Commercial Capital Corp. bought Hawthorne Financial Corp. in June 2004 largely for Hawthorne's deposits, but an investment bank's recent analysis of deposit trends at California banks and thrifts suggests that the acquisition has not worked out as well as planned.
Friedman, Billings, Ramsey & Co. Inc. last week released a report using Federal Deposit Insurance Corp. data that said Commercial Capital's same-store deposits fell 17% in the one-year period that ended June 30.
It was the poorest showing among the 46 California banks and thrifts the firm studied, and James Abbott, one of the report's authors, attributed the drop in large part to runoff from the Hawthorne acquisition.
Commercial Capital's chairman and chief executive officer, Stephen H. Gordon, disagrees with Mr. Abbott's conclusions. He acknowledged that deposits had declined, but argued that the analysis was meaningless because it failed to look at the whole picture.
Buying the $2.7 billion-asset Hawthorne, of El Segundo, more than doubled Commercial Capital's assets, quadrupled its branch network, and roughly tripled deposits, which it needed to fund its fast-growing multifamily lending operation. And though its cost of funds is higher now than it was in June 2004, its net interest margin and returns on assets and equity have improved, according to FDIC data.
"We let high-cost CDs and money market accounts roll off, and replaced them with good, solid, low-cost deposits," Mr. Gordon said in an interview.
The banks and thrifts in the Friedman Billings study control 75% of the California's deposits. In calculating same-store data, it omitted headquarter branches that tend to hold a lot of escrow deposits and brokered certificates of deposit, and used only branches that had been open for at least two years. The report is the second of its kind Friedman Billings has issued in recent weeks, and Mr. Gordon is not the first bank executive to disagree with the Arlington, Va., firm's findings.
A report on deposit trends at larger banking companies found that same-store deposits at U.S. Bancorp in Minneapolis fell 1.4%. In an interview with American Banker earlier this month, Richard Hartnack, a vice chairman at U.S. Bancorp questioned the exclusion of in-store branches, which are a big part of U.S. Bancorp's expansion strategy. Besides, he said, the company is less interested in deposit growth than in increasing the number of accounts.
Commercial Capital's Mr. Gordon said the same-store deposit analysis did not take into account the $685.6 million in exchange balances the bank had as of June 30, from two Commercial Capital subsidiaries that hold the proceeds of real estate transactions for investors until they are ready to buy another property, in order to defer capital gains taxes.
But Mr. Abbott said the analysis is useful because it shows that Commercial Capital has not made the best use of the Hawthorne acquisition. The company paid about 2.4 times Hawthorne's book value and a 21% premium on deposits. At the time, Mr. Abbott said the premium was justified because Commercial Capital, which had four branches, would gain access to more lower-cost deposits at Hawthorne's 13 branches.
"But they've since lost a fifth of Hawthorne's deposits, and now it appears that Hawthorne was a very expensive transaction," which will continue to be a drag on earnings as Commercial Capital pays for the goodwill in the deal, Mr. Abbott said. "If they kept all those customers and really grew that business, they would have gotten their money's worth."
Scott Carmel, the West Coast bank and thrift analyst for Moors & Cabot Inc. in Boston, said that generally same-store analysis "is useful to see how efficient banks are in using their branches to draw more deposits, without increasing overhead."
Mr. Carmel stopped short of saying Commercial Capital overpaid for Hawthorne. He noted that after letting the high-cost deposits it inherited run off, it still has the former Hawthorne branches, which it can use to gather low-cost deposits.
The challenge, he said, is competing with the large banks that dominate in California.
"It's difficult for Commercial Capital to generate new core deposits when they're up against powerhouses like Bank of America and Wells Fargo," Mr. Carmel said. The bigger banks "have huge advertising campaigns drawing people to their branches."
In July, Commercial Capital hired veteran retail banker Richard Grout to bring in more core deposits. It also started a commercial banking division that month, after a team of bankers defected from Comerica Bank. The division will solicit deposits and offer cash management and treasury services to title and escrow companies, homeowner associations, property management firms, and other companies (though it is in a legal tussle with Comerica over the team's right to solicit Comerica's customers).
