Publications & Resources

February/March 2007
Focus: Balance Sheet Management

Sale-Leaseback Transactions for Mid-Size Banks
A Timely Way to Realize Off-Balance Sheet Value

By Thomas Killian

The double whammy of declining net interest margins and rising operating expenses has put tremendous pressure on the profitability of many banks. To grapple with this, adroit bank managers have begun converting all or a portion of the off-balance sheet value of the real estate properties onto the income statement through a sale-leaseback of bank properties they own. Indeed Bank of America , Wachovia and many others have engaged in significant sale-leaseback transactions in the past several years.

While sale-leaseback transactions have been around since the late 1950s when the first major transactions were completed, what has changed in the past several years is the influx of capital into the real estate sector and the strong credit performance of middle market banks in pooled trust preferred programs. Now institutional investors and specialty REITs, such as American Financial Realty, are focused on offering attractive financing terms to non-investment grade middle market banks.

The basic structure of a sale-leaseback transaction is straightforward. A bank sells property to a buyer. The bank agrees to lease the property back from the buyer pursuant to a long-term lease generally for 15 to 20 years during which time the bank agrees to pay a series of rent and tenant reimbursement payments to the buyer. The lease is structured to qualify as an operating lease (pursuant to FASB 13 and FASB 98 guidelines) and the property is removed from the balance sheet of the bank.

By entering into a sale-leaseback transaction of bank owned real estate, a financial institution can realize a number of benefits including:

  • Improve financial performance ratios such as ROAE and net interest margin by reducing non-earning assets and increasing income earning assets;

  • Bolster recurring GAAP earnings by eliminating depreciation expense associated with properties sold, amortizing the gain on sale over the lease term, and increasing net interest income from the reinvestment of the cash proceeds less the rental expense;

  • Convert off-balance sheet value of real estate owned into the income statement by amortizing the GAAP gain on sale into non-interest income;

  • Obtain cash to fund reinvestment in earning assets, stock repurchases, dividends, repayment of debt, or M&A activity;

  • Focus bankís efforts on core operations rather than managing real estate;

  • Mitigate the risk of decline in the market value of real estate owned by prudently managing the levels of real estate owned; and

  • Reduce 100% risk-weighted assets and reinvesting in lower risk-weighted assets such as loans and securities.

While the benefits of a sale-leaseback transaction are numerous, there are many important considerations including: - the potential loss of control over the bankís branches and offices and the potential impact on the future merger market value of the bank. The concern about loss of control is typically addressed by giving the bank multiple renewal options at the end of the initial lease term and a right-of-first refusal repurchase option at fair market value at the end of the lease term. Since the primary determinant of a bankís valuation is sustainable earnings, the recurring earnings pick up from a sale-leaseback transaction will generally enhance both the trading and merger market valuation of the seller. Conversely, we have rarely seen an acquirer pay a multiple of a sellerís off-balance sheet value of real estate in an M&A transaction.

To determine if a sale-leaseback transaction is right for your institution, consider whether you have the following:

  • Branches and other buildings with a net book value of at least $3 mm or a significant amount relative to the total asset size of your bank;

  • Potential GAAP gains in the properties you own;

  • Need for liquidity to fund strategic initiatives;

  • Need for risk-based capital; or

  • Desire to focus management efforts on core banking operations.

If you answered yes to any of the above questions, you should consider evaluating the merits of a sale-leaseback transaction for your institution. In doing so, please keep in mind that there is a trade-off between maximizing the price for the properties sold vs. rent payments and retained flexibility to restructure or substitute leases as your plans change. By monetizing the off-balance sheet value of real estate owned through a tailored sale-leaseback transaction, you can ease the double whammy of declining net interest margins and rising expenses.

Thomas Killian is principal, investment banking, with Sandler O'Neill & Partners, L.P. in New York , N.Y. He can be reached at 800-635-6851 or

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