Aggressive Approach to Credit Pays Off Big for State Bancorp

Thomas O'Brien, the chief executive and president of State Bancorp Inc., just proved the adage that short-term pain can sometimes yield long-term gains.

Under O'Brien, State Bancorp. of Jericho, N.Y., had been purging problem loans at steep discounts, rather than holding them, as many other banks have done, in hopes of a greater recovery. His strategy was validated, observers said, when the once-troubled company announced Thursday it would sell itself to Valley National Bancorp in Wayne, N.J., at a hefty premium of 1.85 times tangible book value.

When selling loans, O'Brien "prefers 65 cents today over the possibility of 85 cents in 36 months," said John Moran, an analyst at Macquarie Capital Ltd. "That type of action can really help a buyer get comfortable with a balance sheet."

Deal values have varied widely this year. Troubled banks have agreed to sell themselves for a third of book value, while prices for healthier targets are approaching two times tangible book. Data from SNL Financial shows that the median valuation of the 34 deals announced in the first quarter was 1.07 times book.

Observers said would-be sellers should consider State Bancorp's take-your-lumps-now approach to asset quality, if they can afford it. "This transaction highlights the positive benefits of cleaning up your balance sheet and disposing of distressed loans. You can't fetch a premium if your institution is loaded down with risk," said Kingsley Greenland, the CEO of DebtX, an online market for commercial real estate and other debt.

O'Brien, 60, said that beyond providing clarity to the balance sheet, a lack of problem assets also improved the bottom line. The result: greater perceived value for the $1.6 billion-asset company.

"The cost and the economic drag of those assets would have not let us return to profitability. I am more convinced than ever that it was the right move," he said. "It made understanding our company much easier. And they looked at us every which way from Sunday."

The stock deal, valued at $222 million, gives State Bancorp shareholders a share of Valley National for each share owned. Valley National also plans to redeem the seller's $37 million of preferred stock from the Troubled Asset Relief Program. Valley National expects to complete the acquisition in the fourth quarter.

The $14 billion-asset Valley National has long coveted the Long Island market. But Gerald H. Lipkin, Valley National's chairman, president and CEO, said the company is not interested in turnarounds aside from those with a safety net from the Federal Deposit Insurance Corp. (Valley National has bought two failed banks in the last few years.)

"We get to start out with a relatively clean slate here. We get to be optimistic toward growth, not standing in place for a bit while we have to clean things up," Lipkin said. "They've done a great job of cleaning it up and turning this franchise around."

O'Brien has had a reputation for confronting problems early and vigorously since he joined State in November 2006 as president and chief operating officer. At the time the company had fallen below well-capitalized status partly because of a protracted legal battle with HSA Residential Mortgage Services of Texas Inc.

A month after O'Brien arrived, State Bancorp raised $36 million in a private placement. (O'Brien also bought stock.) In January 2007, State settled with HSA for $65 million. As the economy went south State Bancorp quickly turned its attention to problem residential development loans.

"He was early in recognizing the problems and has been very proactive. They never have an OREO balance," said Matthew Clark, an analyst at KBW Inc.'s Keefe, Bruyette & Woods, using the acronym for "other real estate owned" (i.e., foreclosed properties).

During a conference call with investors, Lipkin said O'Brien (who has sold two other banks) had agreed to stay on with Valley National after the deal closes, but the executives did not describe his role at the combined company.

State Bancorp has charged off 5.5% of its loans since 2007, Moran said. The company sold $22 million of nonperforming assets in late 2009, lowering nonperformers 78% from a year earlier, to just 0.5% of total assets. At the end of the first quarter, nonperforming assets made up 1% of total assets.