By Debra CopeInvestors betting on consolidation as the best path to improve bank performance have unleashed a wave of shareholder activism at banks. In 2015 alone, activists launched 22 campaigns aimed at U.S. banks both small and large, up from eight in 2009, according to Thomson Reuters activism data. And beyond these formal campaigns, hedge fund investing in banks continues to rise.
Usually, an activist shareholder is seeking to shake things up. They typically identify companies that are underperforming, purchase a large number of shares, and try to obtain board seats in order to effect major change. Activists argue they have an ability to add value, and the data seem to bear that out. On average, activist shareholders create 130 basis points of excess return above the relevant S&P industry index, Bain and Company partner Josh Hinkel told American Banker earlier this year.
However, many bankers and banking experts see activists as too willing to trade long-term value for short-term pricing. “In community banking, activism is too often synonymous with pressure to sell a bank,” says John Gorman, a partner with the Washington, D.C., office of Luse Gorman PC.
But not engaging with activists, regardless of their goals, is one of the biggest mistakes a bank can make, Gorman and others added, because they are first and foremost shareholders. “Most banks aren’t prepared, and react in a defensive or hostile way,” says Dory Wiley, president and CEO of Commerce Street Holdings, a Dallas-based investment banking firm. “This is the absolute worst thing you can do.”
“Shareholder activism in banks tends to be a milder form than in other sectors because of the regulatory aspect,” Wiley adds. But, he continues, “Most activists in banking have pretty legitimate issues. Banking isn’t rocket science, so it isn’t that hard to pinpoint where management is making mistakes and needs to improve. More often than not, it is more of an alignment issue.”
Often the goal of an activist campaign is to pressure the company to sell—but it’s far from the only possible objective or outcome. Shareholder campaigns can also focus on executive compensation, proxy access, the role of the board chairman and environmental and social issues, among other topics. Activists have a wide variety of tools at their disposal, including proxy fights, shareholder resolutions and direct negotiations with management.
For example, one of the most potent strategies now being used by activists is the proxy access proposal. Nearly 200 were submitted for all public companies during the 2016 proxy season, according to Skadden LLP. These proposals upend the traditional approach to board nominations by enabling shareholders to nominate their own director candidates on the company’s proxy statement alongside management’s choices. The most common approach allows investors who have held at least 3 percent of the company’s shares for at least three years to nominate up to one-quarter of the directors. As of mid-June, according to Skadden, 65 percent of all public companies that received a proxy access shareholder proposal had adopted or proposed a 3 percent bylaw or announced plans to do so.
Banking has never been the easiest industry for activist investors to enter. The banking regulatory framework places a premium on safety and soundness and strong capital requirements. To avoid triggering regulatory restrictions, investors often keep their stakes in banks and bank holding companies to no more than 4.9 percent, though a position up to 9.9 percent is also common. By and large, however, “shareholders are going to try to stay away from going over a 5 percent position unless they are willing to sign on for regulatory issues,” says Tuck Washburne, a partner in the Washington, D.C., office of Venable LLP.
There is no question that activist shareholders are making an impact in corporate America broadly. During 2015, activist investors gained 127 board seats at U.S. companies—and 117 of these were granted, with only 10 won in a vote, according to SharkRepellent.net, a corporate governance site.
Thirty-five percent of micro-cap companies—those with a market capitalization of less than $300 million—were approached by activists between the spring of 2014 and the spring of 2015, according to the National Association of Corporate Directors, citing its most recent data at press time. Among small cap companies—with market capitalization of $300 million to $2 billion—13 percent had been approached by activists.
Michael D. Schiffer, a partner in Venable’s Baltimore office, sees clear reasons why activism has increased for companies generally since the beginning of 2015. “Practically speaking, there is a lot more money in activist hedge funds than a few years ago, and the simple targets have all been used up.” Additionally, he points out, “We are now far enough away from recession that shareholders…are no longer satisfied banks are just surviving—they want to see performance.”
Community banks have been the focus of a small but active cadre of investors for years, though the financial crisis dampened interest for a time.
One of the best known hedge funds focused on banking is Stillwell Value LLC, which held $161 million in investments in 43 financial services companies as of June 30, 2016. Founder Joe Stillwell, a soft-spoken man whose name often provokes anxiety across the banking industry, is known for pushing banks to sell. He says overcapacity can be resolved reasonably if bank boards are willing to engage in constructive conversations with investors. But, he adds in an interview, “When the managers of a bank or any company confuse themselves with the owners or the institution itself, bad things happen and they get worse as time goes on.”
