Town Center Bank in Coppell, Texas, is practically giving itself away.
The hobbled $50 million-asset bank has a deal to sell itself, but instead of cash or stock, the payment is merely the bad loans on its books.
Industry observers said this type of deal structure had been used by struggling sellers in the late 1980s and early 1990s, and now is making a return.
"We are seeing this more and more," said Randy Dennis, the president of DD&F Consulting Group in Little Rock. "It really is a great idea," because buyers are reluctant to take on bad loans and sellers often believe the loans are worth more than others are willing to pay.
In some cases such a fire sale can be the only option for a capital-strapped bank besides failure, Dennis said. "The alternative is to hold on and let the plane crash and lose everything."
Observers said Town Center's deal also could be a harbinger of another trend in mergers and acquisitions activity, as more strugglers are looking to partner with start-ups that have excess capital.
Town Center's buyer is the $87 million-asset Access 1st Capital Bank in Denton, Texas, which opened in October 2007.
Typically a start-up cannot do an acquisition without special permission from regulators — which Access said it expects to obtain.
It also has lined up an additional $10 million of capital from a group of investors, who initially had planned to open their own bank, but encountered regulatory delays.
Randy Robinson, Access' chairman, president and chief executive officer, cited the structure of the Town Center deal as a key to making it attractive. "We have excluded certain assets out of the transaction — nonperforming and criticized loans — and they will stay with the current owners. That is the consideration for the purchase," he said.
Sanford Brown, a managing partner at the law firm Bracewell & Giuliani LLP, said new banks file a business plan for their first three years of operation, and regulators often frown on deviating from it. But for those with extra capital and a strong management team, a proposal to buy a struggler is likely to get a favorable response from regulators these days, if only to spare the Federal Deposit Insurance Corp. the cost of another failure.
"It takes a problem off the FDIC's hands, so they have an incentive to approve a deviation from the business plan," Brown said.
For start-up banks — probably more so than for older ones — buying a problem bank before it fails can be attractive.
Unlike the more established banks, most start-ups would not have the option of doing an FDIC-assisted transaction, Brown said. "If you are less than three years old, you are probably not going to get on the bid list," he said.
And because of the weak economy, many start-ups cannot find enough good loans, despite having capital to deploy. Instead of taking longer to reach profitability, some might prefer buying a struggler to accelerate their growth.
"There was a whole wave a few years ago where there was a number of new de novos that were supercapitalized," said Richard Levenson, the president of the San Diego investment bank Western Financial Corp. "They may be finding it difficult to grow into that much capital."
Levenson said many California banks with loan trouble have been unable to raise the capital they need and are now looking to merge with a better-capitalized competitor instead, often with much more realistic pricing than just a few quarters ago.
He had yet to hear of a start-up agreeing to buy a struggler locally, but said such banks would be "a natural fit" for one another.
A deal like Town Center's has little risk, because the buyer gets a clean bank without diluting shareholders or using capital to pay for the acquisition.
But the buyer would need excess capital to take on the new assets and cover the expense of operating additional branches.
In Access' case, it gains two branches, bringing its total to three.
It did not disclose how much of Town Center's loans would be excluded from the deal. It also did not say what would become of Town Center's debt.
Several other deals announced this year have used a structure where bad loans served as at least part of the seller's payment.
The $107 million-asset First Business Bank in San Diego announced last month that it had a deal to buy 1st Pacific Bancorp, also of San Diego, for about $7 million and whatever is later recovered from charged-off loans and a lawsuit.
The $272 million-asset First National Bank and Trust Co. in Powell, Wyo., said in February that it would retain nine participations in construction and land-development loans as part of a $17.5 million deal to sell itself to the $5.7 billion-asset Glacier Bancorp Inc. in Kalispell, Mont.
And the $134 million-asset Timberland Bank in El Dorado, Ark., sold itself in June to the $698 million-asset Southern Bancorp Inc. in Arkadelphia, Ark., for $6 million. But Timberland retained roughly $6.5 million of nonperforming loans, and Phil Baldwin, Southern's president and CEO, has said that this "clean slate" arrangement clinched the deal for his company.
Like Town Center, these sellers were privately held, and observers said such deal structures would be more difficult to achieve for publicly traded companies, because shareholders might balk at getting little or no payment.
For buyers like First Business, however, the deals can be too good to pass up.
Nathan Rogge, First Business' president and CEO, said it never intended to do an acquisition. But given that it had excess capital and experience with loan cleanup, it opted to capitalize on the unexpected opportunity.
"In our position it seemed to make the most sense," Rogge said.
With assets of $419 million, 1st Pacific is nearly four times the size of First Business.
But 1st Pacific has been walloped with loan losses — its chargeoff ratio topped 12% a few quarters ago.
A principal shareholder at First Business, Ernest Auerbach, also committed to adding even more capital to facilitate the transaction.
The Town Center deal is structured so that problem assets would move into its holding company, much like a noncash dividend.
Then the bank — including the charter, branches, deposits and remaining assets — would be absorbed by the buyer.
Though no cash would change hands, Town Center's owners get the opportunity to collect on the loans and foreclosed real estate that they retain.
"We want the time they deserve and need to get the full value for them," said Robert Buchholz, Town Center's chairman. "Obviously we don't think that will be tomorrow, but by the same token, I expect these properties to sell."
Town Center, which has been operating under a regulatory order since December, has not had a profitable year since it opened in 2004.
Its noncurrent loans rose to 15.68% of its total loans at March 30, from 4.11% a year earlier, according to FDIC data. The ratio had shrunk to 8.33% at June 30.
Stephen Skaggs, the president of Bank Advisory Group, an investment bank in Austin, said a deal structure like Town Center's could work for securities in addition to loans and real estate.
"You look at some of these mortgage-backed securities that are being marked down to no value whatsoever, and I guess one could argue there is probably more value there in the long run than what the securities are being marked down to today," he said. "There could be value in holding those securities longer-term."