Securitization for Community Banks

Access to capital markets provided for $200 million-$10 billion banks.

By Rob McDonough

Community banks face many struggles in today’s competitive and highly regulated financial services industry, but many do not realize the hardships that smaller financial institutions in particular face when accessing the capital markets. For example, most mom-and-pop banks that issue bonds are unable to justify the expenses charged by agencies like Moody’s, S&P and Fitch to provide a credit rating for their debt. This can scare off many investors, particularly those that are unfamiliar with the community banking space and its risks and rewards. However, recent developments in the capital markets have provided a new and improved approach to effectively direct investor capital to these institutions.

Buckhead One Financial Opportunities, LLC, an affiliate of Angel Oak Capital Advisors, LLC, recently announced the issue of BFNS 2017-1, a $155.2 million securitization backed by the subordinated debt (sub-debt) of 25 small banks with total assets of between $200 million and $10 billion. The senior tranche of the structure was given an “Aa2 (sf)” rating from Moody’s. Securitizations of this type are win-win opportunities for investors and community banks alike. Investors benefit because they can feel confident in acquiring an instrument that has been rated by a major ratings institution. This significantly increases the likelihood of success for community banks trying to issue debt in the capital markets.

All banks have substantial regulatory compliance requirements, which include maintaining minimum capital reserves. However, for small financial institutions, any adverse event such as greater-than-expected loan losses or a sudden outflow of deposits can make meeting these capital requirements a daunting task. Sub-debt counts toward a bank’s tier 2 (or supplementary) capital requirements and can be a valuable source of funding for ongoing operations. However, community banks frequently struggle to issue this type of debt due to the expense of obtaining a credit rating and lack of interest from many investors in smaller issues. Fortunately, securitizations such as the BFNS 2017-1 transaction can pool together the sub-debt of a large number of issuing banks, creating the scale necessary to attract more investor capital and also justify the expense of obtaining a rating.

For example, a $2.5 million slice of a $25 million sub-debt issuance from a mutually owned bank holding company was used as collateral in the BFNS 2017-1 securitization. The company had been experiencing substantial growth in its commercial and industrial and small-business lending divisions. This asset growth resulted in a decline in their capital ratios because deposits were not growing as quickly as assets. As mutual BHCs cannot issue stock, the institution had to look to the debt markets in order to boost its total capital. The existence of a securitization structure such as BFNS 2017-1 increased the company’s access to debt capital by establishing an investor-friendly vehicle with a large enough issue size to attract more capital and obtain a rating.

Bank stock valuations have generally soared in the post-election period, making this an ideal time to raise funds in the equity capital markets. However, community banks with small market caps and closely held ownership structures might not want to issue more common stock due to dilution concerns. And, of course, mutuals and other member-owned institutions such as credit unions can’t issue stock, leaving debt markets as the only option available to fund a serious expansion effort or to support merger-and-acquisition activities. Once again, the existence of a securitization vehicle like BFNS 2017-1 creates a cost-effective way to tap the debt capital markets that otherwise might not be open to these institutions.

The banking industry has been consolidating substantially in the post-crisis period. This wave of M&A activity has been a function of the generally improving economic environment for lenders as well as an overall increase in bank capital ratios, an indication of stronger financial health. BFNS 2017-1 holds the bonds of a number of institutions that entered into significant acquisition transactions funded at least in part by the proceeds of recent sub-debt issuance. The additional investor capital that is attracted to a rated securitization of bank subordinated debt will continue to facilitate this consolidation wave.

The 2017 corporate tax cuts, coupled with the deregulatory components of the recently passed Economic Growth, Regulatory Relief and Consumer Protection Act, will continue to provide a tailwind to acquisition strategies. Issuers of sub-debt, whether seeking acquisition targets or otherwise, clearly benefit from gaining access to capital through as many channels as possible. The number of bank sub-debt securitizations such as BFNS 2017-1 are expected to increase in the coming quarters, providing access to debt capital for community banks that might otherwise be left sitting on the sidelines.


Rob McDonough is senior research manager at Angel Oak Capital Advisors, LLC, an investment management firm providing fixed-income investment solutions for its clients. For more information, visit

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