The Growing Season

&MSeven years ago, the State Bank of La Grange was just another one-branch community bank in rural Texas, with a board that harbored few ambitions aside from ensuring the institution survived. Since then, assets have increased sevenfold, and expansion has become the mantra.

The institution, now known as Texas United Bancshares, boasts 18 branches, stretching from Houston to Austin, and includes an investment adviser, trust division, and factoring unit. The $558 million holding company also has a Nasdaq-listed stock and is hurtling toward a first-ever public offering.

It’s often said that the most important decision a board makes is to hire a chief executive, and Texas United’s outside directors credit CEO Don Stricklin, a 44-year-old former Banc One executive, with instilling a sense of urgency and swagger to their 135-year-old institution. Since his hiring in 1996, directors say, Stricklin has leveraged the company’s capital in shrewd fashion to drive earnings and return on equity higher than any of them ever thought possible.

During the first three quarters of 2002, Texas United reported net income of $3.4 million, or $1.30 per diluted shareu00e2u20ac”which is up 11% from the previous year’s level and dwarfs the $1.1 million earned the entire year before Stricklin’s arrival. The company’s ROE was 14.9%, despite some hefty merger-related charges. “It’s just amazing how smart we look now, compared to how stupid and backward we looked before,” says Lee Mueller Jr., the company’s largest shareholder and a director since 1993. “The difference is, we’ve got a leader who generates enthusiasm and brings out the best in people.”

This is clearly an exciting time for Texas United directors. But there’s something about the fast growth and higher profile that can be a bit unnerving, as well. All of the directors grew up and live in rural south Texas, and while they consider themselves and their colleagues sharp, they also have read stories about outside investors who scrutinize the quarterly numbers, demand board seats or other changes, and sometimes even force sales. That raises the anxiety about going publicu00e2u20ac”and the sense of responsibility.

“There’s no question that there’s a little bit of fear and trepidation on our part,” says Bruce Frenzel, owner of an engineering consulting firm in La Grange and a director since 1982. He supports a public offering, but “we’re going to have people looking at us who will really question us on the numbers. That’s going to raise the pressure on us as a board.”

For directors, the trick will be to ensure that the numbers stay positive while increasing their own oversightu00e2u20ac”both because investors nowadays demand it, and to protect themselves. If things continue as they have, the first part should be no problem: Stricklin’s disciplined approach to capital and his opportunistic expansion strategy should keep Texas United in good stead for some time. But one of the touchy side issues raised by the company’s growing profileu00e2u20ac”the level of communication between management and the boardu00e2u20ac”has been more worrisome.

By all accounts, Stricklin is a strong leader who has surrounded himself with good managers, many lured away from big banks like Bank One Corp. and Wells Fargo & Co. But he hasn’t been real big on communicating with directors. Board meetings are relatively short, and he has an informal policy of not talking with board members outside of meetings.

This style works for many companies, and some Texas United directors say they get enough information already. But for other directors who have watched corporate scandals blossom just as their company heads for Wall Street, it won’t do. In recent months, some have encouraged Stricklin to provide more information and allow the board to mature in step with the company.

“All of us are small-town guys, and there are times when we get a little uneasy and wish that we’d had some more information about the decisions made by management,” Mueller says. While the board is getting more reports now than in the past, there’s still progress to be made. “We’re growing as a company and as a board, and we need to make sure we’re seeing the whole picture,” Mueller adds. “That’s our job.”

Texas United traces its roots to the Czech and German immigrants who moved in the mid-1800s from Galveston to La Grange, along the Colorado River about halfway between Austin and Houston. One of them, John Schumacher, launched a general store and, in 1868, set up his own informal deposit and lending business, the John Schumacher Private Bank. The enterprise was one of the federal government’s first distribution centers for silver. In 1906, Schumacher got a charter, and the bank’s name changed to John Schumacher State Bank. In the 1940s, it became the La Grange State Bank.