Another renowned bank hedge fund is Seidman & Co., which held $146 million in shares of 28 banks as of June 30, 2016. Manager Lawrence B. Seidman continues to make steady inroads into banks; on July 1, he was granted a board seat at MSB Financial, parent of $380 million-asset Millington Bank in Millington, N.J.
The price of winning
The cost to a financial institution that decides to challenge an activist investor can be substantial. In June, Financial Institutions Inc., the parent company of $3.5 billion-asset Five Star Bank of Warsaw, N.Y., won a proxy fight when its slate of board nominees was elected over those nominated by activist Clover Partners. However, the company accumulated $1.7 million in proxy-related expenses during the second quarter, according to regulatory filings.
Even after a company wins a proxy fight, it may find itself making compromises down the road. Virginia-based Middleburg Bank in May re-elected its director slate over the objections of Teton Capital, which owns about 30 percent of the $1.3 billion-asset bank’s stock and was pressing for a sale. In July, the bank announced that John V. Lee IV would succeed Joseph Boling as chairman, with “driving profitability, improving efficiency and managing risk” as his goals.
What makes a bank vulnerable to activist shareholders? “Activists will focus on companies they think they can overcome,” Gorman says. “Maybe your vote has drifted lower on say on pay—that could be an indication of some brooding discontent. Maybe you are viewed as underperforming—management needs to know where they stand relative to peers in terms of performance. And by regularly meeting with shareholders, you’re more likely to know about possible issues, rather than being surprised.”
In addition, Gorman explained, banks’ shareholder bases evolve over time, especially if they are pursuing a growth strategy. “The stockholder base is not necessarily a local community base,” Gorman says. “As you move up the market cap scale, more shares are being held by funds and institutions.” Participating in investment banking conferences, where executives can meet one-on-one with known stockholders, is valuable, he said. “Engagement and familiarity build trust. If you do get into an activist situation and you haven’t built up a relationship, you may face complaints that ‘You haven’t reached out to me.’”
Banks can reduce their vulnerability through some basic blocking and tackling measures—ongoing shareholder communications that are purposeful in telling the bank’s story, for example. There are also steps banks can take when they find themselves in an activist’s crosshairs:
- Don’t be hostile or defensive. “Every offer should not only be considered, but in a friendly, business-like way,” says Wiley. “Attitude is everything. Saying no through a formal process and a respectful smile is preferred.”
- Don’t ignore any shareholder. “You’ve got to interact to give them the right level of attention and show you understand what they are pushing for,” Schiffer says. “Interacting doesn’t mean capitulating. If they want a sale for a quick buck, you can say no.”
- Consider ways to accommodate shareholders. “Activists often have a long litany of things they want done. Sometimes they are pushing for something that is already part of the strategic plan and will be pacified if just one thing is done,” says Washburne.
- Focus on the message. “You may not like the delivery, but sometimes what they have to say is not that onerous,” explains Becky Pendleton Reid, president of the Cereghino Group, a Seattle-based investor relations firm. “Maybe it’s a matter of publishing a dividend policy or going over it with them.” She added, “It’s very easy to take what they say personally. When they come out with guns blazing it’s hard to open a dialogue.”
- Know your shareholders. “Monitor your stockholder base every single day and throughout the year,” says Schiffer. “You don’t want the first notice that you have an activist to occur when you receive a letter.” Reid recommends obtaining the bank’s NOBO list—short for non-objecting beneficial owners, meaning those that do not object to the issuer knowing their name, mailing address and share amount—from a broker or proxy intermediary.
- Benchmark your bank against competitors. “It all starts with performance,” Gorman adds. “You must understand how you stack up relative to your peers. What are your plans to maintain or improve your results?”
And what if an unwelcome letter arrives in the mailbox despite everything? “Take the letter seriously,” advises Schiffer. “Learn what you can about the investor and their typical approach to activism and investment. Then get your team together—[internal] investor relations, the board, and your external advisers, who will probably include your lawyers, your regular investment banker, and certainly a proxy solicitor.”
“You need a kitchen cabinet you can call together,” adds Reid. “The last thing you want is to be scrambling around saying, ‘Whom do I call?’”
Debra Cope is editor-in-chief of the ABA Banking Journal Directors Briefing.