Newtek Business Services, a business development company and a prolific Small Business Administration lender, is trying to buy a bank. Its investors aren’t thrilled with the plan.
As a business development company, Newtek is required to pay out at least 90% of earnings as dividends. Investors fear that income stream will be diminished after the company converts to the bank holding company structure, so much so that a significant number have already sold off the stock. Between July 20 and Jan. 12, investors holding 6.3 million shares sold down to zero, according to Newtek.
But as a bank, Newtek would be able to develop deeper relationships with clients, access cheaper funding and, ultimately, produce more value for investors, according to Barry Sloane, the Boca Raton, Florida, company’s chairman, president and CEO. To this end, Newtek applied last week with the Office of the Comptroller of the Currency to acquire the $200 million-asset National Bank of New York City.
In a recent investor presentation, the company cited research showing fintech-enabled banks — the business model it is aiming for — are valued at 18 times pretax earnings per share, as opposed to 15.2 times for commercial finance companies.
“The board and management team believe in this transaction and believe it will be beneficial to shareholders,” Sloane said. “We believe it’s the future and that in order to do the things that we want to do for our customers, we think you need to be a bank in a regulated environment.”
But on Aug. 3, the day it announced its deal for National Bank of New York City, Newtek's stock price plunged more than 30%, to $24.61, and is still trading below the pre-announcement level of $35.14. The stock was trading at $26.36 Tuesday morning.
“A lot of investors are attracted to the dividend, especially in the current interest rate environment,” said Vincent Curotto, a director at the investment firm Klaros in San Francisco. Curotto characterized the trend as more of a technical issue — dividend-focused investors selling — than something denoting a fundamental problem.
And even as its stock price fell, Newtek was generating record operating results.
Full-year 2021 investment income totaled $108.5 million, up 18% over the prior year. At the same time, 7(a) loan production reached the highest level in company history, at $560.6 million for the 12 months that ended Dec. 31, 2021. For 2022, Newtek expects 7(a) production to hit a new high of $750 million and is forecasting lending under the SBA’s second-largest program, 504, to total $150 million in 2022. That would also be a company record.
Under its flagship 7(a) program, the SBA guarantees loans up to $5 million to small businesses. Most 7(a) loans are used for working capital or equipment and have 10-year durations. SBA 504 loans are used for real estate and big-ticket equipment and can extend as long as 25-years.
Newtek is the No. 2 SBA 7(a) lender in the country, with $219 million in fiscal 2022 loan volume, according to the SBA.
Yet despite those positive trends, Robert Dodd, who covers Newtek for Raymond James, doesn’t see any near-term lift in the share price.
“Newtek’s shareholder base, in our view, remains concentrated in income-oriented retail investors, as with other business development companies,” Dodd wrote in a research note. “The proposed conversion will likely necessitate a dividend cut, leading to continued projected shareholder rotation.”
For his part, Sloane doesn’t expect a turnaround to start until after Newtek gets the okay to convert to a bank.
“When you transform a company into a different type of financial structure, you do have to change your shareholder base,” he said Friday. “We’re still too far away at this point. I think investors want to see a proxy; they want to see us get approved before you get some of the bank people.”
Sloane and his team have met repeatedly with regulators to discuss Newtek’s conversion plans and estimate that the deal will close in the third quarter of 2022. It plans to rename the bank Newtek Bank & Trust and transform it into a national digital bank, which would draw deposits from around the country to help fund a growing lending operation.
Becoming a bank offers more long-term value than the business development company structure, Sloane contends. It gives Newtek the ability to lower its funding costs, retain more earnings to reinvest in growth initiatives and develop deeper relationships with its small-business clients.
“The bank tends to be the center of the universe for most small-to-medium-sized businesses,” Sloane said. “Our goal is to make our clients better and more successful. If you do that, whether you’re selling an iPhone or you’re Amazon, you ultimately have a great company that accrues benefits to shareholders.”
Sloane founded Newtek in 1998, but he wants the bank to start with a clean slate. Rather than merge Newtek’s existing SBA business with the bank, the company intends to keep its portfolio separate and allow it to run off over time. New originations would be made by Newtek Bank & Trust. The bank holding company would start with $1.2 billion of assets and a common equity Tier 1 capital ratio of 24.6%.
