Shareholder activism is a rising threat to the independence of community banks, and recent investor fights at ECB Bancorp (ECB) and First California Financial Group (FCAL) illustrate the danger factors.

The two share several characteristics that led return-hungry investors to urge them to consider selling to another bank. ECB of Engelhard, N.C., and First California of Westlake, Calif., are fairly healthy, but their equity values are depressed. They also compete with banks strong enough to make acquisitions.

The clashes were striking because institutional and family investors initiated them, not classic activists who raise money specifically to take a position and force change.

Gregg Gibbs' family is ECB's biggest shareholder. He sat on the company's board for 17 years before calling this month for the bank to replace Chief Executive Dwight Utz and set up an independent committee to explore selling itself.

First California was effectively put in play in January after one of its largest investors — the Pohlad family — demanded that management hire an investment bank to explore options. It opened the bank up to an aggressive takeover bid in May from PacWest Bancorp (PACW) in Los Angeles.

Such disputes are adding to community bankers' mounting list of worries.

Who should be most concerned? Banks with decent scale in desirable markets, where at least three or more active buyers operate, experts say. ECB has slightly more than $900 million in assets, and First California has nearly $2 billion. That could make them attractive to bigger banks, but they are not so big that they can brush off the legal costs and customer-flight that shareholder battles incur.

Acquisitive Neighbors

Bank deals require a willing and able buyer. First California and ECB are surrounded by more than a few. Southern California, where First California operates, is a highly desirable banking market. It has a dense population, a lot of small businesses and a real estate market with good long-term prospects. A number of West Coast banks were recapitalized by private equity groups in recent years and are eager to scoop up smaller players.

Among the banks with buying power and operations near or overlapping First California's 19 branches from Los Angeles to San Diego are: City National (CYN), Comerica (CMA) and East West Bancorp (EWBC). Umpqua Holdings (UMPQ) and U.S. Bancorp (USB) have ambitions to buy other banks in California, too.

The 25-branch ECB competes directly with a handful of acquisitive players in its core market of eastern North Carolina, including: BB&T (BBT) of Winston-Salem and First Citizens BancShares of Raleigh. Private-equity-backed consolidators BNC Bancorp in High Point (BNCN) and North American Financial Holdings (CBKN) of Raleigh have been busy acquiring in the state.

Whether First California or ECB fetches an offer would depend on pricing, potential compatibility and other considerations. An investor is unlikely to push for the sale of a bank that no one would be interested in buying. The reputational risk of going activist has to be reconciled with the allure of a potentially high shareholder premium, also.

Vulnerable Points

ECB and First California have high expenses and depressed equity values, so the right buyer conceivably could afford to pay a healthy premium for their shares in a stock-based deal that anticipates big cost cuts. That is because if a bank's equity trades at a low multiple, all a buyer needs is an excuse to make an offer that values its equity at a better one.

First California — with an efficiency ratio of 72% — has taken flak from some shareholders for rebuffing PacWest's offer in May that valued its shares at a 32% market premium, or $7.25 per share.

Shares of First California closed Thursday at $7, or a respectable multiple-to-tangible book of 161%, largely because of the recent run-up in its share price. But it closed at $5.43 per share on May 7, the day before PacWest went public with the news of its offer.

In the ECB fight, Gibbs in a June 7 letter to the board noted that ECB's stock had fallen 52% since new management took over in July 2009. ECB currently trades at 42% of its tangible book value of $22.34 at March 31. It also had an exceptionally high ratio of costs to revenue of 93%.

Problem Loans

First California and ECB have fairly high — but not drastically high — levels of overdue loans.

Their loan problems are one of the main reasons they have weak profits and angry shareholders. They cannot make enough money to generate good returns and repay their outstanding aid to the Troubled Asset Relief Program.

But they likely do not have such severe loan problems that a buyer might have to take a massive markdown on their loan portfolios of 15% to 20%.

First California's had a nonperforming asset ratio of 3.42% in the first quarter, according to the Federal Deposit Insurance Corp. ECB's nonperformer ratio slightly exceeded 4% last quarter, according to company filings.

A ratio of 2% is considered low, a 3% to 4% NPA ratio is considered elevated and anything much higher is considered excessively high.

Officials from First California and ECB did not respond to request for comment. The status of the talks between First California and PacWest is uncertain; the ECB board has strongly defended management and says its turnaround plan deserves more time to work.

Struggling banks in M&A-prone markets are especially susceptible to investor challenges, experts say, and these fights could force them to make a deal when they were not necessarily seeking one.

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