Thaw Seen in Stock Loans

The terms are stricter now, but bank stock lending is back.

After going into hibernation during the financial crisis, bank stock loans once again are allowing small bank holding companies to borrow against their stock and pump the proceeds into subsidiary banks-while giving bank stock lenders a chance to revisit an old business line.

With regulators of small firms generally more concerned with capital ratios at the bank level rather than the holding company, more bank holding companies (generally those with less than $500 million in assets) are using the loans to finance mergers and acquisitions, to invest in internal growth strategies or to restore depleted capital. Activity in these areas has picked up as the economy and banking industry rebound to health.

"Increasingly, banks are trying to take advantage of opportunities rather than just dealing with problems," says Jeff Gerrish, chairman of Gerrish McCreary Smith Consultants. That goes not just for borrowers but also for lenders, primarily bankers' banks that act as correspondent banks for community institutions.

"Lenders are now coming out," says Gerrish, whose Memphis firm helps community banks find loans. "We did four or five transactions last year after doing virtually none in 2008 to 2010."

Midwest Independent Bank in Jefferson City, Mo., has seen a "gentle" rise in its portfolio of bank stock loans since early 2009, says Bill Lloyd, the bank's chief lending officer. His firm initiated 12 new bank stock loans last year, along with several renewals. Demand isn't "wild," but it is steady, Lloyd says. "As long as you have smaller community banks, there will be a need for bank stock lending."

Some borrowers simply use the loans to pay shareholders who want to cash out. Others send the proceeds of the loans downstream to the bank level to finance a variety of activities. Bankers and consultants say the loans generally amount to $1 million to $10 million, with an interest rate of 4 percent to 6 percent and a maturity of three to 12 years. In the wake of the financial crisis, lenders are demanding stricter terms. They want 100 percent of the bank's stock as collateral and will accept no less than 50 percent, says Gerrish's colleague Greyson Tuck.

Midwest Independent Bank typically requires 100 percent, "so we end up with a very conservative loan to value," Lloyd says. "If I have to foreclose, I need control of the bank."

Lloyd says the loans also come with performance covenants "that we hadn't used previously to manage loans better in these uncertain times." Asset quality, capital adequacy and earnings performance are measured quarterly as part of the covenants.

Finlayson Bancshares of Finlayson, Minn., took out two bank stock loans last year for a combined $5 million. Both loans were used to finance mergers. The company's Northview Bank bought First National Bank of Sandstone, Minn., and its First Independent Bank subsidiary bought State Bank of Lucan, Minn. The loans came from United Bankers' Bank of Bloomington, Minn. Finlayson has borrowed from UBB nine times over the last 25 years to finance purchases of banks or individual branches, says Bruce Pogatchnik, vice president of Finlayson.

This time around, "we weren't running around looking for banks," he says. "Lucan approached us, and the other one we bumped into."

Pogatchnik's family owns all the company's stock and didn't want to pony up more equity itself or dilute its holdings by bringing on new shareholders. "So we just borrowed against the banks that we already have," he says. "We had to put up all our stock as collateral."

The interest payments on the loan are deductible, making the terms attractive. "We borrowed at 5 percent and have a tax deduction that amounts to 40 percent. So the after-tax cost is 3 percent," Pogatchnik says. "No one would want to give you boatloads of capital for 3 percent."

Kevin Bostrom, UBB's chief credit officer, says bank stock loan volume will likely continue to rise. "I'm assuming we will see more M&A activity going forward, and then we would see more activity on our side to fund those transactions. We may see some for internal growth too."

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