Survival of community banks depends on outlasting the shareholders

Every month, I read in a banking publication or receive information that another friendly community bank has sold. What would make a profitable bank that has been growing and has more than adequate capital sell? The answer is simple: The shareholders want out, they want liquidity and they must sell

Over the past several months (without identifying the bank or the state), I have been working to sell a financial institution. The major shareholder owns 60 percent of the bank and wants to turn his longterm investment into liquid assets. Even though the bank has a holding company, there is little interest among management and the remaining directors to encumber the organization to any significant degree in order to cash out the majority shareholder.

To give you a perspective of the kind of money involved, let's assume that they would have to come up with $6 million cash in order to cash out the majority shareholder. Since the remaining management and directors are mature and do not have long-term potential careers with the financial institution, they are not interested in incurring debt or investing personally in order to keep the bank alive and independent. So - there goes another one!

Widely held banks and bank holding companies

If your bank or thrift or holding company is widely held, then this is not a significant problem. A corporate stock redemption policy can be incorporated along with buysell or right of first refusal options to buy back the stock of a significant shareholder. By widely held, it means that a major shareholder would be a five percent shareholder, not a 60 percent shareholder.

Generally, redemption of stock from a significant shareholder can be financed through the cash flow of the holding company or financial institution. It is not necessary to go outside the institution to borrow funds or sell stock in order to meet the needs of larger shareholders.

Closely held financial institutions

On the other hand, if your thrift or bank or holding company is closely held, then it is probable that there is a significant shareholder or shareholder family who owns easily 30 to 70 percent of the outstanding stock. In such a situation, unless carefully planned for, the need for liquidity of the shareholder group will put the bank or thrift into play and it will disappear from the independent financial institution arena.

If you are aware of such a potential problem, do not attempt to bury your head in the sand and ignore the situation. The directors must plan for such shareholder transition, which may be a significant burden on the financial performance and condition of the bank or thrift.

Planning for survival

The first decision that must be made is whether the financial institution wishes to remain independent. It is entirely possible that remaining independent may not be worth the extra effort to try to buy out the majority shareholder and continue operation. The initial decision is monetary:

Is the financial institution profitable enough to be able to buy itself from the majority shareholder group?

* Can the money be borrowed from an outside institutional investor, bankers' bank or correspondent bank?

* Are the remaining shareholders willing to sacrifice dividends for the next three to five years until the borrowings are reduced to a reasonable level?

* Are there current shareholders who are interested in investing more common stock capital into the institution in order to buy out the majority shareholder?

* Alternatively, are there new shareholders/investors within the marketplace who would purchase significant stock in the bank or thrift in order to buy out the majority shareholders?

If the answers are no, then the bank will be put into play and you won't have to worry about financing for long.

If the answers are yes, then you are just rounding first base, not heading for home. The next real question is whether an agreement can be reached with the remaining directors and the majority shareholder group on a satisfactory price to be paid. This is to imply that the price you are willing to pay as remaining directors or new investors may not be the "highest" price the bank or thrift could receive if it is sold.

Thus, if a shareholder with 60 percent or more of the stock wanted to sell, that shareholder could probably control the sale and receive a much higher price by selling to another financial institution than by selling his or her holdings through a management buy-out or director capital infusion.

Such a deal may be a fair value, but not the highest price that could be achieved. It is impossible to generalize as to how the shareholder might react, but don't be surprised if there is a lack of cooperation and the financial institution ends up being sold.

On the other hand, many times over the past 30 years I have encountered majority shareholders who were willing to settle for a fair value for their stock and not necessarily the highest price simply because they were going to remain in the community and wanted the bank or thrift to continue as a viable, independent institution within the market.

This situation would be great for your financial institution, but it may also be irrational. The decision all depends upon the difference between "fair value" and the "highest price" that can be received by the majority shareholder. If the difference is only a few dollars a share, then the financial institution may remain independent.

However, once the difference moves into hundreds of thousands of dollars if not millions, the bank's or thrift's days of independence are numbered. It is much more desirable when no one wants the bank except the remaining directors and officers. If others are already circling for the carcass, the bank is dead meat.

Controlling the shareholder base

The next step is to determine which shareholders may want to sell. Again, if there is a majority shareholder, the answer should be evident. On the other hand, if there is a group of shareholders equaling 10 to 15 percent, then it becomes important to preplan and discuss who might want to sell and when, or how estates are set up when significant shareholders die.

The best solution is for the financial institution to establish a buy/sell or right of first refusal agreement with the shareholders so that outstanding shares come back to the bank or thrift. Always be in regular contact with major shareholders and be especially conscious when their health begins to deteriorate.

Arranging financing

If the approximate amount of money needed for purchasing outstanding shares can be determined, financing arrangements should be discussed and prearranged to assure that transactions can be made to the benefit of all parties in a timely fashion.

If $3 million to $5 million needs to be borrowed from a correspondent bank, bankers bank or institutional investor, a stand-by line of credit should be established. If stock is the option, the board should know the exact location of potential investors who could cough up hundreds of thousands of dollars within a month's notice.

It is important to be ready to finance the takeout of a major shareholder within a reasonable period of time and to know where the funds are, what it will cost and what impact it will have on the financial institution. Moreover, regulatory approval for such transactions may be required, depending upon the amount that must be financed.

Such information must be available to submit to the regulatory agency quickly. The better the pre-planning, the better the results and the more likely the possibility that the institution will remain independent.

If survival is the desire of the board, planning is essential. If board members sit back and simply wait for a major shareholder to pass out, pass on or sell out, they have made a significant mistake. Survival depends on being ahead of the curve, not behind it. If the board is aging and the bank has significant shareholders, don't buy green bananas.

On the other hand, if there are a handful of younger board members (in their 40s and 50s), it is entirely possible to transist the shareholder base to a younger, long-term interested directorship and investor syndicate, which would allow for future survival. It's up to the board of directors whether planning includes the future of the financial institution or whether the board is simply treading water waiting for the dam to break.