Disappointing fourth-quarter earnings from community banks have ratcheted up tensions between some bankers and activist investors.
New Jersey investor Lawrence B. Seidman is battling management at two banking companies there in which he is the largest shareholder - the $1 billion-asset Center Bancorp Inc. in Union and the $2.6 billion-asset Yardville National Bancorp in Hamilton.
In the past 10 days Mr. Seidman has accused Yardville's board of improperly sharing nonpublic information with at least one shareholder and called Center's fourth-quarter performance "pathetic."
Meanwhile, management of the $1.5 billion-asset Bancorp Rhode Island Inc. in Providence refused to allow questions from its largest outside shareholder, PL Capital, during its earnings conference call Jan. 25 - a day after it denied PL Capital's request for two seats on its board.
Activist investors agitating for change is hardly a new phenomenon, and these three conflicts have been under way for some time. But observers say the cases illustrate a few trends.
For one, industry earnings are under pressure, particularly for banks that rely on spread income. Also, regional economies are playing a role - the relatively sluggish Northeast and Midwest are seen as ripe for this sort of friction. And third, the nature of small banks' investor bases is shifting in a way that can aid investors seeking to influence or replace boards and management.
Mr. Seidman and his counterparts at PL Capital, in Naperville, Ill., typically seek to be among the largest shareholders at companies in which they invest, and are well known for pressuring management and boards to improve performance or find buyers. They often succeed.
Mr. Seidman and two of his allies had sought seats on Center's board, but their request for nomination was formally denied Tuesday. On Thursday, Mr. Seidman asked Center for a list of shareholders so that he could he take his bid directly to them at this year's annual meeting. Likewise, PL Capital principal John Palmer said on Jan. 24 that he and co-principal Richard Lashley intend to wage a proxy fight to win seats on Bancorp Rhode Island's 15-person board.
Mark Fitzgibbon, the director of research at Sandler O'Neill & Partners LP, said recent earnings reports are giving activist investors like Mr. Seidman and Mr. Palmer more ammunition. "The industry has come into a more challenging time, so investors in these stocks are being forced to become more aggressive in order to produce better results," Mr. Fitzgibbon said.
Many small banks and thrifts are reporting slower loan growth, higher expenses, and slightly weaker asset quality. A report released Thursday by BankAtlantic Bancorp's Ryan Beck & Co. said 57% of small commercial banks it covers that have reported earnings missed earnings-per-share estimates in the fourth quarter, and 45% of thrifts missed.
Mr. Fitzgibbon said shareholder activism has "really soared" at banks in recent years. Though the trend is widespread, he said companies in the Northeast and Midwest, where growth is slower, appear to be the most common targets.
He sees several factors fueling the trend: growing institutional ownership of stock in the industry; the proliferation of hedge funds, with their short-term, bottom-line focus; and changes in governance, including the requirement that mutual funds disclose how they vote on proxy ballots.
Since the disclosure requirement took effect, in 2003, there has been a profound change in funds voting patterns, Mr. Fitzgibbon said. He cited statistics published in CFA magazine in January that indicated Vanguard supported the full slate of directors proposed by management 90% of the time before 2003 and 29% of the time since then.
Mr. Fitzgibbon said institutional investors now own 57% of the stock in the banking industry, including a 49.1% stake in Bancorp Rhode Island and 41% of Yardville's shares. "It was harder to run proxy contests when retail investors owned the majority of stock, because you had to contact every one of them," he said.
YARDVILLE NATIONAL
Yardville, which announced earnings Jan. 30, blamed its $8.7 million fourth-quarter loss on a balance-sheet repositioning.
F. Kevin Tylus, Yardville's president and chief operating officer, said Friday that it is executing its long-term strategic plan to expand in central New Jersey and eastern Pennsylvania. It is up to 33 branches, nearly double the amount it had five years ago.
He said all the new branches, including five added last year, are meeting their performance goals and contributing to deposit growth - which is allowing Yardville to reduce its use of more expensive wholesale funding. He said new branches generally take one to three years to become profitable, but they are boosting overall growth.
"We would hope that the shareholders would appreciate the longer-term strategic plan that's in place to continue to develop the company," Mr. Tylus said.
Mr. Seidman, who failed in a bid to win two seats on Yardville's board last year, does not support management or its plan, and has repeatedly said Yardville should either replace chief executive Patrick Ryan and his team or find a buyer.
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On Jan. 26, Mr. Seidman's attorneys sent Yardville a letter alleging that one or more board members had been leaking sensitive information to a shareholder - an action they said "is unquestionably improper and probably unlawful."
Mr. Seidman declined to elaborate on the nature of the allegations. Mr. Tylus said the company is looking into them.