And that’s where things stood for the next 50 years. The one-branch bank grew slowly, to $80 million in assets, and always seemed to turn a modest profit. But it was viewed more as a local utility than a vehicle for shareholder returns. Its most notable achievement may have been surviving the banking crisis of the 1980s, which decimated hundreds of Texas banks. “It was a sleepy community bank that let things happen as they happened,” recalls Mueller, who served on the board previously between 1973 and 1983, before leaving to start his own thrift.

Much the same could be said for the board. Like other community bank boards, directors immersed themselves in little things, like the bank’s advertisements in the high school football program, or approving $1,000 tractor loans, but never engaged in any serious discussions about strategy or the future. “The kind of decisions we made were, ‘What kind of calendars should we give out next year?’” Frenzel says.

In the mid-1990s, a great merger-and-acquisition boom was commencing. In the towns surrounding La Grange, banks were failing. Directors knew they didn’t want to sell out to a big out-of-state acquirer. So when E.H. Baumbach, the bank’s president for nearly two decades, began talking about retirement in 1996, directors encouraged him.

Directors knew the institution lacked the in-house talent to thrive, so they enlisted a headhunter to rustle up some good candidates, winnowed the list to a chosen few, and interviewed them. Stricklin quickly emerged as the candidate with the most energyu00e2u20ac”and the most compelling vision. A former examiner with the Office of the Comptroller of the Currency, the self-described “community bank guy” had spent the past decade with the old Banc One Corp. and its Texas predecessor, MCorp., working his way from senior credit officer to branch president to head of the company’s local three-state mortgage production office in Dallas.

Over time, Stricklin had grown disenchanted with Banc One’s move toward greater centralization. Still, when the headhunter called about running a tiny bank in a town of 6,000 people, he didn’t know what to thinku00e2u20ac”or even where La Grange was. He spent the ensuing days examining call reports, not to mention the atlas. “My wife said, ‘I had more people in my high school than this,’” he recalls.

One thing intrigued Stricklin immensely: the more than $9 million in capital on the bank’s balance sheet, which would afford the opportunity to pursue growth in a part of the world dominated by small banks poised for consolidation. In the interview, “I told them, ‘If you want someone to run an $80 million bank, I’m not the guy. But if you want someone to expand and build shareholder value, I’d be interested in signing up for that.’”

It was a message that resonated with a board that saw growth as the key to independence. Still, most directors didn’t totally understand what they were buying into, and some were leery about Stricklin’s views of the board’s role. During his interview, Stricklin told directors, “I don’t want to bother you guys with decisions about day-to-day operations of the bank. That’s not how I see the board’s role,” Frenzel recalls.

“I thought he was the right guy,” Frenzel adds. “But I also worried that we might be hiring a dictator, and that we would wind up finding out at [the local grocery store] what was happening at the bank, because he wouldn’t tell us.”

Shortly after being named CEO, Stricklin laid out a vision of a core banking franchise that would expand opportunistically, leveraging traditional community banking service and relationships to drive sales. Local managers would get latitude in setting their own goals and would be held accountable by headquarters for achieving profit and growth goals. At the same time, complementary businesses would be pursued to boost fee income.

At the same time, Stricklin began preaching a hawk-like approach to capital management. From the beginning, every board meeting has included at least some discussion of capital, and Stricklin himself is nearly obsessed with itu00e2u20ac”and with good reason: having too little capital means you can’t expand; having too much means shareholder returns can suffer, leaving a bank vulnerable to outside influences. “Every day I think about capital,” Stricklin says. “A lot of guys in my spot, they don’t want to think about capital that much. But it’s much better for shareholders if we run things tight.”

Directors quickly absorbed the message. “Before Don came, I thought the more capital you have, the better. That’s what a bank is about, right?” Frenzel says. “But if one of your responsibilities is to increase shareholder value, then you have to make sure that you’re putting all of your capital to good use.”

Within months, “La Grange” was removed from the moniker to give the new “State Bank” more universal appeal. A short while later, Stricklin launched a mortgage division to generate origination and servicing income. Later in 1996, he established a working-capital unit to provide margin-rich factoring services to business clients.

