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To say the last year has been tumultuous for SWS Group Inc. may not give proper respect to tumult.
Since last summer, the Dallas brokerage and banking fixture has parted ways with two leading executives, canceled a critical debt offering, accepted a regulatory order to improve its banking unit and paid two big regulatory fines for alleged brokerage violations.
The company's rocky ride may not be over.
In need of capital to shore up its bank, the parent company of Southwest Securities Inc. and Southwest Securities FSB recently struck a deal with two of the biggest names in North Texas business circles for $100 million in lifeblood cash.
Some current shareholders complain that their stakes in SWS Group would be heavily diluted if the proposed deal closes later this year. They question whether the deal should go through at all.
"I'm scratching my head trying to figure out what is going on," said Phil Frohlich, founder of Prescott Group Capital Management, a Tulsa, Okla.-based asset manager that is SWS Group's largest shareholder, with a stake of 9.2 percent as of Dec. 31.
"The concept is good: bringing in industry players that have great experience," he said. "But if you look at the big-picture outcome of the deal, I think the result is completely absurd."
He said the deal with outside investors, coupled with a canceled debt offering in December, constituted "two strikes" against the current management team.
SWS chief executive Jim Ross took over after predecessor Donald Hultgren quit in August. Stacy Hodges replaced outgoing chief financial officer Kenneth Hanks in October.
Their first big move: a planned debt offering of $95 million announced Dec. 6. It was pulled from the market two days later as the company cited "unfavorable market conditions."
"We thought they learned their lesson from the last one," Frohlich said.
In March, SWS Group announced the latest effort to raise capital: its deal with Dallas banking billionaire Gerald Ford and Oak Hill Capital Partners, a private equity firm whose lead investor is Fort Worth billionaire Robert Bass.
Under terms of the deal, Ford's Hilltop Holdings Inc. and Oak Hill would each lend SWS $50 million at 8 percent interest over five years. In addition, they would each receive warrants to buy nearly 8.7 million shares at $5.75 per share. Upon exercise, that would give them about 17 percent of the company apiece.
The deal requires shareholder approval and would close in the third quarter. The company's stock rose more than 5 percent Friday to $6.40 a share, its highest level since November.
"I think the board and the company acted in what they perceived to be the best interests of the shareholders," Ford said. "And in my opinion, this is an attractive deal for the shareholders."
The company defended the deal, which it said has support from many shareholders.
"We believe this deal will provide SWS Group with the capital necessary to address challenges at the bank and help ensure the company's long-term strength," Ross said in a statement responding to questions.
"We have spoken with many shareholders who are happy with this outcome and share our belief that the transaction provides shareholders with the opportunity to participate in the long-term upside potential of the company," Ross said.
Banking unit struggles
Investors and observers say SWS has a fairly robust brokerage business, in which it clears trades for individuals and other institutions along with selling and buying securities. That business accounted for more than 80 percent of the company's total revenue in its most recent quarter.
It's a different story for the banking unit, Southwest Securities FSB, which has $1.5 billion in assets.
"It's the bank that's dragging the whole thing down," said Chris Terry, an analyst at Hodges Capital, which owns SWS shares. "But if you strip away the bank and just look at the broker-dealer, the broker-dealer is profitable and well-capitalized."
According to the Office of Thrift Supervision, the bank "has engaged in unsafe and unsound banking practices." In particular, the OTS pointed to an excessive level of bad loans, and insufficient earnings to augment capital and cover losses.
In February, Southwest Securities FSB consented to an OTS regulatory order, in which the bank agreed to improve its performance and capital position.
SWS said the bank's problems come from "deterioration in the commercial real estate loan portfolio."
Southwest Securities FSB's non-performing assets amounted to about 8 percent of its total assets as of Dec. 31, according to a report by Dan Bass, managing director of FBR Capital Markets. The bank posted pre-tax losses of nearly $44 million during the second half of 2010, SWS said.
Still, the bank problems are probably fixable, analysts said.
"I don't think they're in dire straits by any stretch of the imagination," said Bass, who is no relation to Robert Bass.
SWS Group's underlying appeal brought an unsolicited acquisition offer from rival Sterne Agee, which offered $6.25 a share on March 15.
SWS' management rebuffed the bid three days later, saying it "significantly undervalues" the company. SWS also chastised Sterne Agee for attempting to talk with SWS employees about its takeover pitch.
"We do not appreciate the distracting, interfering and unprofessional communications from Sterne Agee employees to SWS Group employees regarding this proposal," SWS chairman Don Buchholz said in rejecting the offer.
Terry, from Hodges Capital, believes the company is worth north of $8 a share. He and independent analysts said other bids may be forthcoming as SWS works through what is expected to be opposition to the Ford-Oak Hill transaction.
Compliance operations
SWS Group declined to answer questions about its compliance operations after it settled two investigations into its brokerage practice in March.
SWS paid fines of $500,000 and $650,000 and agreed to new oversight measures to end inquiries from the Financial Industry Regulatory Authority, which polices individual brokers and their firms.
The first was for the company's payments to individuals aimed at winning more municipal bond business. The second settled the broker's handling of short sale transactions - bets that stocks or investments will fall in value - in its clearing business. The settlements neither admitted nor denied the Finra findings.
One Dallas attorney who files securities-related suits said SWS' latest run-ins are probably a red flag for its compliance department.
"The most recent fines give me a little concern - they're pretty big," said Charles "Trey" Branham of the Dallas law firm Goldfarb Branham LLP. "If you're facing pressure from one area of the company and your compliance and risk management teams are focused there, it wouldn't surprise me at all to see that they might not be paying as close of attention to other areas of their business. It bears watching."
Southwest Securities Inc., under the SWS corporate umbrella, has 36 inquiries on its FINRA record dating back to the mid-1980s, records show. Some observers said that's not a surprising number of compliance events for a financial company - SWS - with $366 million in revenue.
In any event, the compliance problems may not be the key challenges. Fixing the bank, soothing shareholders over the Ford-Oak Hill deal and battling takeover attempts are front and center.
Frohlich, the executive from SWS Group's largest shareholder, has been watching chapters one and two of SWS' saga, pointing to the failed debt offering and the deal with Ford and Oak Hill.
He sees more uncertainty ahead, adding "I think the plan will be voted down by shareholders, and we'll go to chapter three of this saga." |
