Barney.
Chris Martin, First Sentinels chief operating officer, said the pool option made more sense, because the investment banking team did all the legwork, such as creating a trust to issue the stock and marketing it to potential investors.
Rate-wise, we might have done better if we issued on our own, said Mr. Martin, whose Woodbridge, N.J., company got $30 million from the offering. But it wasnt like we had to go out and sell the deal and go to the agencies to get a rating. This was just very easy.
Trust-preferred securities are often described as hybrid instruments, because they combine debt and equity. To sell trust-preferred securities, a bank or thrift holding company must establish a trust company, which then issues preferred stock to investors and lends the proceeds to the bank or thrift. The institution pays interest on the loan back to the trust company, which then forwards that interest to the investors.
Banks are attracted to trust-preferred issues for two reasons. First, thanks to the Feds 1996 ruling, the cash raised may comprise up to 25% of Tier 1 capital. Second, the interest paid to investors is tax-deductible.
The two reasons have proved alluring bank holding companies have issued close to $60 billion of trust-preferred securities since 1996, according to SNL DataSource.
But by the late 1990s community banks found that the market for trust-preferred issues was drying up, mainly because the spreads narrowed as interest rates rose. Also, private placements for small banks began to fall out of favor, because most were not rated, and many investors wanted rated paper, said Thomas Killian, a principal at Sandler ONeill.
That is when investment bankers came up with the idea of pooling the securities of multiple issuers to sell to institutional investors. Where many investors in the securities had historically been other community banks, the pools, which are typically rated as investment grade, opened up a whole new universe, Mr. Killian said.
As the number of banks issuing trust-preferred securities on their own dwindled, the number of banks issuing through pooled deals soared. In 2000 nearly 90% of all banks and thrifts that sold the securities did so through pools, compared with fewer than 10% in 1999.
The high percentage held true in 2001, but the dollars raised in six pooled deals topped $3.4 billion, compared with $533 million from two pooled deals in 2000, according to Sandler ONeill. Last years largest deal was a $941 million issue by 75 banks and thrifts, which closed last month and was co-managed by FTN Financial (a unit of First Tennessee National Corp.) and Keefe Bruyette.
The asset size of the banks and thrifts in that deal ranged from about $150 million to more than $10 billion, according to Jim Wingett, a managing director at FTN Financial. Typically, a pool also will include a mix of publicly traded and privately held companies from different regions, to protect investors from geographic downturns.
The advantage for investors is that it diversifies the risk considerably, said Joseph M. Ford, a partner in the Austin, Tex., office of the Houston law firm Bracewell & Patterson LLP.
Because of underwriting costs roughly 3% of an institutions portion of the proceeds Mr. Wingett said pooled issues are the most economical for companies looking to raise less than $15 million.
Simply put, investment bankers will charge higher fees for small, single-issue deals because we still have to do the same amount of work, he said.
Also, by teaming with other banks and thrifts, issuers share the costs of road shows, setting up trusts, prospectus printing fees, and legal issues.
One other advantage to joining a pool is the adjustable rate. In single-issue deals, the rates the trusts pay to investors are generally fixed over a period of 30 years. Issuers can opt for fixed rates in pooled deals, but most go the adjustable route, which favors them in a lower-interest rate climate.
However, that is not to say that single-issue deals are history. Large banks almost never join pools SunTrust Banks Inc. of Atlanta, for example, did a $300 million trust-preferred offering last month and last year 18 community banks raised more than $546 million in single-issue offerings, the highest volume since 1998.
Just last week the $4.2 billion-asset First Republic Bank in San Francisco announced a $40 million offering of REIT-preferred securities. In such offerings, stock is issued by a bank- or thrift-owned real estate investment trust, rather than a holding company-owned trust.
Ben Plotkin, the chief executive officer of Ryan, Beck & Co., in Livingston, N.J., said he advises smaller banks and thrifts to join pools but that most issuers looking to raise more than $10 million are better off going it alone.
You have more visibility in the broker-dealer community, said Mr. Plotkin, whose firm is a co-manager of First Republics $40 million offering as well as a $60 million deal issued by Northwest Bancorp of Warren, Pa., that closed in November. (Northwest raised an additional $30 million in the Keefe-FTN pooled deal last month.)
He also dismissed the argument that investors would prefer to buy only rated securities. They are being sold on the promise that community banks have a lower-risk profile, so rating really isnt relevant. Investors will take 8.75% from a community bank versus betting on the stock market.
Bracewell & Pattersons Mr. Ford acknowledged that the pools have some drawbacks besides the visibility issue. In a recent report he wrote that institutions need to consider the other banks and thrifts in the pool before diving in themselves.
A bank with a particularly strong track record could end up paying a higher interest rate through the pool than might otherwise be necessary, because it will be grouped with more mediocre institutions and thus will not be able to tell its story directly to potential investors, he wrote.
Whether community banks choose to join pools or not, it is clear that more of them than ever are tapping into the trust-preferred market. Some are using the proceeds to expand into new lines of business, such as insurance; others are funding acquisitions or buying back their own stock.
If you have a dissident shareholder and youd like to buy him out, this is a way to fund that, said FTNs Mr. Wingett.
Then there is First Sentinel, which is simply taking advantage of low interest rates.
Mr. Martin said his company does not need the money it is raising, as it is already well capitalized and would have trouble putting that money to work for us and make money.
But, he added quickly, Its there for us if we ever need it. 
