It seems that everyone today is searching for an instant fix. We all have the best intentions, but down deep, we hold out the hope that someone will come up with a quick solution for our most complex problems. Well, it just doesn't seem to work that way. It takes commitment, time, and most of all, a great deal of old-fashioned hard work to successfully raise additional bank capital in today's market.
Here is the tale of two banks, both of which built their franchises during the speculative '80s. Both banks re-evaluated their positions within their respective communities. Both needed to shore up their capital base. They both suffered the same capital erosion that took its toll on many community banks in Southern California during the early to mid-'90s. One bank tried what appeared to be the "easy" way, and the other took the more demanding but effective path.
The real story lies not only in the need for capital itself, but in the manner in which each bank approached the subject and, of course, the ultimate outcome. We have presented a review of the banks in question from two different perspectives. The first is how Bankmark views the individual banks' strategies from an editorial perspective. This is followed by an analysis of both banks in a case-study fashion by James R. Miller, a respected securities analyst/appraiser for the community bank industry. Mr. Miller has intimate knowledge of both banks' capital positions and their capital-raising methodologies. Mr. Miller's analysis is highlighted in Case Studies 1 and 2 below.
The Overview: In examining the history of Monarch's attempt to raise additional capital, we notice two key issues that contributed to their lack of success: Issue #1) Their hope that the stock could be sold quickly by dealers out of the area on a "best effort" basis to buyers who had little connection with, or understanding of, the Southern California market (other than what they might learn from the abundance of negative press). Issue #2) The way in which the investment instrument was structured. We believe the pricing strategy was flawed.
Issue #1: Monarch elected to pursue the broker-dealer network strategy. The central elements in this pitch are: a) the "Advisor," who is supposedly connected with a dealer network consisting of "hundreds" (by his count) of securities salespeople, who in turn: b) supposedly have access to a "large inventory" of names of sophisticated, eager, buyers (generally in the Midwest and East) of bank stock. The most appealing aspect of this theme is simply that the Board and Senior Management will not be directly involved in the process. They merely sit back, let the "Advisor" and the dealers go to work, pay a commission of 15%-18% and watch the stock subscriptions roll through the front door. One might reasonably ask the question: How much California community bank stock is likely to be sold in the East, over the telephone, by telemarketers to individuals who are strangers to them?
However, there is also a more subtle rationale for having someone else other than the bank staff handle the stock sale. The '90s were not kind to community banks in Southern California, and the thought of facing members of the local community may not be comfortable for the Board and Management of any bank. Given this less often discussed, but powerful issue, it is understandable that a "remote controlled" stock sale may have some appeal. Yet as Bankmark points out, facing the community is an advantage if managed properly.
Issue #2: Today, more than ever, a new issue must be priced attractively. That is to say if a bank's capital instrument is placed outside the bank's trade area to semi-sophisticated investors, there must be some compelling incentive for the buyer. In Monarch's case, their "Advisor" suggested pricing the offering at a level that was not perceived as an attractive value by knowledgeable investors. We can understand the initial reluctance on the part of the present Shareholders (the Board and Senior Management control approximately 8% of the outstanding shares) to happily accept the dilution of their positions by discounting the new issue short of book. However, a Board must always realistically weigh the, alternatives. Should a bank be in a capital-impaired position and thereby fail to meet regulatory requirements? The alternative is not a pleasant one. If the best way to attract new subscribers is to accept a dilution in present stock value (the new issue offered at less than present book value) then so be it. So perhaps at best the Monarch Board had misplaced concerns. It soon becomes a question of: Is 70% or 75% of something worth more than 100% of nothing? With a recent operating history such as Monarch's, is it any wonder that investors were not pushing and shoving to get in line to trade their checks for overvalued certificates?
The Outcome: The Monarch results are now in. The outcome, which is now known to all, was predicted by some. Monarch's "Advisor/dealer" network raised less than $200,000. During a recent regulatory exam, Monarch had to make a further charge directly to capital of some $300,000. This figure represented costs associated with this very expensive "best effort" program.
At year's end 1993, Monarch's core capital ratio was 6%. As of this writing, their core capital stands at less than 4% and they may face the possibility of yet a deeper crisis.
Lesson #1: Always carefully verify the success claims of any "Advisor" group that presents a simple solution to a complex problem. Such an illusionary, slam-dunk plan should raise questions and elicit direct checks with the "Advisor's" latest client(s) to validate that they can make good on their "you sit back, we do the rest" capital plan.
