UPDATE ON BANKING : Small Banks’ Hopes of Windfall by Buyout May Be Pipe Dreams

For years, the conventional wisdom has been that, come 1991, many of San Diego County’s smaller banks would be taken over by a horde of East Coast banks intent upon building immediate market share in Southern California through acquisitions.

The conventional wisdom further suggested that, when interestate banking barriers fall in 1991, local shareholders would make a killing as cash-rich Eastern banks waged a bidding war for profitable California banks with healthy asset bases and strong branch networks.

Expectations of windfalls were fueled in 1982, when Mexico’s Bancomer paid $33 million--or three times book value--for Grossmont Bank. At the time, Grossmont, which was profitable, had about $150 million in assets and five branches.

The “three times book” multiple also seems to apply to Southwest Bank, which will merge into Security Pacific in October after completion of a stock-swap deal announced in January.

However, although Southwest shareholders will receive a price equal to three times book value, the comparison is not accurate, according to Brea-based banking industry consultant Gerry Findley.

The value to Southwest shareholders, who will receive 6.27 shares of Security stock for each Southwest share, increased in recent months because Security Pacific’s stock price has risen in value, Findley said. Additionally, “Southwest presented a unique situation because it was undercapitalized, so it’s not accurate to use a price-to-book value ratio,” according to Bank of Commerce President Pete Davis.

“Southwest shareholders just got lucky,” said Don Clague, Grossmont Bank’s president. Another bank president who is familiar with the deal suggested that Southwest’s shareholders who purchased the stock just before the deal was announced in January “made out like bandits.”

Can shareholders at other local banks realistically expect to earn a premium if their bank is acquired? (Bank executives contacted earlier this week suggested that La Jolla Bank & Trust, Torrey Pines Bank and First National Bank might be acquisition candidates.)

Probably not, according to Clague, who believes that Mexico’s Bancomer paid a fair price for Grossmont--given the competitive and regulatory situation at the time.

Then, a third of the bank’s deposits were demand deposits that earned no interest. Interest-bearing deposits seldom strayed above 5%, so banks enjoyed a hefty spread--the difference between interest paid on deposits and interest earned on loans. And, the country had yet to enter the rocky era that followed deregulation of the financial services industry.

In today’s competitive environment, bank board directors who expect hefty price tags for their shares “might be disappointed,” said banking consultant Findley. “It’s wishful thinking because it’s a different environment today, and it ain’t going to happen.”

Shareholders might better determine the value of their shares by using a multiple based on earnings because “that’s what you’re buying, the assets and potential earnings,” Davis said.

‘Stars in Their Eyes’

Davis said that in the current market price-to-book ratios are hovering at about 1.5. But he added that “1.5 times book is the base, not the ceiling” for prices that future in-county bank sales will generate.

Still, some bank board members have “stars in their eyes, (and) believe they’re going to get multiples of 2.5 to 3 times book,” said a bank president who in the past has listened to preliminary offers from larger, out-of-county banks.

Large banks have learned that “it’s not worth the hassle to go through (relatively small) deals,” the bank executive said. “It took 10 months for Security Pacific to complete the Southwest deal . . . and (big banks) just don’t have time to do these deals for banks with just three or four branches.”

However, Bank of America recently acquired a one-branch bank in Oregon and “intends to now go open a branch system based on that bank,” Davis said. “It breaks the theory that you’ve got to have a billion in assets to be of interest.”

Bank presidents believe that the recent S&L; bailout legislation will have an as-yet undetermined impact on prices paid for local banks. The legislation clears the way for bank holding companies to pick off healthy S&Ls; in other states and convert them into banking operations.

“We’ve seen some shuffling around, some looking around already,” Findley said.

Banks might be attracted to S&Ls; with strong branch systems but that “are capital short and don’t see much promise of raising capital on their own,” Findley said.

Clague and others, however, are not convinced that healthy banks will rush to acquire S&Ls; because thrifts, which are extremely sensitive to interest rate shifts, typically face tighter profit margins than banks.

Davis wondered if out-of-state bank executives would want to buy S&Ls; and face the “regulatory nightmare” of converting them into bank branches. “It would be like buying a camel and trying to convert it into a horse,” said Davis, who believes out-of-town banks would prefer to acquire existing bank branches.

“This is a fun time to be in banking in San Diego County,” Davis said. “You can sit on sidelines and watch everything that’s going on. Banks in the county are all making really good money, we’ve got good spreads and the problem banks have all been cleaned up.”