Extreme Makeover

Its never a simple matter to alter a company’s strategic direction. Many bank boards struggle mightily grappling with the minutiae of whether to add another branch or launch a new loan product. Few dare attempt major surgery for fear of screwing up what they’ve already got, no matter how uninspiring it might be. And then there’s the board of United Western Bancorpu00e2u20ac”previously known as Matrix Bancorpu00e2u20ac”in Denver, which in less than a year turned a $2 billion institution on its strategic head.

Over the course of several months in the summer and fall of 2005, directors digested a complicated plan to transform what essentially had been a wholesale mortgage operation into a more traditional community banking company. They studied their options intently, hemmed and hawed over execution challenges and potential risks, and fretted over how and where they would find the talent and money to accomplish such a drastic makeover. After satisfying themselves on those fronts, they helped pitch the vision to regulators and investors. Since then, they’ve overseen initial execution of the plan, including the sale of several noncore businesses, and even changed the company’s name to one they thought better carried the type of regional gravitas all good bank names should possess.

It has been a monumental tasku00e2u20ac”one that’s required board members to put in long hours. In perhaps the most worrisome part of the deal, they swallowed hard and followed the advice of investment bankers and lawyers in pursuing an unconventional financing plan that involved convincing new investors to pay $19 per share for a stock that, for years, had traded in the low teens. They then turned around and bought out existing shareholders who wanted an exit at that same $19u00e2u20ac”about a 50%-plus premium to the former trading price.

Some board members admit they had misgivings at first. Before it was over, most of the company’s top executives and three directorsu00e2u20ac”including two cofounders of the original companyu00e2u20ac”had exited, either for lack of skills or interest. The departees left on ostensibly good terms, with nice severance deals in their pockets. Observers might ask why the remaining board members took on such a big risk and time commitment. In the end, the answer boiled down to one simple concept: improving shareholder value.

“We were looking at a stock price that was no better [in late 2005] than it was when we went public [almost nine years earlier],” says Lester Ravitz, 68, a director since 2001 and previously the chief operating officer of the former First Union Corp.’s brokerage services unit. “We had spent so much time working with the old business plan, and it wasn’t working. So people had begun to think that maybe we needed to do somethingu00e2u20ac”make a change in direction.”

The change they opted for was a doozy. New CEO and director Scot Wetzel, a smooth 37-year-old with slicked-back hair and well-pressed suits, argues that the new United Westernu00e2u20ac”the name change became official at a June shareholders’ meetingu00e2u20ac”is best thought of as “the largest de novo banking operation in the history of U.S. banking.” The company boasts a $20 million lending limit, and an operating platform capable of accommodating a mid-sized community banking business. “This is a $2 billion startup,” Wetzel says. “We have a huge head start on other community banks.”

The company plans to target primarily small- and middle-market businesses across Colorado’s Front Range, an economically vibrant area along the eastern edge of the Rocky Mountains that contains the state’s largest cities and much of its populationu00e2u20ac”reckoning the combination of high lending limits and local decision-making will be a winner with prospective customers. It will retain one of its key strengthsu00e2u20ac”Waco, Texas-based subsidiary Sterling Trust Co., which manages 45,000 IRA and qualified plan accounts, and $300 million in low-cost deposits. But over time, the asset side of the balance sheet will shift from predominantly low-yield mortgage loansu00e2u20ac”Matrix’s net-interest margin in the first quarter was just 2.7%u00e2u20ac”to higher-yielding business loans. Already, the company has spun off some ancillary businesses, bought sites for two new branchesu00e2u20ac”with another four on the drawing boardu00e2u20ac”and hired a team of experienced executives and local bankers to man those operations.

While it’s too early to say how things will play out, observers are bullish. Brad Ness, an analyst for Friedman Billings Ramsey Group based in Arlington, Virginia, the investment bank that underwrote the financing for the transaction, says the new United Western “has the potential to post 20%-plus earnings-per-share growth for the next three to five years” as corporate assets replace mortgage loans on the books. Ness has a 12-month per-share price target of $27 on the stock, which in late June was trading at $23.

“This is a wonderful story,” says Howard Adler, a corporate transactions partner with Gibson, Dunn & Crutcher in Washington, D.C. Adler advised FBR on the legal mechanics of the deal, and he gives Matrix’s board high marks for its efforts. “They’ve taken a set of assets, brought in experienced and talented people, sold some things, rejiggered the mix and changed the focus, and all of a sudden they’ve got something that’s worth a lot more than it used to be,” Adler says. “The job of any good board of directors is to create value for shareholders, and that’s what these guys did.”