At times, Stricklin seemed like a man possessed. After a year on the job, one director pulled him aside and said, “Don, you need to slow down or you’ll burn yourself out,” recalls Mueller, who returned to the board in 1993. “He looked at him and said, ‘This is slow.’”

In 1997, Stricklin formed a holding company, Premier Bancshares, and a short while later did his first deal, for Citizens State Bank, a poorly run $50 million bank in Hempstead, just outside of Houston. Stricklin quickly centralized the back-office operations, brought in new management, added mortgage lending and free checking to the product mix, and spiffed up the branch with new drive-up lanes. The deal was a good oneu00e2u20ac””We’ve probably tripled the profits from it,” Stricklin saysu00e2u20ac”but left Premier’s capital well all but dry. “We couldn’t expand further without more capital,” he says.

That led him to Ervan Zouzalik, CEO of South Central Texas Bancshares in nearby Flatonia, which, like State Bank a couple years earlier, had lots of capital and wanted to put younger management in place. Over several lunches with Zouzalik, a former Army colonel, Stricklin hatched the idea of a merger. That was followed by an informal dinner at a local country club for directors of both institutions to hear the proposal and ask questions. Stricklin’s argument to the South Central board was simple: “Your shareholders can pick up some liquidity, you won’t have to sell the entire bank, and you can stay involved,” he recalls.

Some directors were initially reluctant. “By training, I’m something of a skeptic … a worst-case scenario kind of guy,” says Michael Steinhauser, a former South Central director. “But we saw the energy Don Stricklin brought to his group and were sold.”

The two organizations pooled their stock and launched Texas United, making Stricklin the CEO and Zouzalik, who remains active today, the chairman. “It was a true merger of equals, very complementary,” says Steinhauser, who currently serves on the Texas United board.

Emboldened by his company’s newfound stature and capital, Stricklin went on an expansion tear. In the year following the holding company’s formation, Texas United opened three de novo branchesu00e2u20ac”one in Schulenburg, just south of La Grange, and two along the northwestern fringe of Houston.

It also made some opportunistic acquisitions. In 1999, Stricklin cold-called owners of the First State Bank in tiny Dime Box, about 45 miles north of La Grange, after hearing they were interested in selling. A short time later, one of them visited his office. In less than 30 minutes, Stricklin offered him $7 millionu00e2u20ac”cheap, given the $5.5 million in capital it had on the booksu00e2u20ac”and it was quickly accepted. After centralizing the back office, promoting one of the junior bankers to president, and working through a few small balance-sheet surprises, the institution’s performance soared.

A few months later, Texas United purchased a branch in Pleasanton, south of San Antonio, that giant Wells Fargo & Co. was forced to sell after an acquisition. And in 2000, Stricklin picked up the pace even more, acquiring two Houston-area branches from Texas Guaranty Bank, giving Texas United a leading market share in growing Waller County, and opening a branch in suburban Cedar Park, outside of Austinu00e2u20ac”the first of four de novo branches in the Austin area.

In September of that year, the company bought Third Coast Wealth Advisors, an Austin-based investment advisory firm with $80 million under management, issuing $7 million in trust-preferred securitiesu00e2u20ac”and selling an additional $1.8 million in stock to existing shareholdersu00e2u20ac”to finance the deal.

The fast pace of growth has led to some miscues. The timing of the Third Coast deal, Stricklin concedes now, couldn’t have been much worse. While the fees and growth potential looked compelling in 2000, a prolonged stock market slump has left the unit’s asset levels stagnant. A bank-run trust division that utilizes much of the same expertise has been a bust, too. The two lost $140,000 during the first three quarters of 2002.

At a recent meeting, the board discussed whether to continue investing in the two units. Some directors say they’d just as soon cut bait. “My view is, we ought to cut our losses,” Mueller says. But Stricklin advised directors to “remember the original reason for getting into those businesses. We knew it would take a while to build it, and while it’s not a real significant piece of the company now, it could be some day.” On Stricklin’s recommendation, the board decided to forestall any action on the units until mid-2003.

