Santa Monica Bank has staged a dramatic comeback in recent months.
As a result, its future is threatened.
The bank’s dilemma may seem like a desirable one what to do with a pool of excess capital that has accumulated in the course of a recent turnaround.
“They need to do something to grow shareholder value,” said Charlotte Chamberlain, an analyst with Jefferies & Co. “I think they’re sitting on their laurels and need to get more aggressive.”
Santa Monica Bank posted impressive second-quarter earnings last week, signaling further improvement.
Net income for the quarter ended June 30 was $3.05 million (43 cents per share), compared with $2.1 million (30 cents) for the like period a year ago. Shareholders equity the equivalent of the bank’s capital was $77.3 million vs. $68.0 million.
But while that capital grew 13.7 percent in the quarter, net loans were up only 5.2 percent, meaning the bank’s capital continues to accumulate faster than it is being utilized.
Unless the bank gets busy utilizing that capital, whether by stepping up its lending, opening new branches or acquiring another bank, it could be at risk of a takeover, say analysts.
“I’m positive on them, but their main issue now is how to effectively leverage the excess capital they’ve generated,” said Dave Winton, an analyst at Keefe Bruyette & Woods Inc.
If left idle, the rising supply of capital could erode average return on equity. Too much idle capital could also attract unwanted takeover attention.
Santa Monica Bank President and CEO Aubrey Austin responded to analysts’ concerns by saying that the bank is constantly looking at growth opportunities, both through increased loans and through acquisitions.
“There are more and more opportunities out there,” he said. “Even though we haven’t hurried the way (analysts) want us to, I think we’re positioned well. We need to grow more than we have been.”
The current boom is reminiscent of the bank’s early years when it was one of L.A.’s most successful community banks, turning a profit every year since its founding in 1928.
But that stellar record came to a screeching halt in 1992, when the bank reported a net loss of $9.4 million. That was followed in 1993 by the Federal Deposit Insurance Corp. clamping a cease-and-desist order because of poor asset quality. Under the order, the FDIC required the bank to reduce its problem asset volume and seek regulator approval for all its major moves.
“(The cease-and-desist order) really was a horrible blow for us,” said Austin. “However, we knew we were in the wrong and the regulatory authorities were in the right.”
Like many other lenders at the time, Santa Monica Bank owed most of its woes to problems in the L.A. real estate market.
When the collapse began, Santa Monica Bank’s portfolio contained $170 million in construction loans and $142 million in real estate-secured loans, most of which plummeted in value.
Austin recalled one extreme case in which developers purchased a vacant lot in Beverly Hills for $4 million to build four luxury condominiums. The developers put up half the money themselves and borrowed the other half from Santa Monica Bank.
“When property values started to decline, the developers decided they would wait,” said Austin. “We finally took the property back around 1994. When we sold it about a year ago, it went for $900,000.”
In selling off and restructuring its worst loans, the bank’s assets shrank from a pre-recession high of $900 million to as low as $619 million in 1995. Construction lending also plummeted to a scant $4 million in 1994.
But rather than adopt that slash-and-burn strategy, Santa Monica Bank took a more methodical approach of working through its problem loans, disposing of the worst ones and restructuring others that were savable.
The strategy paid off: The bank returned to profitability in 1994 and posted its first net asset growth in five years in 1996. Capping off the turnaround, the FDIC lifted the cease-and-desist order in February 1996, signaling that Santa Monica Bank had officially returned to good financial health.