RENNINGER: Community bankers fret a lot these days

The financial headwinds caused by the economic turmoil of the last several years are not the only significant issue keeping community bank CEOs and board chairmen and chairwomen awake at night. Many have been wrestling with how to handle the growing liquidity needs of their shareholders.

These leaders understand that their ability to remain independent hangs in the balance if shareholders demand a liquidity event, such as an outright sale of the bank.

While the nine-county Indianapolis area is dominated by large regional and national banks, the area also is headquarters to 10 banks, with median assets of about $250 million.

Most community banks are privately owned by fewer than several hundred individual shareholders. In most cases, a couple of families might individually own 5-percent to 15-percent blocks of the outstanding shares, but the preponderance of shares are owned in relatively small blocks by average citizens. For many of those shareholders, ownership has passed down through inheritance and financial planning.

Some shareholders no longer live in the communities served by the bank and their interest in holding the stock has waned. Still others might have a pressing need to redeploy their investment.

Meanwhile, the entire shareholder base is aging, with some shareholders needing to augment their fixed incomes with stock sales. Some shareholders (or their heirs) will eventually need to sell large blocks of stock to settle their estates.

To balance the needs of sellers, privately held community banks need to find new investors. That can be a tall order as shareholders tend to opt for diversification offered by mutual fund investments rather than individual stocks, and investors that buy individual stocks usually prefer the publicly traded variety because substantial financial information is available and the investment can be readily sold.

The population of hearty souls who eagerly invest in illiquid stocks is often insufficient to match the supply of potential sellers, so the shares either don’t trade or the price suffers. Private community bank stocks typically trade at significantly lower multiples of earnings and book value than publicly traded banks.

Of the 123 banks and thrifts headquartered in Indiana, 20 are publicly traded, another 20 are thinly traded over-the-counter or in the pink sheets, and 83 are basically traded over bank presidents’ desks. Privately held banks often cannot justify the cost of becoming a public company and adhering to Securities and Exchange Commission reporting requirements, and relatively few equity funds are interested in owning illiquid shares.

For years, community banks used ongoing stock buyback plans to provide some level of liquidity to shareholders in the absence of ready buyers. Many of these plans were suspended in recent years due to unusually large loan losses coupled with increased regulatory capital requirements.

Community bank directors and management teams acknowledge that shareholder complacency and inertia will last only so long. The number of shareholders that are willing to own stock as a point of civic pride and community support without regard for its investment merits is going the way of the buggy whip. The banks’ ability to remain independent ultimately lies in their ability to interest astute local investors through attractive earnings.

It is hard to overstate the challenge of improving earnings relative to investors’ alternatives in the current banking environment. Banks of all stripes are struggling with interest rate margin, several years of relatively large loan losses, regulatory and consumer pressure on non-interest income sources, and increased operating costs due in no small part to unprecedented increases in government regulation.

Community banks are further disadvantaged by the economies of scale enjoyed by the larger banks. Of the $32 billion in bank deposits in the nine counties in the Indianapolis area, Chase and PNC control about 46 percent and six other out-of-state banks control another 32 percent.

It is clear the challenge is daunting when the president of an Indiana bank with $1 billion in assets recently cited the need for greater profitability as a primary driver in deciding to affiliate with a $9 billion bank. This is particularly sobering when you stop to consider that the median asset size for banks in Indiana is under $200 million.

Despite the competitive and economic headwinds, community banks will continue to put up a good fight to remain independent. They are well-positioned to meet the unique needs of their communities, satisfy customers who value staff continuity, and provide better access to the ultimate decision makers.

The question remains as to the level of profitability that can be achieved and whether enough investors will come forward to meet the liquidity needs of current shareholders.

At a time when there is much discussion about banks being too large to fail, community banks have to combat the possibility that they are too small to succeed.•

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Renninger is a principal in Renninger & Associates LLC, a Carmel-based advisory firm focused on mergers and acquisitions. Views expressed here are the writer’s.