Other deals haven’t panned out, either. In 2000, for example, the company bought an Internet service provider, only to sell it off about six months later. (Stricklin says no money was lost.) A branch opened within the Austin city limits that same year also has failed to live up to expectations, producing a loss of $109,000 during the first three quarters of 2002. Similarly, a small foray into insurance sales hasn’t worked as planned.

Still, directors say they’re willing to accede to most of Stricklin’s requests because he has grown in the job and shown a willingness to abandon initiatives if they don’t work out. “He’s not afraid to say he was wrong,” Steinhauser says.

Along the way, they also can learn something. With branch expansion, for instance, the conclusion now is that Texas United’s formula works best in smaller communities and outlying suburbs “where they’ve got their own high schools, newspapers, and chambers of commerce,” Zouzalik says. “We wouldn’t have known that without trying” to locate in the city.

The fact that the board is now willing to raise issues like Third Coast is a good sign. While directors gets regular updates on company matters, and Stricklin reacts to their concerns, it’s also fair to say that Texas United’s board is smaller and less involved than many of its peers.

The board includes seven membersu00e2u20ac”Stricklin, Zouzalik, and five outsidersu00e2u20ac”who defer to management on most operational aspects. The board has never shot down a management acquisition proposal, nor have directors traditionally challenged Stricklin on most matters, though they do keep a close eye on earnings per share, which they say needs to grow at least 10% a year.

Stricklin makes no apologies for what could be described as an efficient board structure. Seven members, he says, “is a good number to deal with when you need to make decisions. We don’t get bogged down in politics. We just get right down to business.” The directors generally concur, saying that a smaller group allows for more discretion on sensitive matters.

Monthly board meetings are typically shortu00e2u20ac”often less than two hoursu00e2u20ac”and committees meet just once a quarter. Directors willingly limit their roles mostly to approving management ideas, even on broader strategy questions. In turn, management solicits board opinions on key issues, factoring those views into its deliberations. “We have a free hand,” confirms Zouzalik. Directors “let us run things and make decisions, but they really watch what we’re doing.”

Contrary to many boards, directors also live by Stricklin’s desire to limit nonmeeting communications. The old State Bank president regularly confided in a couple of “favorite directors” who would get information before the rest of the board, Mueller says, breeding resentment. Stricklin’s policy of discouraging communication with directors was meant, in part, to address such concerns.

As the institution has grown, however, this has become a “pretty touchy issue,” Mueller says. Some directors fret that Texas United might be involved in too many businesses and communities for a company of its sizeu00e2u20ac”a concern shared by analysts. “The biggest risk they face is that they might be spread too thin,” says Scott Alaniz, a banking analyst for Stephens, Inc. in Little Rock, Arkansas.

When directors found out recently that some offices were not producing as well as they thought, because some overhead expenses were being figured into the numbers they received, it set off alarm bells. Mueller, who once served as chairman and CEO of Fayette Savings Association in La Grange, says he cautioned Stricklin “to be careful or one day directors will wake up and say, ‘I didn’t know we did this,’ when all the while you thought they did.”

But other directors say the onus is as much on them as management. “At a certain point, I decided I had to speak my mind,” Frenzel says. “If you think something isn’t a good idea, but you don’t speak up, then there’s no one but yourself to blame.”

Chalk up such introspection to growing pains. As the issues have become more complex, directors have worked to educate themselves. Management, to its credit, is helping. At meetings, Stricklin has addressed the curiosities and concerns of directors by giving board-level tutorials on such issues as mortgage servicing or (of course) risk-based capital. He’s also brought in outside consultants to address key issues, such as director responsibilities in a publicly traded company.

Directors also attend an annual board retreat, and many gather with other area bankers for a quarterly dinner that features speakers from a regulatory or industry group. In recent years, they’ve all attended the annual convention of the Independent Bankers Association of Texas (Zouzalik is the current chairman), and some have even gone to national meetings of the Independent Community Bankers of America, where Stricklin serves as a director.