Matrix was founded in 1989, primarily as a mortgage servicing operation. It would collect wholesale funding, originate some loans, and do most of the processing and back-office work. Four years later, it acquired a small, family-owned thrift in Las Cruces, New Mexico, changing its name to Matrix Capital Bank. “We were charter shopping, looking for a federal thrift charter so we could acquire loans on a national basis,” recalls cofounder Guy Gibson, the company’s largest shareholder and now chairman of United Western.

During the early years, Matrix’s operations grew haphazardly. In the mid-1990s, for instance, it acquired a branch in Sun City, Arizona that was being divested by the old Norwest Corp., mostly because “real estate was cheap, and we were able to get a branch on an acre-and-a-half on a great corner for a half a million bucks,” Gibson says. “All we had to do was put up an ATM machine and we had a branch.” Over time, other businesses joined the mix, including a securities clearing business, an aviation lending operation, a real estate management company, a specialty charter school financing unit, and a mortgage brokerage and consulting business.

The pieces never really seemed a good fit to officials at the Office of Thrift Supervision. Nor did the regulators feel comfortable having a banking company the size of Matrix in a small town like Las Cruces. As Gibson recalls, Matrix’s growth left it with the feel of “a $1 billion bank in a $15 million town.” After some prodding from the OTS, in 2001 the company moved its headquarters to Denver, buying a big building along the downtown financial district, and emblazoning the Matrix name on its top. But even that couldn’t completely assuage the regulatory folks.

In retrospect, Gibson says the original business plan might not have been all that workable. “The theory was that, instead of doing bricks-and-sticks branching, we’d acquire processing businesses that created large assets for the bank. And we’d grow the liability side of the balance sheet by acquiring these businesses, instead of doing business on the corner,” he says. “What we learned over the yearsu00e2u20ac”and the board had to deal with this a lotu00e2u20ac”was that it was a very complex business plan for the regulators to grasp. They always were coming to us and saying, ‘Get a little bit more traditional.’”

If the OTS had a tough time embracing the plan, so, too, did investors. Through its nearly nine years as a public company, Matrix’s book value had more than tripled, as its asset base blossomed from $275 million to $2.1 billion. But after briefly jumping to near $30 in 1998, the share price fell close to its IPO level of $12 a year later, and it never really moved after that. The stock was actually trading at a substantial discount to its tangible book value when the board started considering the makeover plan in earnest.

The flaws in Matrix’s wholesale mortgage strategy became painfully obvious a few years ago when interest rates started climbing and home loan activity cooled off. Investors say it paid big premiums for loans and then got caught in a wave of prepayments, which required writing off those premiums and cutting into servicing revenues. In 2002, it earned $27.4 million in revenue from administering loans; by last year, the figure had dropped to $10.1 million. Net-interest income growth over that time was more or less flat. Matrix reported losses in both 2002 and 2003, earned $3.28 per share in 2004u00e2u20ac”due mostly to a big asset saleu00e2u20ac”and then eked out just 22 cents per share in 2005.

Directors say they were pleased that the company was able to retain its independence in a consolidating wholesale mortgage industry where few smaller players remain standing. “When you recognize the economic environment we went through, we were extraordinarily proud that the company didn’t fail, and actually made some money,” says Peter Weinstock, a nonvoting board member and head of the financial institutions practice at Jenkens & Gilchrist, a Dallas law firm. Even so, he concedes that without earnings growth, dividend payments, or share-price appreciation, “it wasn’t very exciting for investors.”

Such frustrations had been simmering for quite some time when Gibsonu00e2u20ac”who had resigned as CEO and left the board in 2002 after acquiring a securities clearing business, but was still Matrix’s largest shareholderu00e2u20ac”began plotting a significant course change. It was 2004, and he had the idea that Colorado’s Front Range, dominated as it was by superregional banking companies, could use another strong community bank. Matrix, he reckoned, could remake itself into that institution. “We had this $2 billion institution that was positioned to take advantage of [the market dynamics] in some way,” he recalls. “Now seemed like it might be a good time to try it.”

The rationale was simple: Colorado was one of the last states to permit branch banking. Once interstate banking became the law of the land, the state’s big banks fell. According to the Federal Deposit Insurance Corp., the six banks with the most deposits in the fast-growing Denver metropolitan area are all big, out-of-state players, including Wells Fargo & Co. in San Francisco, Minneapolis-based U.S. Bancorp, JP Morgan Chase & Co. in New York, and Oakland, California-based Golden West Financial Corp., recently acquired by Wachovia Corp. in Charlotte. Combined, they control more than 55% of the state’s deposits. But just like everywhere else, many clients would just as soon do business with a bank that makes its decisions locally.

