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While all of the big banks have repurchased or converted preferred stock, and two-thirds of the regionals have followed suit, community banks are expected to hold the vast majority of unpaid Tarp funds on their balance sheets by the program's two-year anniversary.
May 24
Being small can complicate a bank's quest for capital, but some institutions have found ways to use smallness to their advantage.
For example, bank holding companies with less than $500 million of assets don't have to meet consolidated capital requirements. In other words, a small holding company can take on debt without its counting against capital levels at the subsidiary banks.
At least two such companies have made use of this exemption to turn debt at the holding company level into equity for their banks.
American Enterprise Bankshares Inc. in Jacksonville, Fla., raised $6 million in the fourth quarter through convertible debentures, nearly 95% of which were issued to the bank's customers.
"They knew us, they trusted us, and they came in and helped us," Bennett Brown, the $210 million-asset company's chief executive, said Wednesday.
The customers essentially made loans to the bank at a 7.5% interest rate, which they can convert to common stock at 75% of book value at the end of the seven-year term, or earlier if the bank is prepared to pay the money back. In the meantime, they receive monthly interest payments.
Jeff Marsico, the executive vice president at Kafafian Group in Parsippany, N.J., said this is often a better alternative to raising common equity, which can be quite dilutive if a bank's stock valuations are low.
"You don't want to issue common equity at 80% of book value," he said.
Docking Bancshares Inc. in Arkansas City, Kan., employed a similar strategy to push money down into its subsidiary, Union State Bank, which was grappling with nonperforming commercial real estate loans.
Bill Docking, the company's CEO, along with his brother, Tom, senior vice chairman of the company's board, and their mother's estate, made three loans to Docking Bancshares totaling $900,000, which they injected as capital into the $216 million-asset Union State in late 2008.
The family members receive monthly payments on the 10-year notes, which carry a 6% interest rate. To satisfy regulators they included a provision that allows the holding company to defer payments if a majority of the board agrees.
"Insiders are in a position to understand the financial health of both the bank and its holding company, so they can make an informed judgment about making this type of loan," Docking said.
Philip Smith, the president of Gerrish McCreary Smith, a law firm in Memphis, said such arrangements can provide a more reliable return at a time when many banks have stopped paying dividends.
Banks with assets of less than $1 billion often have fewer stockholders, and thus fewer places to turn for capital.
"Stockholders are real, live people at small banks — it's not institutional types of investors — and those people are strapped for cash, too," Smith said. "Trying to go back even to your existing stockholders and encourage them to buy more common stock may be a very difficult sell."
Small banks' capital-raising options are further limited because many investors don't think it's worth sinking less than $10 million into an institution — which is much more than a bank in the under-$1 billion asset category would need.
"Gone are the days of the retail investor that's looking to invest $500,000 to $50,000," said Michael Iannaccone, the president of MDI Investments, a Chicago consulting firm that helps community banks with, among other things, capital raises.
Another alternate capital-raising strategy for small banks is to seek merger partners who will bring money with them.
Iannaccone said some investor groups, which may have wanted to start a bank but were denied regulatory approval, are looking to put their money to work in small, healthy banks. Others are investing in small institutions as platforms from which to pursue failed-bank deals.
Nondepository businesses, such as mortgage lenders, are offering to invest money in exchange for coming under the umbrella of a bank charter, a move that could help them avoid new regulations, Iannaccone said.
But those attachments can lead to complex negotiations with the investors, who may want a seat on the board or a majority of stock.
For the banks, "if they want money, that's what they have to go up against," Iannaccone said.
