Sunwest Bank had some explaining to do after it pulled away from construction lending about five years ago.
Glenn Gray, the president and chief executive of the $688 million-asset Sunwest, said regulators questioned why its earnings looked anemic compared with other banks at the time.
"They said, relative to our peer group, we didn't seem to be growing the bottom line strong enough," Gray recalled. "We said, 'You are right. We want to be around in the next few years.' "
Now the Tustin, Calif., company's patience is paying off. After years of mediocre earnings and sticking to a strict vanilla lending strategy, Sunwest is on a growth tear.
It has picked up three failed banks since the end of June, nearly doubling its asset size and increasing its profits significantly.
And it is not done. Gray said Sunwest continues scouting for failures in California, Arizona, Nevada and Utah, and it could double in size again within a year.
Industry observers endorse the strategy, saying it should prove lucrative as long as Sunwest can bring on enough bankers experienced in working out loans.
Still, "it isn't for the weak of heart," said Randy Dennis, the president of DD&F Consulting Group in Little Rock.
Sunwest opted to do whole-bank acquisitions through the Federal Deposit Insurance Corp., without any loss-sharing agreements.
It put in a negative bid each time, so essentially it gets paid up front to take the failed banks, Dennis said.
But nearly all of the assets are included, however iffy they might be, he said. Gauging their value quickly and properly becomes more important in such deals, to avoid getting hurt later.
"You have to bid to account for all the losses," Dennis said. "To do a whole-bank walkaway, you have to be able to do due diligence in four days and get a good idea of losses in the portfolio."
So far Sunwest has had only upside.
In June it absorbed the failed $80 million-asset MetroPacific Bank in Irvine, Calif., marking the first acquisition for Sunwest in its 40-year history.
Its third-quarter profits, which included a one-time extraordinary gain from the Metro deal, swelled to $5.4 million. (It posted a $317,000 loss in the third quarter of last year, after selling securities that had lost value. In the second quarter of this year, the bank earned $1.5 million.)
The exact amount that Sunwest ended up gaining from the FDIC payment was not immediately clear, and neither would discuss the issue.
However, its third-quarter noninterest income grew by $7.6 million from a year earlier, largely because of the payment.
Sunwest has done two more deals this fall, for the $105 million-asset First State Bank in Flagstaff, Ariz., in September, and the $134 million-asset Pacific Coast National Bank in San Clemente, Calif., in November. Both took the bank into new markets.
Gray would not estimate how many banks Sunwest could absorb or at what point it would be done with government-assisted deals.
"We will keep doing them as long as we can," he said. "To me, it is a function of three things. One, keeping the bank sound. If we drift from that, then we lose our license to do this. We also have to keep our capital ratios in order. And the third element is having the human resources to do this."
Observers said the people component is likely to be the biggest challenge for Sunwest, especially since bankers skilled at working out loans are in short supply lately.
"To double your size, have three integration projects to take care of and baskets of bad loans, that really stretches the competency of the acquirer," said Bill Bradway, the managing director of Bradway Research LLC in Framingham, Mass., which analyzes bank strategies.
Hiring is not as fast a solution as it seems, because getting people up to speed takes time, he said. "It isn't like you can go out and hire 20 people. If you did, they would still be new employees."
Gray agreed that finding qualified people could become a hurdle as Sunwest rolls up more banks.
He said it already is looking to hire — which has not been easy.
"There is no shortage of bankers looking for work, but it is still tight in respect to the type of bankers we want," Gray said. "This isn't the type of position that you can take a young rookie banker and say here is a portfolio of $20 million in workout deals, and tell them to go figure it out. It takes people with experience to know how to handle them."
But he said Sunwest also has been "fortunate" with the employees it gained in its three deals so far. "One of the things you find at a failed bank is the people who caused the problem have left," he said. "The people who are left have been working hard to fix the problems."
The deals have dented Sunwest's previously hefty capital cushion, and Gray said the bank intends to raise money next year so it can keep buying. But he declined to provide specifics, such as how much it might raise.
At June 30, the bank reported a total risk-based capital ratio of 20.52%, double the level needed to qualify as well capitalized. But after accounting for the acquisitions, this ratio would be 11.6%.
Observers speculated that attracting capital would be easy for Sunwest, even though it is thinly traded.
Its chairman and largest shareholder is Eric Hovde, founder of Hovde Financial LLC and Hovde Capital Advisors LLC. His expertise in both raising capital and evaluating bank acquisitions can only benefit Sunwest, said Richard Levenson, the president of the San Diego investment bank Western Financial Corp.
"He has an investment banking company," Levenson said. "He is good at deciding if it is a deal that is going to work, and if Sunwest needs capital, I think they could come up with sources of capital."
Levenson said because Sunwest's deals have been relatively small, they require less time to integrate, allowing it to buy failures at a faster pace than some other bidders.
Dennis said their small size is also a factor in facilitating the whole-bank type of transaction that Sunwest favors. Buyers typically would not be comfortable taking on a large failure without the FDIC sharing in future losses.
Of the 15 whole-bank deals the FDIC has done since the beginning of this down cycle, the average winning bid was for negative $30 million and the average asset size of the failed bank was $118 million, according to data from DD&F Consulting.
(That translates into an initial payment of $30 million from the FDIC, Dennis said. But the buyer then must mark down the assets and make other adjustments that end up lowering, often significantly, how much of a gain the bank actually realizes from the payment.)
Gray said Sunwest likely would continue concentrating on banks with $300 million of assets or less in future deals.
He said that it does not have a target asset size for its growth, but that it has always been conservative.
This approach led to relatively lackluster performance when competitors were growing quickly. In 2005, Sunwest's return on equity was a paltry 6.7%, compared with an average of 13.34% for all California banks.
But more recently Sunwest has been able to shine, because its performance has held steady as competitors faltered. In the second quarter, before the impact from its acquisitions, Sunwest's ROE was 7.51%, compared with a state average of negative 5.36%.
And in the third quarter, its ROE jumped to 36.11%.
"We are in this position because of what we did and didn't do back in the hay days," Gray said. "We stuck to our consistent, somewhat conservative underwriting standards. We didn't touch subprime and we didn't get involved in what subprime was driving in speculative construction."