Lesson #2: Know when to say when! When it became evident that the sale was sluggish and time was slipping away, the bank should have quickly stepped in and begun to ask some hard questions of their "Advisor." Based on the answers received, options could have been considered and exercised. Know when to step in, have a Plan B and know when to pull the plug. The old adage "if it promises to work miracles, it's probably a miracle if it works" holds true in this instance.
The Overview: First and foremost, Marine National Bank had decided upon a pro-active strategy. They expected to: a) increase capital before they incurred any regulatory order to do so: b) position themselves to accept the business generated by the recovering Southern California Market and: c) acquire other community banks unable to weather the economic downturn. To accomplish this, they considered three possible options: Option #1) a private placement Option #2) the "Advisor" broker-dealer network and Option #3) Bankmark's directed capital acquisition program.
Option #1: A private placement was a quick solution. The Bank identified a few financially strong business associates who would be willing to invest $1.5 million in new stock. While this option could be quickly implemented, it only addressed short-term issues. The Bank really needed $3 million, and this plan would have concentrated the stock in the hands of a few, thus not broadening the Shareholder base.
Option #2: The broker-dealer arrangement was considered (presented coincidentally by the same "Advisor" engaged by Monarch Bank). While the "Advisor's" promise of "we do it all for you" had appeal, this approach was rejected because of the 15% commission structure. In addition to this, Marine National Bank failed to see the value in their stock being purchased by investors out of the area who would, or could, do little to expand the business base of Marine National Bank once the offering closed.
Option #3: Bankmark's program had the most appeal. Marine National Bank liked the idea that stock would be placed within the community, thereby opening doors for other business from new investors. In addition, they wanted to expand the existing narrow Shareholder base (control was in the hands of approximately 15 Shareholders) and create more liquidity for the stock. Finally, and no less important, was the fact that Bankmark's fee was more cost effective.
The Outcome: This capital campaign represented one of the few times in Marine National Bank history that it launched and actually completed a marketing program. Bankmark's strategy creates a situation where bank officers must meet and work one-on-one with potential investors. Marketing skills are developed and applied. All the while the program measures the officers' results (no effort, no sale, no increase in capital).
When the results were in, Marine National Bank had hosted 71 investment meetings and met face to face with 1,271 potential new investors/customers. Many attendees were existing customers with which the Bank had little or no contact for some time. During the campaign, and in the wake of three bank failures right in Marine National Bank's backyard, the Bank picked up 150 new shareholders, increased its capital by $1.5 million and, equally important, increased deposits by some $10 million.
Marine National Bank learned some valuable lessons by participating in Bankmark's program.
Lesson #1: Foremost, they learned that there is no substitute for direct, full and active participation by the Officers and Directors. This was critical if they expected to maximize the opportunity to add capital and increase the Bank's business base.
Lesson #2: It was evident that no "remote" sales force could have told the Bank's story and develop new and enhanced existing relationships better than the bankers themselves. The bankers are always more motivated to see the plan succeed than some distant commission sales force.
Lesson #3: Marine National Bank learned what all Bankmark clients learn: the importance of strong leadership. Even the best of staff intentions will not translate to success without leadership. Bankmark's experience indicates that there is a direct correlation between the degree of success of a stock sale and the level of leadership provided by Senior Management.
Lesson #4: This is probably the most important one. To be successful, a project such as this demands hard work from the participants and the plan must be followed religiously!!! This is not to say that the staff and Officers at Marine National Bank did not put out a great deal of effort, because they certainly did. The only downside that we can see is the fact that Marine National Bank could have placed more stock in the community than they did. In retrospect, the Officers of the Bank agree that had they embraced certain elements of the Bankmark program earlier and met all of its check points, they could have been even more effective. Particularly important was the critical timely follow-up of guests after an event [see Mr. Miller's comments in Case Studies 1 and 2 in Exhibit A].
One reason the Bankmark method is so effective is that the profile of a local community bank investor is that of someone who wants to have both direct interaction and a sense of belonging with "their" Bank. So emotion is also a critical element in the buying decision. Many local purchasers view ownership in a community bank not only as a good investment but also as a statement of commitment that enhances their own professional or business standing.
When all is said and done, the real secret to a community bank's success lies within the community itself. Yes, capital can be raised outside the community under certain conditions, but absentee investment is more demanding and does not drive and support a community bank like local involvement can. After all, isn't that the story you first told when you organized the bank??? Why would the basic premise not hold during a re-capitalization campaign?
