Takin' It to the 'Street'

Article excerpt

Understanding investors can keep community banks ahead of the game

Whether your bank is publicly traded or privately held, creating value for shareholders is what allows a community bank to grow and prosper, drive market share and remain independent. Although banks look at and define shareholder value in many different ways, it is important to understand how "Wall Street" looks at value creation.

So, who or what makes up the "Street"? Anyone in the investing public who can influence the value of an organization, and that historically includes institutional investors, money managers, hedge funds, research analysts and private equity funds. Taking the definition one step further, it could also include banks that are the acquirers in today's market. These are the people who have tremendous influence on current valuations for the community banking sector.

Why do these people have this much influence? Any bank seeking a liquidity event will need to interact with the Street. This could mean an IPO, a Trust Preferred, private equity or some form of merger or acquisition. Only the case where a bank has the ability to internally fund its capital needs for continued growth, and the board and shareholders have no desire or need for liquidity of any kind, can an organization avoid the Street. Understanding what motivates these investors and what drives their investment decisions can open a bank to a large pool of capital investment dollars.

Banks define shareholder value in many different ways. Some define it as hitting specific return on equity hurdles. Many look to growth in earnings. Still others define value with the makeup of the franchise they are building. Unfortunately for bank management teams, there is no magic formula to creating more shareholder value, though there are typically some common themes successful banks focus on to drive value for their investors. Companies that narrow their focus and try to excel at a few of the following generally trade at above peer premiums in the public market:

* Quality asset generation. Since the late 1990s many de novo banks have grown very rapidly, many topping more than $1 billion in assets in seven years or less. It is hard to imagine a bank being able to drive that type of growth 10 to 20 years ago. Given the way de novos are put together today it is easier to understand. How many times have we seen a community bank acquired and within two years a large part of the management team is back together with a new bank? Even for more mature banks, finding talented lenders and driving quality asset growth is an opportunity to add value and a driver that the Street is interested in. In the public market, banks that have shown strong asset growth, while still keeping an eye on asset quality, have enjoyed above peer multiples.

* Profitability at or above peers. The larger a bank, the higher the typical profitability ratios (see Chart 1, below). One of the most obvious reasons for the distinction is that larger organizations can spread costs over a larger base of revenue. Also, smaller community banks historically lacked access to the same capital tools of larger banks. Until very recently it was almost impossible for a bank under $100 million in total assets to issue trust preferred securities. Keep in mind that the 1 percent ROA and 15 percent ROE benchmarks are still what the investing public look for in an investment. Achieving those levels or showing progress towards that goal will result in more interest and more value.

* Management. Management is the single most important factor a research analyst looks at when considering a recommendation on a company, and is always an important factor in an institutional investor's decision to buy. The importance of inside ownership cannot be stressed enough. Whether at the board level or through the management team, investors want to know that the people who are running the company are motivated as shareholders and not only as insiders. …