Quietly, Gibson began discussing the idea with investment bankers and a handful of confidants, but not yet with the full board. There were a lot of moving parts that needed to be addressed, and “I wanted to see if it was something investors would buy into before getting the board excited about it,” he explains. Eventually, he invited four investment bankers to make pitches on how to accomplish his vision. “I didn’t want a change in control. I wanted to redirect the business efficiently,” Gibson recalls. One of them, FBR, came up with a unique plan to raise the money and execute the transformation.

To build a commercial bank, Gibson also knew he’d need to recruit a top-flight banker with local know-how and connections. He asked close associates for recommendations, and one suggested he talk with Wetzel, the Colorado division president for Birmingham, Alabama-based Compass Bancshares, who had privately expressed a desire to someday start his own bank. As it turned out, Gibson already knew Wetzel, who was one of his personal bankers. So when they met over lunch one day, Gibson cut right to the chase. “Are you thinking about starting your own bank?” he asked.

Wetzel was surprised, but also somewhat receptive. Gibson told him he might be willing to fund a startup. “But first,” he recalls saying, “I’ve got this other idea that could give us a big head start.” For Wetzel, it would be a big risk. He had a young family to support and was a rising star inside Compass. Eventually, the duo reached an agreement: If things didn’t work out with Matrix, they would go in together on another bank.

In July of 2005, Gibson brought his plan to the board: The company, with the help of FBR, would raise $87 million from mostly institutional investors in a “private investment in public equity,” or PIPE, transaction. Matrix would then turn around and do a company-sponsored self-tender to buy out any investorsu00e2u20ac”including board members and senior managersu00e2u20ac”who didn’t want to be part of the new community banking company. The dual transactions would leave the board with shareholders who wanted to be there, treat those who wanted to depart fairly, and hopefully increase the float by getting more shares spread among institutional hands.

Hand-in-hand with the investment, a new management team would be hired to rebuild Matrix into a community banking organization, complete with branches. As low-yield mortgage loans fell off the books, or so the idea went, they’d be replaced by higher-yielding commercial loansu00e2u20ac”boosting margins and profits. A 30-page report from FBRu00e2u20ac”filled with details on everything from local market dynamics, demographics, and competitive analyses, to what sort of premium a well-run community bank’s stock could fetchu00e2u20ac”buttressed the argument. If the deal was to be done, Gibson added, it would need to happen by the end of the year. The reason, Wetzel says, was to limit potential liabilities and the ability of would-be suitors to jump into the middle of the transaction.

It was a startling proposal, though directors weren’t completely surprised. Gibson, an entrepreneur with a boyish glint in his eye, has long had a knack for coming up with new ideas. “Let’s just say that we’ve known Guy for a long time,” says James Bullock, 69, an emeritus professor of accounting at New Mexico State University and a director since 2003. Even so, the initial reaction from board members was guarded. “I’ve got to say that from a personal perspective, the idea of community banking wasn’t something I was really comfortable with,” Ravitz says.

It perhaps didn’t help that Wetzel, who was unknown to most of the directors, did a lot of the talking. Wetzel felt good about his efforts. “We demonstrated what a community bank asset could produce versus a wholesale asset, and the process for transitioning those assets. It was a discussion about spread mechanics,” he recalls. “And then we translated that into earnings-per-share growth over time.” Board members, however, were skeptical, recalls Robert Slezak, 47, a director and former chief financial officer at Ameritrade Holding Corp in Omaha. “As a board, it was apparent that the direction we were on wasn’t in the best interests of shareholders. But this was a new structure that none of us was really familiar with.”

By the end of that first discussion, board members had latched onto three key themes that would color their deliberations in the coming months: Viability of the business plan, the abilities of the proposed management team, and how the deal’s financing could possibly be pulled off. “If you’re going to do something like this, you have to feel very comfortable with it,” Bullock explains. “We knew we’d need a much better understanding of the financing and the retail banking market. And we were concerned whether we could find the right people to build this kind of franchise.”

In short order, the board established a committee composed of the five independent directorsu00e2u20ac”Bullock, Ravitz, Weinstock, Slezak, and David Frank, a New Jersey mortgage consultant who had been on the board since 1996u00e2u20ac”to dig into the details. During August, the committee met often, sometimes even twice a day, to pore over details and address questions. It was a time-consuming task. Weinstock recalls being in Lake Tahoe on a family vacation and rising early each day for a conference call with the other directors. “Every morning I’d get my Starbucks coffee, go to a pay phone, and conference in,” he says. “And that was just in the early due diligence phase.”

