How to Make Money Off Community Banks

By Denise Carabet

From the San Diego Metropolitan, Uptown Examiner & Daily Business Report, November 2001.

Picture the ubiquitous cartoon of a tiny fish being swallowed by a slightly larger one, in turn being chased an even bigger predatory piscine. That's the visual that bank analyst and appraiser James R. Miller often uses when discussing the cyclical nature of investing in community banks. With the right care and caution, a minnowy bank investment could be just the right snack at the right time for a wealthy predator.

"Investing in community banks has shown—depending on whose data is used—an annual rate of return of anywhere from 10 to 20 percent," Miller says. But he adds this caveat: "Never, never, ever buy into a community bank just because it may be a takeover candidate. Always go for the fundamentals and the rest will follow."

While aggressive mid-sized banks have determined that buying a one-branch bank is a more cost-effective way to gain a market toehold than trying to establish a branch, the current economic and Wall Street climates have conspired against them. Their currency—or stock value—is down, and hence their buying power. Private investors, or small limited partnerships, still are scouting opportunities, though, as evidenced here by Sunrise Bank, whose majority owners are Midwesterners.

At this point in the region's community banking cycle, not all that many institutions are out there available for stock purchase, since so many have been merged or acquired over the last few years. The largest and strongest homegrown community banks—Grossmont Bank, North County Bank, Scripps Bank, Bank of Commerce, Peninsula Bank, San Diego National and others—were purchased by out-of-town banks or investors, after fattening themselves up on a number of smaller local institutions in preparation. Still others were organized as, or through regulatory urging, forced to become closely or privately held concerns. Those who remain are the plodders (albeit with new game plans), the newly opened and the soon-to-capitalize groups.

OK, the investor is willing to be patient and to do some homework: What separates the winners from the losers; the out-and-out bank failures from the home runs? What does the investor look for to ensure his or her neighborhood bank investment won't just tread water forever? Hans Schroeder, bank analyst with San Francisco-based Hoffer, Arnett distills the key areas to four: management, credit quality, operational expertise and market area.

Management

The first benchmark Schroeder assesses in a community bank investment is management. The team has to be experienced, have a good track record, be shareholder-oriented as well as operationally competent, he says, "and have his or her money invested in the bank as well. Otherwise, it's too easy for them to walk away." With the recent years' number of bank buy outs, management teams are being created from a patchwork of top- and second-level community bank officers. "This is where track record comes in," says Schroeder. "Some of these people are successful community bankers at the core and everyone knows that's where they excel. Others were left, after mergers or takeovers, because they just weren't all that good to begin with. Ask questions."

"There's no doubt about it," adds a longtime local banker, "the talent pool is thinning."

Top management is something that 1st Pacific Bank, only 10 months in operation, already is grappling with, says interim chief executive Vince Siciliano. He had to step up after organizing CEO Bob Hildt and the bank's high-profile board issued a press release last month, citing Hildt's intention to "pursue other interests." An outside search firm will be canvassing local, regional and even national candidates, if need be, to find a new CEO by the end of next year's first quarter. Organized as a community business bank with $11 million in capital last November, 1st Pacific reports nine-month total assets of $36 million, total deposits of $27 million and total loans of $24 million. Its net loss of $1.35 million is a function of heavier start-up costs because the bank opened its doors as a two-branch entity: one in the Oceanside-Tri-City area where one group of shareholders lives and does business; the other in the University Towne Centre area, to make the most of Golden Triangle business contacts.

Financial planner Judy Stewart is one who invested in 1st Pacific Bank simply because of its management, but then, she has a rather unique view of the situation. For 16 years she worked at Rancho Vista National Bank—the last four as chief executive officer. She knows the track records of 1st Pacific's top financial and loan personnel, as well as two board members, for they were crucial to Rancho Vista's turnaround from a plodding entity to a construction-loan specialist that eventually accepted Bank of Commerce's bid—the best of about a half-dozen—in 1998 for about five times book value. "These are smart, smart people who know how to make money," she says.

Enthusiasm and energy are traits Miller likes to see in the management that gets his investment money. "I can guarantee that 80 percent of the (community) banks in operation today will be simply OK, doomed to mediocrity because so many managements are sitting around waiting for the telephone to ring rather than getting out there, making the contacts and bringing that business into the bank," Miller says. "These new guys have got to build the bank up, move it forward under a clear strategic plan to get top dollar down the road, because there's no tooth fairy sitting there waiting to take it over."

Escondido-based Palomar Bank's Rick Sanborn uses himself as an example of enthusiasm and energy at the helm. A little more than a year ago, when Santa Barbara's Commercial West Bancshares had to sell its Palomar asset to raise cash, CEO Sanborn stepped up. "I signed a letter of intent to buy us back, with investors to be named later," he says. His search brought him in touch with Doug Spencer, CEO of Redlands Centennial Bank, a community bank of like size and like thinking. "We were a couple of young guys (Sanborn is 39, Spencer, 42), breathing fire...went out to tell our story to potential investors." That guts-out effort, performed concurrently in Redlands and in Escondido, netted the duo $7 million in new capital in the first three weeks, about $9 million after 30 days.

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