In today's market, the key element is not just raw effort, but a matter of directed, focused effort. Bankmark never down-plays the size or scope of the effort needed to be successful. Indeed, the Bankmark Staff are firm task masters. After everything else is considered, remember: "you get out only what you put in" to any activity. Also there is no substitute for strong leadership. It takes dedicated effort and a commitment to hands on involvement in re-capitalizing and managing a community bank's capital campaign in today's challenging environment.
Case Study 1: Monarch Bancorp
Monarch Bancorp retained the services of Spectrum Securities in March of 1994 to raise $3 - $8 million on a "best efforts" basis. Additionally, Mr. James Avery was contracted as a consultant on the project. The purpose of the offering was to comply with a regulatory order to boost capital ratios.
I performed two appraisals of Monarch Bancorp, one in conjunction with the purchase of shares by the company KSOP Plan and the other for the purposes of the proposed offering. I concluded that a fair evaluation of the Bancorp at that time in relation to a public offering was 80% of stated book value. The fund raising effort turned out to be a total and dismal failure. The Bancorp expended more than $300,000 (requiring immediate write off to capital by the regulators) and now face the real possibility of having to find a "white knight or knights" to make a capital infusion. This new investor group will undoubtedly come in at a price that is a severe discount to tangible book value. Additionally, the future of present management is most assuredly in doubt.
The problems in this case are: 1) The deal was priced wrong. 2) The wrong people were chosen to execute the plan. 3) The basic chemistry of a broker-dealer "best efforts" offering and a community bank's shares sale to the public is not a good mix.
A Fair Market Valuation is designed to establish a price at which knowledgeable investors may establish a transaction. The underwriters of the Monarch offering used that valuation as a starting point for the sale of securities. The fatal problem created by that move was that after offering potentially $2 million shares at a discount to book value, the "at rest" position of investors was a poor value. For instance, investors are paying 80% of current book value for their shares but after dilution of the offering to the moving book value is calculated, those same investors may have an "at rest" holding at 100% of book or greater. Given today's market environment, those levels present an overvalued situation. Simply stated, the offering was overpriced by the underwriters and knowledgeable investors were rightfully not moved to invest as the risk/reward balance was not favorable.
Spectrum Securities represented to Monarch Management that it would sell stock through its own efforts and those of syndicate partners. This simply did not prove to be the case. Spectrum's individual efforts were woefully short of results. Additionally, virtually no syndicate was effectively formed. These specific failings lead into the next area of failing, which is more generic in nature.
Case Study 2: Marine National Bank
Marine National Bank engaged Bankmark to assist them in their capital formation plan, which called for raising $2 - $3 million in new capital. The Bank had lost over $1 million in fiscal 1993 but was under no regular orders to meet any ratio levels. The new capital was to be used to enable the Bank to take advantage of growth opportunities that were present in their market area. In particular, three banks had failed in their backyard during the most recent six months: Pioneer Bank, Commerce Bank, and Bank of Newport. Management felt, and rightfully so, the Bank must boost capital to finance deposit growth and meet incoming loan demand.
Coincidentally, Marine, as well as Monarch, contracted with me to do a Fairness Opinion Valuation as part of the preparation for a public offering. My conclusion in the case of Marine was that a valuation of 75% of given book value was a price at which knowledgeable investors may opt to establish a transaction. Marine chose to use that value as an offering price of the common shares but as a value kicker to investors, establishing a unit offering consisting of one common share at $5.40 per share with a two year warrant to purchase an additional share at $5.40. The inclusion of the warrant made the deal attractive to the investment community. Without the warrant, the deal would have suffered from the same weakness the Monarch structure encountered - an "at rest" holding value to book that provided the investor with a poor value. However if not handled properly in the market place, the warrant may be problematic in the future. A strong market-maker structure must be consistently applied to avoid a down draft in share price at the maturation of the warrants.
Unlike Monarch, Marine chose to engage Bankmark to facilitate and manage their capital acquisition program. I was on hand to observe the Bankmark Program and to compare it to others with which I am familiar. Simply stated, the Bankmark approach organizes, guides, and manages the Bank's Officers, Board, and employees in the capital raising process. It is a structured program that must be adhered to precisely to be successful. In Marine's case, the investment opportunity meetings managed by Bankmark were well organized, well run, and well attended.