With fellow board members and co-CEOs Richard Schmitz and D. Mark Spencer each owning more than 17% of the company and wanting to sell their stock and pursue something else, the directors viewed one of their main responsibilities as safeguarding the interests of minority shareholdersu00e2u20ac”in part due to director liability concerns. “Whenever you’re issuing stock or buying back stock, those are fiduciary decisions, and you need to be careful,” Weinstock explains.

Much of the discussion focused on the business plan’s feasibility. “There wasn’t really a blueprint out there for converting a wholesale bank with a hodge-podge of businesses into a community bank,” Slezak says. Was the community banking opportunity as good as it sounded? If so, some directors wondered why the company needed help from outsiders. “One of the first things we asked was, ‘Why can’t we do this ourselves?’” Bullock recalls.

“We talked ourselves out of that one fast,” he adds with a chuckle. “We didn’t have what it takes to execute a plan like this.”

In late August, Wetzel flew to the hometowns of each director to further introduce himself and lobby for the change. These were important meetings for the board members: They were considering handing over the keys to Wetzel, and needed to have confidence in his abilities. Directors were cordial, but also diligent. “All of us approached those meetings with skepticism,” recalls Weinstock, who discussed the legal and industry landscapes with Wetzel in his Dallas law office. “We recognized that Scot’s job was to convince us to go along with the plan.”

Prior to a lengthy breakfast meeting with Wetzel at the Las Cruces Hilton, Bullock says he researched the prospective CEO’s background on the Web. “I did a little Googling on Scot’s name,” he explains, and found loads of information about charitable activities he was involved in. As he came to grasp the business plan, “Scot was really the only remaining unknown in the equation for me,” Bullock adds. “I really needed to be impressed with him.”

Slezak’s meeting came over a long lunch at Piccolo Pete’s, an Italian-style restaurant on the south side of Omaha. He quizzed Wetzel intently on his background, and the experience of the other people he proposed bringing in to help run the new organization. “It was akin to interviewing a babysitter before you leave your infant for the first time,” he recalls. “I wanted to have some degree of comfort with who would be tending the child.”

Wetzel impressed the directors with his professional manner, the amount of thought he had put into the plan, and his ability to articulate its nuances. They also were heartened by his local connectionsu00e2u20ac”he had a full roster of bankers who seemed willing to take a flyer on the revamped company.

None of that, however, addressed the most puzzling part of the entire proposal for directorsu00e2u20ac”the financing. Matrix’s stock had traded between $9 and $14 in recent years, and it was around $13 last summer. For the transaction to work, FBR intended to sell the stock at a substantial premium to satisfy big shareholders, such as cofounders Spencer and Schmitz, who needed to be bought out. “If you’re an investor, why not just buy stock at $12?” Weinstock recalls asking. One problem with that argument was that Matrix’s stock was thinly traded, which would make buying a block at that price next to impossible. And officials from FBR, a reputable firm, had offered examples of two similar deals they had engineered in the past.

Even so, the directors remained leery of the idea and insisted on a separate fairness opinion from FBR on the terms of the proposed transaction. “We had to address an investor mindset of why anyone would want to pay a 50% premium over the trading price,” Weinstock says, because if that part of the deal didn’t happen, all the other component parts would be moot.

As part of their education, board members leaned heavily on the investment bankers and lawyers, who assured them the idea wasn’t as far-fetched as it sounded. “At some point, a board has to rely on the professional opinions of experts,” explains Slezak, who serves on two other public company boards. “These firms do this stuff for a living. As directors, you listen to them and ask appropriate questions.”

From that process, board members came to understand that the combination of a big, new community bank with strong management in a market as good as Denver’s promised the kind of growth that attracts institutional investors. Tell the story right, they reasoned, and investors would do the math and ignore the price discrepancy. “The great thing about institutional investors is that they’re only motivated by one thing: seeing the stock price go up,” Slezak says. “There’s no emotional attachment to old management teams or stock prices. They just put their money where it can appreciate most.”

On a separate track, Wetzel, Gibson, and Bullock traveled to San Francisco to meet with OTS officials. While nothing about the deal required regulatory approvalu00e2u20ac”the transaction was crafted carefully to avoid that necessityu00e2u20ac”it still added a layer of comfort to know that the regulators who had long struggled with the company’s old model would embrace the new one.

