Smaller banks draw more attention from market sophisticates

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Small banks once fretted about a lack of attention from potential investors.

Size has often been a factor behind investment decisions. On the equity side, smaller institutions are often privately held, which has created more complications for those considering an investment. With debt, the amounts community banks sought to raise were typically too small to attract Wall Street's attention.

Some of that bias is starting to change.

In recent years, companies such as Kroll Bond Rating Agency and OTC Markets Group have started targeting smaller community banks as a business, either by helping them raise capital or providing coverage and analysis for stock and debt.

Kroll, founded in 2010 to serve as an alternative to rating agencies that suffered black eyes during the financial crisis, stepped up its efforts to track the performance of community banks. The New York firm currently rates the debt for about 120 institutions that each have assets of $500 million or more.

That number should grow "for several more years," said Van Hesser, senior managing director of Kroll’s financial institutions and corporates group. “More and more banks are interested in what we offer — especially in the community bank sector,” he said.

The market for small bank debt “literally did not exist” six years ago, as conventional wisdom held that “community banks could not be rated investment grade as they simply couldn’t keep up and compete with the larger banks,” Hesser said.

Beyond debt, ratings can also boost the prospects of banks seeking large public deposits, Hesser said. "Ratings have really taken root in the institutional deposit sector," he said.

When it comes to equity investing, OTC Markets is finally seeing its OTCQX Banks index, which it formed 2015, take off, said Jason Paltrowitz, the company’s executive vice president for corporate services.

The OTCQX has about 80 community banks, including five that voluntarily delisted from the Nasdaq in the past six months. The smallest bank on the index is the $98 million-asset Town Center Bank in New Lenox, Ill.

OTC Markets' pipeline of new applicants is growing rapidly, Paltrowitz said.

OTC Markets offers banks a chance to offer shares to investors at a greatly reduced cost and decreased reporting burden. Its value proposition should look even better early next year, when banks listed on larger exchanges will be required to pay listing fees.

“We’re having more and more conversations,” Paltrowitz said.

To be sure, firms like Kroll and OTC Markets rely heavily on investor appetite for small banks. That's where companies such as Angel Oak Capital Advisors, which oversees a family of mutual funds, and StoneCastle Financial, a closed-end investment firm, play a critical role.

An investment adviser affiliated with Angel Oak in January completed a private placement of $155 million of bonds backed by the subordinated debt of 25 small and midsize banks. Since 2015, the Atlanta firm and its affiliate have managed two community bank securitizations, totaling about $380 million.

“We are actively engaged in acquiring assets that would be suitable for securitization and we would certainly love to do" another deal, said Rob McDonough, Angel Oak's senior research manager. “We're definitely looking for the right kind of assets that could go into a securitization.”

Angel Oak sees significant untapped value in smaller banks often overlooked by investors.

“The fact that a bank is unrated ... does not mean that they're a higher risk," McDonough said. "it simply means it’s not economical for them to get a rating.”

Indeed, smaller size can often be a benefit for community banks and, by extension, their ratings, Hesser said.

Community banks “can be every bit as competitive as larger banks," he said. "The benefits of scale are [often] offset by the costs and risks brought on by complexity. Community banks have a fairly simple business plan, built on local scale, local market knowledge and superior responsiveness.”

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