“We’re working much harder to educate ourselves today,” Steinhauser says. “This is a bigger job than it used to be, and we’re taking it more seriously.”

For his part, Stricklin is approaching opportunities more cautiously. In contrast to what some saw as rash decision making on the ISP acquisition, Texas United’s latest deal, a $2.6 million acquisition of Bryan-College Station Financial Holding Co., was a study in patience. That company’s main operating unit, First Federal Savings, was a traditional home lender that got heavily into subprime auto loans. At one point, its subsidiary, Second Chance Auto Loans, boasted $18 million in bad auto loansu00e2u20ac”about 25% of its total portfolio. Early in 2000, First Federal’s losses grew so large that its president was forced to resign and the Office of Thrift Supervision officially designated it a “problem association.” An investment bank shopped the company later that year, but none of the 22 institutions contactedu00e2u20ac”including Texas Unitedu00e2u20ac”were willing to take on the risks.

Exploring the deal whetted Texas United’s appetite for a presence in College Station, a 150,000-person market that’s home to Texas A University. But when Stricklin hired a demographic research firm to pick out sites for a de novo expansion, he was shocked at the costs. “We’d have had to pay $2 million just to get the dirt and build the sites,” he says.

So when First Federal approached Stricklin again the next year, he was open to talking. The subprime portfolio had been paid down at a rate of about $600,000 a month, and top management had resigned. Stricklin eventually negotiated a deal that called for non-accruals to be below $1 million on the date of closing and required a specified level of capital. If those conditions weren’t met, the purchase price would go down, which is what happened.

Zouzalik concedes to having some difficulties in getting First Federal’s thrift employees to embrace a more aggressive sales culture, and Alaniz, who does not formally cover Texas United, says the deal “looks risky.” But he also says it represents a cheap way to get into a promising market. Stricklin notes that the subprime portfolio is now down to less than $3 million, and chargeoffs have declined. “We don’t think it’s risky,” he says. “This gets us three locations in a market where there’s loan- and deposit-growth potential.”

After so much growth, Stricklin says Texas United will take a breather in 2003, digesting its acquisitions and deciding whether to continue pursuing some key businesses. Not that he has much choice: After the First Federal deal, the company once again lacks the capital to expand in any meaningful way.

The future, however, is another matter. Alaniz figures there are about 100 small banks in south-central Texas. As owners age, many will look to partner with a larger institution that can provide local ownership and liquidity. The only other serious competitor in that geography is Prosperity Bancshares, a $1.4 billion Houston company that tends to focus most of its energy on larger cities. “They don’t have much competition,” Alaniz says.

Taking advantage of these opportunities will require more capital. And this time, it doesn’t look like anyone will be willing to hand it over as part of an acquisition. Last year, Texas United, with 1,200 shareholders, registered its stock on the Nasdaq. Before the listing, a consultant spent two days with directors, educating them on the implications of public ownership. “It was quite an eyeopener,” Mueller says. “Now there’s an even higher sensitivity to making sure we, as a board, are doing things right.”

The listing has laid the groundwork for an eventual IPO, which could raise anywhere between $10 million and $20 million. In December, Stricklin visited New York to test the ground with some fund managers. Directors are curious to see how their story is received by large investors. But bearing in mind the hectoring they’ve received on controlling capital levels, some also are apprehensive. If the company is serious about sitting on the sidelines this year, then “there’s no sense in raising a bunch of capital just to let it sit,” Zouzalik says.

Stricklin reckons there’s a middle ground, where the company can prepare for an offering, but then wait until a promising deal emerges to pull the trigger. “It’s a question of timing. If you get the capital, but don’t have something to do with it, you’ll be tempted to do something stupid,” he says.

That they’re even addressing such concerns today still has some directors pinching themselves. “We never used to discuss capital or shareholder returns before,” marvels Mueller. Remembering that makes the growing pains and uncertainty worth it. “We’ve come further than any of us ever imagined we would,” Mueller adds. “It’s been a pretty dramatic change. But it’s also been very rewarding.” |BD|