Novel Idea: Buying Back Leased Branches

Old National Bancorp's decision to buy back branches it had been leasing may seem counterintuitive at first blush, but a closer look shows that the move could make sense for other banks that are flush with cash and struggling to put it to work.

The Evansville, Ind., company recently agreed to pay two real estate firms $66 million for 14 properties.  Like many other banks, the $11.9 billion-asset Old National sold branches during the financial crisis to boost capital. Long-term leases ensured that the company would continue to occupy the locations.

But times have changed.

Interest rates remain low, making real estate investment more appealing, Christopher Wolking, Old National's chief financial officer, said. "We don't have as much opportunity to deploy cash … and we have a lot of cash," he added.

Buying back the branches now also allows Old National to get ahead of a proposed change to lease accounting rules.

The Financial Accounting Standards Board is expected to approve a new accounting standard in that would require companies to record the value of operating leases on their balance sheet.  Most property leases are currently considered off-balance-sheet activities, industry experts said.

The change would undermine a key selling point of sale-leasebacks – taking liabilities off the balance sheet, said Gerry Levin, senior managing director at Mesirow Financial, which specializes in real estate investing.

The FASB is expected to debate the change, which was first proposed in 2005 and has been deliberated for the past decade, at its Nov. 11 board meeting, said Lawrence Smith, a FASB director. "If I were a guessing man" the change will be adopted, he said, adding that it would likely go into effect for the 2018 calendar year.

For a number of reasons, sale-leasebacks may be falling out of favor, said Chris McGratty, an analyst at Keefe, Bruyette & Woods. "Whereas many banks executed sale-leasebacks during the financial crisis," Old National's plan "appears to be an opposite strategy, given the industry's strong capital position today," McGratty wrote in a note to clients.

In recent years, a number of banks trimmed their branch networks, particularly as consumer traffic migrated to digital channels. Smaller banks have also used capital from branch sales to invest in new technology. Sale-leasebacks were also a popular option for banks that wanted to maintain their locations but also realize sales gains.

Some banks are continuing to pursue sale-leasebacks, particularly in markets where real estate valuations are quickly rising.

Flushing Financial in New York, for instance, recently completed a sale-leaseback, cashing in on the fast-rising value of branches in trendy Brooklyn neighborhoods. Others have used the deals to lower costs and boost capital for making more loans.

Old National, for its part, didn't view the accounting changes as a key driver for its branch purchases, Wolking said. Still, the company wanted to get ahead of the reporting requirements by putting the 14 branches on its balance sheet. A spokesman added that the company, which now owns about 40% of its 164 branches, has no immediate plans to buy additional branches.

Old National will likely face additional questions about the transaction – which includes branches in attractive retail markets such as Indianapolis and Evansville – after it reports earnings on Oct. 26.

Wolking, however, made it clear that he thinks other banks should look into buying back their leased locations. "I cannot imagine that people who had done those aren't considering [buying them back] today," he said.