Activist investors shaking up California community banks
Orange County Business Bank has lost more than $1 million in just over a decade, yet its chief executive has picked up $4.6 million in salary and bonuses in that time. The tiny Irvine bank hasn’t grown, either, ending last year as it did four years earlier with $200 million in assets.
Investors are more than restless.
Taking a page from the playbook of the big corporate activist investors, they have launched a proxy fight for seats on the board and for votes to slash managers’ pay, boost shareholder returns and possibly sell the bank.
It’s a scenario jolting the staid world of small community banks in metropolitan areas where investors helped create financial institutions to serve small companies and where the raison d'etre for small banks was to grow and get bought out.
“You used to hear from all kinds of investors that hostile takeovers — proxy battles — just weren’t done in this business,” Chicago investor Stephen Taylor said. “I respectfully disagree. It may be a clubby business, but at the end of the day, these are public companies, and shareholders have expectations that need to be met.”
Taylor led a fight in Pleasanton, Calif., where he helped force Valley Community Bank to scrap a deal to be acquired in a stock swap worth $6.2 million for a higher-priced transaction that gave shareholders stock worth $8 million.
A decade ago, before the financial meltdown, the sales pitch to investors was that start-up California banks could grow large and profitable enough within five years that buyers would pay two or three times the banks’ liquidation value.
The story sounded especially compelling in areas such as Orange County, where smaller businesses — the core clients for the start-up banks — were growing fast, said Jeff Rigsby, a banking consultant in San Juan Capistrano.
It’s possible to sell many of those banks now, Rigsby said, but typically for only half as much as investors expected before the Great Recession. Meantime, some bankers who raised money to spur growth never deployed it, he said, “and just sat on their capital” as the economy recovered.
The result: “You are seeing more activism, more shareholder protest letters being published,” Rigsby said. “Some guys have been sitting on these investments since ’03, ’04, ’05, ’06.”
The uprisings at some California community banks illustrate how investors, often perceived as quiescent and stuck with their thinly traded shares, are beginning to pound on boardroom doors as the financial crisis fades into history.
Banks that survived the Great Recession now are often flush with cash. The Federal Deposit Insurance Corp., which regulates banks and insures deposits, reported last month that income from lending and fees — the two key revenue sources for all banks — were growing much faster at community banks than for the industry as a whole.
Orange County, one of the nation’s biggest incubators for small business, is home to 22 banks, and 13 of them are in Irvine. Orange County Business Bank is one of 10 clustered a few blocks from John Wayne Airport.
Executives at Orange County Business Bank, created in 2002, began talking in 2010 about using their excess capital to fuel growth, said Mark H. Ruh, managing partner at private equity firm Commerce Street Investment Management in Dallas. The firm invested in the bank in 2004 and owns less than 5% of the stock.
Ruh, though, has become agitated with an operation that has struggled to make money and grow, yet has been paying its chairman and chief executive, J.P. Gough, a salary of more than $369,000 in each of the last three years.
Orange County Business Bank, a business lender focused on commercial mortgages and apartment loans, lost $13.7 million from 2009 through 2011. It then appeared to be getting some traction, turning profits totaling $9.1 million for the last three years.
Last year’s earnings of $7.2 million, however, included large one-time accounting gains related to taxes and recovery on a troubled loan. Excluding those, the bank’s profit would have been just $613,000, Ruh noted.
Moreover, he said, Gough’s salary — no bonuses were awarded — amounted to 173% of the average salary for chief executives at similarly sized California banks. Other top officers earned salaries that were more than 165% of the average pay of comparable officers statewide.
“We’re not normally an activist firm, but this situation is so egregious that we have to do something,” said Ruh, estimating that Orange County Business Bank could return at least $27 million to investors while remaining well-capitalized by regulatory standards.
His Commerce Street launched a proxy battle aimed at winning three seats on the bank’s board of directors at the annual meeting this summer. It also seeks shareholder approval of its proposals for pay cuts, special rewards for stockholders and a possible sale of the bank.
Gough did not respond to requests for comment.
Ruh has won support from, among others, three former bank officers and directors. One is Memphis investor Brad L. Champlin, a former executive vice president of banking giant Regions Financial Corp. in Birmingham, Ala.
Champlin said that he welcomed the chance to become a founding director of the Irvine bank because he grew up in Southern California, where he often visits his family, and that he respected Gough as a business acquaintance.
He said he left the board in 2008 after challenging the high executive salaries. He also began investing in a fund that was buying stock in other undervalued banks, and he now regards the more than $2 million he provided to help start Orange County Business Bank as “the worst investment I have.”
“The objective was to be a top performer, to rank in the top 10% of peers, but the record shows it is not a top-tier bank,” Champlin said. “Their salaries have got to come down, man! That’s coming out of my pocket, and I’m not happy about it.”
The pressure is on to return at least the unused capital at these small banks, said Anaheim consultant Gary Findley, who works with several banks on doing that. Large one-time dividends and repurchasing shares are options.
He said that banks with capital equaling 14% or more of assets should consider returning some to shareholders unless they are on a clear growth path.
Orange County Business Bank is at 23%, so it’s reasonable for the activists to raise a question, Findley said: “Is this a bank for the shareholder or is this a bank for J.P. Gough?”
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