Though Bank of America Corp., Washington Mutual Inc., and Wells Fargo & Co. dominate the deposit market in California, the Friedman Billings study found that community banking companies there are actually increasing deposits faster.
Six community banking companies - including three focusing on Korean-Americans - had the state's highest same-store deposit growth rates. Topping the rankings was the $1.64 billion-asset First Regional Bancorp in Century City, whose same-store deposits rose 44.1% from a year earlier.
It was followed by the $1.79 billion-asset Nara Bancorp in Los Angeles, which showed a 34% increase; the $11 billion-asset Fremont General Corp. in Santa Monica (32%); the $3.37 billion-asset Hanmi Financial Corp. in Los Angeles (25%); the $5.4 billion-asset SVB Financial Group in Santa Clara (21.5%); and the $1.6 billion-asset Center Financial Corp. in Los Angeles (20.7%).
Among the larger banks, Bank of America's same-store deposits in its California branches rose 9.8%, Wells' rose 9.9%, and Wamu's 1.4%. The average same-store deposit increase for the banks analyzed in the report was 7.3%; the industry average nationwide was 4.7%
Community banks generally are able to increase deposits faster on a percentage basis than their larger competitors because they are smaller, said Gary Townsend, a Friedman Billings analyst. But they often have to work harder, either by paying up for deposits or delivering superior service.
That is especially true in California, by far the nation's largest, and perhaps most competitive, deposit market. Three banks control nearly half of the $753 billion deposit market, and more than 300 others are battling for the other half.
The trade-off for the smaller banks is that they often have a higher cost of funds than larger banks, or higher salary expenses for talented bankers who can bring in business deposits, Mr. Abbott said.
"But," he added, "these banks don't necessarily have poorer net interest margins, because they can charge higher for loans."
First Regional's growth in deposits is commensurate with its success in commercial real estate lending over the last several years, said Manuel Ramirez, an analyst in San Francisco for Keefe, Bruyette & Woods Inc.
"It's usually more difficult to get deposits from real estate borrowers because there's no requirement for them to have compensating deposits like banks can get" from commercial and industrial borrowers, Mr. Ramirez said. "But First Regional's got a great reputation among real estate investors, and they've been more persuasive in getting the deposit business from these customers."
First Regional was also among the few banks with a high same-store deposit growth, which fueled its overall growth by bringing in a good deal of lower-cost core deposits in addition to higher-priced certificates of deposit, Mr. Abbott said. As a result, its cost of funds for the second quarter was 1.06%, well below the 1.64% average of California banks Friedman Billings examined.
Steven J. Sweeney, the general counsel at First Regional, said that unlike many smaller banking companies, First Regional does not have to rely on paying more for CDs to attract deposits.
"Our business is relationship banking, so we don't compete so much on price, but more on giving our customers the best possible service so they'll do all of their banking with us," he said.
Mr. Sweeney added that the company generally pays higher-than-average salaries to its bankers.
The Korean-American banks - Nara, Hanmi, and Center - all grew their deposits by selling more CDS, not surprising since the instruments make up a substantial portion of each of their deposit bases, Mr. Abbott said. Korean-Americans tend to be more comfortable investing in CDs - including jumbo CDs for more than $100,000 - than in the stock market, and the banks that cater to them are more than willing to accommodate them.
However, since Sung Won Sohn, the former Wells Fargo & Co. chief economist, took over as Hanmi's CEO in January, Hanmi has been actively soliciting core deposits from business customers under a plan to diversify the product line. Mr. Abbott said that the endeavor may slow Hanmi's same-store deposit growth in the future but that its cost of funding should drop. It was 1.79% at June 30.
Stephanie Yoon, a Hanmi spokeswoman said: "We're able to get more noninterest deposits now because we have an initiative to increase our business loans, and we can ask those customers to open business checking accounts. It's free money, so we can get better spreads."
Hanmi wants to make more business loans to decrease its reliance on commercial real estate lending, Ms. Yoon said.
