Amsouth Bancorp's repurchase of one million shares in conjunction with its 1994 acquisition of Fortune Bancorp turned out to be a trendsetter.
The program was among the first buybacks to use short-sales of a company's stock to accelerate the process and represented one of the first in a wave of equity derivative deals.
In such an "accelerated buyback" program, the company's investment bank borrows shares of its stock, creating a short position. Then the investment bank sells the shares to the company, accomplishing the share buyback. The investment bank then buys additional shares on the market to replace the ones it borrowed.
Traditionally, short-selling is used to bet on a decline in a company's stock. But increasingly, borrowing and replacing shares has become a tool to accomplish any number of objectives, including those of the company whose shares are being sold short.
"If you have the capital, it makes sense" to short-sell shares to speed the buyback program, said List Underwood, senior vice president of corporate finance for Birmingham, Ala.-based Amsouth. "This immediately helped the earnings per share and return on equity, and we were able to get the benefits of a buyback immediately."
John Russell, a spokesman for Banc One Corp., Columbus, Ohio, which initiated such a program last year, added, "You don't get the earnings-per- share credit until you own the shares back. Though each buyback is different, this is not a difficult decision to make. Depending on what kind of transaction you're involved in, there are limited risks."
Amsouth has continued its aggressive approach of returning cash to shareholders-and has arranged accelerated share repurchases through Union Bank of Switzerland, Morgan Stanley, and Salomon Brothers, an originator of the strategy.
"The investment community's acceptance of these buyback programs has been the key to their popularity," said Mr. Underwood.
Demand for this and similar investment banking services-which fall into the general category of equity derivatives-has soared, thanks to overcapitalization and consolidation in the bank industry.
"There has been tremendous growth in equity derivatives," said Joseph Elmlinger, vice president of the equity capital markets syndicate at Salomon Brothers.
Shirley Sing-Masuyama, a consultant with Financial Institutions Group and formerly of Citicorp's equity derivatives group, endorsed the techniques. "With the market swinging back and forth, I think that it's good that a lot of banks do this now," she said.
Banking analyst Michael Mayo of CS First Boston agreed. "If the bank believes it has a high opportunity cost relative to excess capital, it makes sense to capture that opportunity sooner by accelerating a share buyback."
Mr. Mayo added that a potential risk is that investors are willing to put a higher multiple on that portion of earnings per share generated with the buyback and have a higher perception of risk for banks that do not use those programs.
Customers say that the accelerated buyback between by investment banks, and incur little or no cost.
On the downside, a company's short interest appears to increase, creating a false impression that investors are dissatisfied with performance, until the investment bank returns the borrowed shares.
Salomon Brothers engineered the buyback method in 1994 and has used it for 50 banks so far, more than in any other industry, Mr. Elmlinger said. Banc One, Amsouth, and NationsBank are among Salomon's clients.
In addition to the short-sale technique, investment banks offer put warrants, equity collars, and forward purchase contracts to enhance buybacks.
Put warrants. The bank "monetizes" its willingness to buy back shares at a particular price by selling put warrants on its own shares to the investment bank in return for an up-front, tax-free cash premium.
The risk: The company's stock price could be below the strike price at maturity.
Equity collars. This method combines the sale of a put option with the purchase of a call, giving the customer the right, but not the obligation, to buy the option. This hedges against a rise in the stock price before the completion of the buyback.
The risk: The spread between the put and call exercise prices may result in a higher buyback price than a standard buyback would.
Forward purchase contracts. The bank commits to buying shares at a fixed price and date in the future, if it does not have sufficient regulatory capital for a buyback but wants to lock in a certain price, in expectation of future capital raising.
The risk: pricing the contract.