Slowly, director skepticism began to melt. By the next full board meeting in early September, momentum for the deal was strong. “The [attitude] was more, ‘What can we do to facilitate the transaction and make this thing work?’” Slezak says. After a detailed update from Wetzel and the FBR team, the directors analyzed some comparable transactions that FBR had engineered and then authorized the team to move ahead on executing the plan.

In just over two months, Matrix’s board had signed off on a majoru00e2u20ac”almost unprecedentedu00e2u20ac”overhaul of the company’s operations. But its work wasn’t done yet. Now able to talk more fully about what the company had planned, Wetzel began recruiting prospective employees in earnest. Heu00e2u20ac”and to a lesser extent, Gibsonu00e2u20ac”also hit the road to sell the vision to institutional investors.

While Denver’s growing market held natural appeal, there were still some issues that investors would have to address. For starters, there was the risky combination of a new plan and management team. Perhaps more daunting, since a PIPE transaction is considered private, some investors would be required to mark down the value of the investment by about 20%, Wetzel says, because the market value was unavailable.

In their meetings, investors would say, “Let me get this straight: You’re doing a PIPE transaction in the fourth quarter, the management team hasn’t run the bank, you’re going to change the name of the companyu00e2u20ac”and you’re increasing the price of the stock by 50%?” Gibson recalls. Not surprisingly, some balked. “They wondered why they should buy at that price,” Wetzel says. “We said, ‘If you don’t buy in now, there might not be a deal.” In the end, enough were convinced by the economic promise of Colorado’s Front Range to buy in.

“You had to get over the fact that a little bit earlier the share price was much lower. But you still had to look at the deal on its own, and determine its worth,” says Jonathan Starr, a portfolio manager for Flagg Street Capital LLC, a Boston-based investment firm. Flagg Street manages 386,000 United Western shares, or just over 5% of the total outstanding, most of which it bought during the offering. Starr says that the subsidiary Sterling Trust and other company assets had value on their own, and Wetzel and Gibson inspired confidence in the plan. “At the end of the day, people just threw out the old price and said, ‘It would have been nice to buy in at that price, but it’s not going to happen.’”

Outside directors, meanwhile, focused on making sure the existing mortgage business stayed on track. Slezak, who did several big transactions as Ameritrade’s CFO, cautioned fellow directors “that a lot of deals wind up failing for one reason or another. So we’ve got to make sure we don’t let what we’ve got slip,” he recalls.

They also began working on the post-transaction board. Wetzel wanted a small, manageable group of directors with skill sets he could use to build the company. So in addition to the departures of Spencer and Schmitz, an agreement was reached to release Frank, who received a $75,000 severance payment. “Given the focus of the new organization, his expertise in mortgages wasn’t really needed,” Wetzel says.

In November, the boardu00e2u20ac”including Frank, Spencer, and Schmitzu00e2u20ac”voted unanimously to approve the plan. On December 9, 2005, Matrix completed its private offering, selling 5.1 million shares at $19 each, to bring in $97 million (less $10 million in fees and expenses) and 85 new investors, most of them institutions. (FBR’s initial target price of $21 had dropped by deal time.) About six weeks later, on January 23, 4.2 million shares were tendered at the same price. The amount included 17% stakes held by Spencer and Schmitz, who also got $1 million each in severance. “This was a strategy they didn’t want to participate in. They wanted to run a wholesale bank,” Gibson says. “So they said, ‘We’ll take our money off the table and let you try to build a retail bank.’”

Since then, five regional presidents have been hired and the company has sold three subsidiariesu00e2u20ac”a mortgage brokerage and consulting unit, a real estate brokerage, and the charter-school lending businessu00e2u20ac”netting more than $12 million. It also plans to sell its downtown office building, which could fetch another $25 million, in order to lease space instead. In mid-June, the name change became official. Two weeks later, a big picture of United Western officials, tossing shovels of dirt as they broke ground for a new branch in suburban Cherry Creek, appeared in the Denver Post.

Directors say they’ll be keeping close tabs on the progress of Wetzel’s team, watching key metrics such as returns on assets and equity, loan growth, and the spread, which is expected to expand over time. But the very nature of what has occurred makes some of the oversight “more of a feel thing,” Slezak says. “When you’re changing a business plan to this extent, it’s difficult to set out a lot of specific benchmarks.” With the experiences of the past year behind them, United Western’s board members say they’re equipped to confront whatever challenges the future holds.