James “Chip” Mahan has a colorful past as a banker who turned himself into a tech entrepreneur. He went from a failed attempt at a hostile takeover of his hometown community bank at the age of 31 to launching the first internet bank in the 1990s, Security First Network Bank, as well as developing a successful technology company that sold internet applications to banks called SQ Corp. Later, he founded what is now one of the largest Small Business Administration lenders in the country, Live Oak Bank, and used it as a jumping off point for a technology platform that is sold to other banks, nCino, which speeds up loan processing.
He speaks here with Naomi Snyder, editor of Bank Director digital magazine on the following topics:
There were 437 bank failures in the United States between 2009 and 2012, according to the Federal Deposit Insurance Corp., most of them victims of the financial crisis and the sharpest economic downturn since the Great Depression. CalWest Bancorp was not one of them, despite experiencing some financial difficulties of its own during the crisis years, and today it faces a bright future with a successful recapitalization and reconstituted board.
As much as anything, the story of CalWest, a $136.6 million asset bank holding company based in Rancho Santa Margarita, California, is a strong vote of confidence for the potential of community banking. It is often said that small banks, especially those under $500 million and even $1 billion in assets, won’t be able to survive in a consolidating and increasingly competitive industry. The story of CalWest is about a group of professional investors who put $14 million into the bank and joined the board without compensation because they believe in the long-term future of their small community bank and are ready to roll up their sleeves and get to work.
Formed in 1999, CalWest has four branches in Southern California’s Orange County that uses three different names: South County Bank in Rancho Santa Margarita, where it has two branches, Surf City Bank in Huntington Beach and Inland Valley Bank in Redlands. President and Chief Executive Officer Glenn Gray says CalWest provides “white glove service” to a small and midsized businesses. “These are companies with probably $30 million or less in annual revenue, mostly family owned,” says Gray. “We focus on C&I lending, although we do commercial real estate [lending] as well.”
CalWest’s biggest problems during the recession were primarily bad commercial real estate loans and loans guaranteed by the Small Business Administration. The bank tried “quite a few different attempts” to either recapitalize or sell itself without success, according to Gray, although it did take approximately $5 million in Troubled Asset Relief Program (TARP) funds from the federal government in 2009. Attracted by the challenge of reviving a flagging franchise, Gray signed on as CEO in 2012, leaving a different Orange County community bank where he had been the CEO for six years. “I made the move primarily because of the opportunity to come into something that clearly needed to be fixed,” he explains. “I had a pretty good idea that it could be fixed. I like doing turnaround situations.” Gray was also drawn in by the chance to invest personally in the bank’s recovery.
The bank had entered into a consent agreement with its primary regulator, the Office of the Comptroller of the Currency, in January 2011, that among other things required it to raise its regulatory capital ratios. Gray spent the next couple of years cleaning up the loan portfolio and shrinking the bank’s balance sheet to improve its capital ratios, but wasn’t ready to raise new capital until 2015 when it retained Atlanta-based FIG Partners to manage a recapitalization of the bank. The effort ended up raising $14 million in fresh capital in December of last year from a group of private investors, although it actually had commitments for $30 million, according to Gray. The funds will be used to strengthen the company’s regulatory capital ratios, support its growth plans and retire the TARP funding. The consent order with the OCC was terminated in May.
One of those investors is Ken Karmin, chairman and CEO of Ortho Mattress Inc., a bedding retailer located in La Marada, California, and a principal in High Street Holdings, a Los Angeles-based private equity firm. Karmin had first met Gray shortly after he took over at CalWest in 2012 and they talked about Gray’s plans for the bank. “It was just too early in the process for new capital to come in,” Karmin recalls. “He had work to do to get the bank in a position to be recapitalized. But I was impressed from the moment we met. I knew he was the real deal; a very capable CEO…in control of the situation and every facet from BSA [Bank Secrecy Act] to credit quality, the investment side, lending, the relationship with the regulators. It was an amazing opportunity for investors like me to put money behind someone like Glenn, who can really do it all.”
Karmin came in as a lead investor and today serves as CalWest’s board chair. (All but two members of the previous CalWest board—Gray and Fadi Cheikha—voluntarily resigned when the decision was made to raise capital by bringing in new investors.) Other investors, who also received a board seat, were William Black, the managing partner at Consector Capital, a New York-based hedge fund; Jonathan Glaser, managing member at Los Angeles-based hedge fund JMG Capital Management; Clifford Lord, Jr., managing partner at PRG Investment and Management, a real estate investment company in Santa Monica, California; Richard Mandel, founder and president of Ramsfield Hospitality Finance, a New York-based hotel real estate investment firm; and Jeremy Zhu, a managing director at Wedbush Asset Management in Los Angeles.
Although Gray and Cheikha did stay on as directors, the current board is really a new animal. The rest, with the exception of Zhu, were people that Karmin already knew. The new CalWest board also has an awful lot of intellectual and experiential horsepower for a small community bank. “A board for a bank of this size, we have the luxury of intellectual talent basically at our finger tips,” says Karmin. The composite knowledge base of the CalWest board includes extensive experience in C&I lending, BSA, investing, commercial real estate and the capital markets. “We have the talent to make intelligent, thoughtful decisions and support management,” Karmin says.
When asked what kind of culture he would like to create on his board, Karmin mentioned a couple of things. First, he says the current directors are “willing to serve and do the work and the heavy lifting.” And from an investment perspective, they are taking the long view. Karmin says they will not receive any fees or compensation for their board service “until the bank is right where we want it, operating at the highest possible level.” Nor will the directors be taking personal loans from the bank. “If you want to borrow from our bank, this is the wrong board for you,” he says. “We’re not going to do any Reg O loans.”
More importantly, perhaps, Karmin wants a board that is very focused on performance. “We want a culture of first quintile performance,” he says. “That means that we expect our financial performance on the most important metrics to be in the first quintile of banks of our size in our geographic area.”
Given the strong private equity and investor background of all of the new directors, it’s logical to assume they will be looking for an exit strategy at some point. Karmin suggests that day, when it finally arrives, will be well off into the future. For one thing, Karmin and Gray are jazzed about the potential of the Southern California market. With about 9 percent of the country’s population, “We expect that it’s going to be one of the most important growth areas in the United States,” Gray says. “Whether the [national] economy grows 2 percent or 1 percent, it’s not going to matter to us. We’re going to be a first quintile performer under all those scenarios.”
“We have instructed Glenn to run the bank for the long haul,” Karmin says. “We were making this investment for a lot of different reasons, but that we expected to be investors and to be on the CalWest board for a long time. We have real plans to grow the bank in a controlled strategic fashion. [The directors want to] use our contacts to make new contacts, use our contacts to make new loans, use our contacts to gather new deposits. We are the kind of a board that can really help on all those metrics.”
Gray says this is the fourth bank board that he has participated on and the CalWest board is very different from all the others. “It’s a board that is very involved,” he says. “They ask good questions. They ask tough questions. If you wanted to be a CEO of a bank [that has] the old country club atmosphere, this would not be the place to be.”