Bank Shareholder Succession Matters

I'm growing more concerned about the time and effort by community financial institutions to understand the needs of next generation shareholders and build a strategy around shareholder succession.

I recently met with a former partner at Wellington Management. You may be aware that Wellington is a significant institutional investor in community bank stocks. I wanted to know from him what he thought community banks should do about shareholder succession. Prior to this post I sent the below summary to our thinly traded clients, and I suspect it might be useful to you. Hope it helps.

 

Here is a summary of our conversation, with my comments/ ideas in red.

1. Hold regular meetings with local wealth managers to generate interest for them to invest their client’s money in your local bank stock. Emphasize that the dividend yield is superior to bonds in many respects (if true) and your bank is more transparent than large banks because the wealth managers can see what you are doing in your communities. (Cocktail hours: Make them feel special. Although any information you give them you would likely have to publicly post.)

 

2. Offer prizes to shareholders. Use a barcode with your annual report. When they scan you capture their name and how many shares they own and their e-mail. And send them some prize. Keep in mind you might have to do this annually, so perhaps set a minimum of share ownership after year 1 for them to get the prize. This way you have a list of your actual shareholders, including street name, to send periodic information to. (This is to keep an accurate and up-to-date list of your shareholders with contact information so you can maintain consistent communication. Probably should check with SEC counsel first.)

 

3. Non-Financial: Tell the stories of how you are meaningful to the community and that it does matter that you are part of the community(s). (Give them that feel-good feeling of owning a local stock.)

 

4. Actually calculate the jobs supported through local lending. Many of us did this for PPP, but did we leverage it well and can we do more of it with our traditional lending. (Can this be executed by having the number of employees of a prospective borrower in the write-up that can be tabulated to tell the story? This might be the same for large bank lending, but my guess is that they are not counting the number of jobs supported in your markets by lending to businesses in them.)

 

5. Much like we expect our lenders and branch managers to consistently build relationships with customers, consistently build relationships with bank trading shops (including friendly institutional investors) so when shareholder xx passes and the estate has 10k shares, you have multiple people to call. This is beyond going to the institutional investor road shows. This is having people with interest in your stock that you can call when large blocks become available. You know each other by name.

 

6. Create your own institutional investor: Consider an ESOP. A built-in friendly institutional investor that can purchase blocks of shares that come available and provide a valuable employee benefit that aligns employees with shareholders.

 

7. Dividends- Emphasize to your shareholders how much in income per year the investment generates (if true) so they think of that investment as an income generator rather than a thinly traded bank stock that they might rather deploy in cryptocurrency. Emphasize how long you’ve paid the dividend and growth rate.

 

8. Why is marketing un-involved or only tangentially involved with what appears to be a marketing function? Marketing follows regulation in advertising so the skill set of complying with SEC rules should be an easy transition.

9. Make shareholder meeting an event. Perhaps a "state of the community" presentation (who else does this?) that accompanies a "state of the bank." An exclusive event that perhaps non-shareholder would feel they wanted to attend.

What ideas do you have?

~ Jeff

A Solution for Closely Held Banks

If you are a family bank and want to sell your shares without selling the bank, what do you do? So was the question that my colleague, Sharon Lorman, put to me in my firm's very first podcast edition of This Month In Banking (follow link to listen!).

The question is not for family banks alone. But all banks that are privately held or have one or a few very large shareholders. How do those shareholders exit if they need liquidity for whatever reason?

This month, Old Fort Banking Company in Tiffin, Ohio gave us an answer... form an Employee Stock Ownership Plan (ESOP). Old Fort, founded in 1916, was run for generations by the Gillmor family. Dianne Gillmor Krumsee is the current Chairman. Looking to divest a portion of her stake, the bank's CEO, Mike Spragg, proposed establishing an ESOP to buy $15 million of her shares and therefore preserve its independence and the Gillmor family legacy.

An ESOP is a trust that is a qualified retirement plan designed to provide employees with an ownership interest in their company by investing primarily in stock of the employer. The ESOP is funded with tax-deductible contributions by the employer in the form of company stock, or in the case of the Old Fort ESOP, with cash that was used to purchase company stock. In this case from its Chairman. The bank's press release did not specify if the ESOP was leveraged, meaning it borrowed to fund the purchase. My guess is that it was leveraged with a loan from a financial institution or Ms. Krumsee herself. Either way, Old Fort would have likely secured the loan.

The bank can then make tax-deductible contributions to the ESOP to service the loan. As the loan is repaid, shares held by the ESOP are released and allocated to employee accounts.

Their may be tax benefits to the selling shareholder. According to Internal Revenue Code Section 1042, an owner of a closely held C corporation can defer, and potentially eliminate, all state and federal capital gains taxes on their sale of stock to an ESOP. This is done by reinvesting the sale proceeds in a Qualified Replacement Property (QRP) within 12 months of the sale. Don't take my word for it. Check with your tax adviser. That's another test I didn't take.

Chase has an excellent ESOP primer that I checked out for this post. Check it out for more information.

The benefits of an ESOP go beyond tax benefits for the seller and independence for the bank, in my opinion. Studies show that employees with ownership stakes in their companies tend to run the companies better... i.e. they perform better. A recent FDIC analysis concluded this. 

Indeed, I checked all the Sub S banks in the US, which are mostly closely held banks with significant employee and family ownership, for their financial performance. The table represents my findings.

For its part, Old Fort had a 2015 ROA of 0.96% and ROE of 10.90%. Not too bad for a $475 million in asset bank. By comparison, FirstMerit, also of Ohio, had a 0.91% ROA and a 7.90% ROE for the same period. Oh, and FirstMerit is $25 billion in assets. And just threw in the towel by selling to Huntington Bancshares (ROA: 1.01%, ROE: 10.60%, Total Assets $71B).

The twist for Old Fort, is the $15 million share purchase represented a 45% stake in the bank, which required the ESOP to apply to be a bank holding company. Which it did. And apparently succeeded, because the transaction closed last month.

Well done to Ms. Krumsee, Mr. Spragg, and all the employee-owners at Old Fort Banking Company for executing on an idea to perpetuate the family involvement, provide liquidity, and keep their well-run bank independent.

~ Jeff