CENTER BANCORP
Mr. Seidman's other target, Center Bancorp, reported that its fourth-quarter profit rose 21%, to $2.1 million. Its president and CEO, John J. Davis, said in the earnings release that the results "demonstrate stability in this challenging rate environment" and deliver on Center's promise of "consistent earnings performance over the long term."
But Mr. Seidman, who owns a 9.28% stake in Center after buying another 7,900 shares last week, did not see things that way. In a letter to Mr. Davis filed with the SEC Jan. 29, he said that the earnings increase was a result of tax and securities gains, and that when those item are factored out operating results showed a loss of $205,000. In an interview, Mr. Seidman said that attributing the performance to the interest rate climate is "a cop-out."
"There are other banks [in New Jersey] that have been able to perform at a high level," he said.
He particularly took issue with Center's expenses, which he called "out of control" in his letter to Mr. Davis. Its efficiency ratio was 94% in the quarter, up from 67% a year earlier.
"Lowering expenses and increasing profitability was a priority in 2006?" Mr. Seidman wrote. "When I look at the results, all I see is the opposite."
Center told American Banker by e-mail that it has implemented initiatives to increase branch profitability as well as to reduce salaries, benefits, and overtime expense. "This year, we are also considering various outsourcing opportunities and instituting other operating expense controls," it said.
Asked why the nominations of Mr. Seidman, Harold Schechter, and Raymond Vanaria to Center's board were denied by its nominating committee, the company said, "We believe that Mr. Seidman is focused on a desire to sell the company and receive a short-term gain on the shares he has acquired."
Alluding to a cease-and-desist order Mr. Seidman received in 1994 from the Office of Thrift Supervision, Center said: "Given his history of conflict with federal bank regulators and other bankers, we believe that Mr. Seidman would pose a needless distraction and an impediment to achieving our objective of delivering long-term value to our shareholders."
BANCORP RHODE ISLAND
Bancorp Rhode Island's profits also were propped up by unusual items. Its fourth-quarter earnings rose 14%, to $2.5 million, from the same period a year earlier. Earnings per share rose 11%, to 51 cents.
However, the results included an $800,000 insurance recovery related to a loss incurred in the first quarter of 2006. Excluding that, the fourth-quarter earnings would have fallen 9%, to $2 million, and earnings per share 11%, to 41 cents. The average analyst estimate was 43 cents a share, according to Thomson Financial.
The company has also estimated 2007 earnings per share at $1.80 to $1.85 - which Mr. Palmer said would work out to a return on average equity of about 8%. "That's not an acceptable range."
Mr. Palmer said he and Mr. Lashley believe Bancorp Rhode Island should consider selling itself. PL Capital owns about 8% of the company's stock.
"When we look at the franchise value of the company compared to what I'll call the operating value, given its poor financial performance, it's going to take a significant amount of work to get earnings to the level that would justify remaining independent, in our opinion," Mr. Palmer said.
Mr. Palmer said he wanted to ask "constructive" questions about what he considered to be poor quarterly and annual results on the earnings conference call.
Merrill W. Sherman, Bancorp Rhode Island's president and CEO, said it did not want to give Mr. Palmer a forum. (The company's annual meeting is May 16.) She said the official board nominations are people active in the local community who can help grow business.
Ms. Sherman argued that the company has delivered "superior shareholder value," and pointed to its stock performance. The stock price is up about 22% over the past 52 weeks, to $43.34 late Friday. She conceded that the takeout value factors into the increase, and she said it should, especially given the company's attractive location.
Several analysts viewed PL Capital's activism as a positive. "We believe the influence of outside investors could manifest into a productive relationship and lead to performance enhancements at the bank," Ryan Beck's Bret Ginesky wrote in a Jan. 25 research note.
KBW Inc.'s Keefe, Bruyette & Woods Inc. added Bancorp Rhode Island to its takeout list in April. "There is more value in a sale than the way that they're running the bank right now," said Jared Shaw, an analyst at Keefe Bruyette. The stock, based solely on the company's earnings, should be trading around $28 a share but could fetch $44 to $48 a share in a sale, Mr. Shaw said.
"The management team has done a good job of building up the franchise value, and it's something you can't disregard," he said.
The quarterly results were "not very good," and it will become increasingly harder for the company to justify its stock price with such performance, Mr. Shaw said. "Yes, the yield curve is making it very tough, but we're not seeing many community banks with margins below 3%."
Bancorp Rhode Island reported a fourth-quarter net interest margin of 2.91%, off 18 basis points from the third quarter.
Mr. Palmer said the company spent $200,000 on a consultant to advise it on shareholder issues in the third quarter - in other words, "to figure out how to deal with us." But Mr. Palmer said PL Capital is not going away.