The problem that manifested during the process was the lack of timely follow-up on the part of Bank staff to those attending the meetings. As in the case with the cultural dilemma of broker-dealers raising capital for community banks, there is a similar situation with bank personnel and the fund-raising process. Bank employees by nature are not sales oriented. From a simple distaste for selling to outright cold fear of the phone, the process slows due to the front-line troops. Helping bank personnel to become more comfortable in this situation is a part of the Bankmark Program. However, the client must be willing to take direction and accept responsibility for the outcome. Bankmark recognized that the Bank's staff were not following up the attendees in a timely manner. Knowing this is critical to the success of the campaign, Bankmark insisted that steps be taken to correct this deficiency.
Finally, in an effort to assist Marine National Bank, I was asked to step in and make follow-up calls on their behalf. I made over 400 calls during a three-day period. Unfortunately, the results were not what we hoped for. I believe this was due to two basic reasons: 1) The time between the date the prospect attended the meeting and the date of the follow-up call (in some cases over 90 days) was far too long and in effect became a cold trail and: 2) Many of those who did receive a timely call were interested but needed more direct attention before they would commit to a purchase. However, as the offering period was about to expire, there wasn't enough time remaining to make the second or third contact necessary for the close. All during the engagement, Bankmark warned that if timely follow-up did not occur, opportunities would be lost. Bankmark estimates, and the Bank staff agrees, that perhaps as much as $1 million was left on the table due to the lack of timely follow up.
Marine National Bank did raise approximately $1.5 million in their effort. While this was short of expectations, I believe the reasons for the shortfall can be identified as client deviation from the basic Bankmark Plan. I further believe that if followed to the letter, the Bankmark Program works effectively for community banks.
The culture of having a broker-dealer raise capital for a community bank is in question. This is true for deals of $5 million and less. Larger deals are accomplished more efficiently due to the size of the participating brokerage firms and the credibility of the institution raising the capital. The basic problem that is present with smaller brokerage firms working to raise capital for community banks is the front-line broker and his priorities. A proper presentation of an investment in a community bank should include a risks' discussion and the fact that investors need to exhibit patience and realize they are holding share in a relatively illiquid security. Although in two to three years there is a good chance of reaping profits. That presentation is not what a front-line broker wants to work with. Right or wrong, it is more appealing to both the broker and potential investor to deal with a high risk, potentially high-return short-term item, i.e. a biotech stock that may double if they get FDA approval for a drug, but if they don't, the company could be bankrupt in a year. That is the culture of the smaller equity oriented brokerage firm and the individual brokers. Those are the firms that would take on a small $3 - $5 million offering for a community bank. Larger brokerages that have the put-away power to raise $5 million and up are not interested in a small community bank deal. It is, in fact, a catch 22.
As with all problem situations, there are solutions. One may be the implementation of a hybrid Capitalization Plan that utilizes the organized resources of the Bank and the professional expertise of a quality brokerage firm. This combination would alleviate the cultural barriers of bank and brokerage while taking advantage of inherent strengths.
The case studies and summary of Exhibit A were written by James R. Miller, ebankstocks.com. He can be reached at (760) 918-9740.
Postscript #1: First Coastal Bank N.A. of El Segundo, California, also engaged a member of the same "Advisor" group which "helped" Monarch Bancorp. The Bank's Board elected to manage this stock offering itself. Despite the collective efforts of the Board and its "Advisor," the required minimum was not reached by the expiration date of the offering. Then the Board positioned a private placement memorandum. They hoped that they could successfully place the entire issue with a few selected investors. Unfortunately, they couldn't complete Plan B either. Finally, a single investor stepped in and now controls 80% of the bank. The equity of the Directors and the other Shareholders is now reduced to 20%. Hardly a Community owned Bank any longer.
Postscript #2: Recently, several California Banks have turned to a new group of "Advisors." The group represents a sales force that specializes in the Midwest penny stock market. It's interesting to note here that the group readily admits that it has never handled a community bank stock offering. So why are some banks still willing to allow an inexperienced group to manage their offering? Well, we guess it's the same old story. The Bank's management likes the "don't worry, we do all the work" sales pitch. Problem is, we have yet to see one of these remote controlled capital campaigns close out successfully. As long as people are looking for an easy way out of a tough situation, they will continue to attempt a "leap of faith" now and then...but boy, those landings can be rough.
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