Cooler Heads Must Prevail in Bank Fights with Shareholders

American Banker is paying close attention to a trio of proxy battles set for next week that will pit entrenched management teams against so-called dissident shareholders.

In recent months, it has been interesting, and at times entertaining, to read about Spencer Schneider, an activist who resigned his director position at First Financial Northwest in February when the other directors refused to limit refreshments at annual meetings to hard candy.

There has been sparring in regulatory documents and outright courting of shareholders. Schaller Equity Partners held a reception last week at the Pine Tavern in Floyd, Va., to introduce locals to an alternative slate of board nominees for Cardinal Bankshares.

For those who think that upcoming annual meetings at First Financial, Cardinal and Harvard Illinois Bancorp will resolve longstanding and contentious disputes, think again. Banks rarely purge themselves of activist investors, who spoil for these contests like a boxer for a Saturday night main event. If they lose a vote, they often regroup, wipe their bloodied nose and return a year later to go at it again.

"The heat really doesn't go away," says Douglas Schaller, the president of Schaller Equity Partners, which is applying pressure on Cardinal to add up to five directors. "I expect to be a shareholder for a really long time. I think we'll prevail. If not, I'll still be angry and I'm not going away. There is always next year."

Therein rests the challenge for the management teams facing proxy battles. There are two possible outcomes: lose and face more pressure in your boardroom, or win with the realization that external pressure is ready and waiting to resume at a moment's notice.

"You have to fine-tune your practices," says Merrill Sherman, who fended off two proxy challenges from PL Capital while the chief executive of Bancorp Rhode Island. After the second vote, the two sides mended fences; the Providence company sold to Brookline Bancorp earlier this year. "If you weren't on your toes every day, they were there to be critical," she says of PL Capital's principals.

Schaller declined to discuss specific strategies for dealing with Cardinal, which has an annual meeting scheduled for Tuesday. Schneider, who represents Stilwell Group, also would not comment. Stilwell has proxy battles on the dockets of Harvard Illinois and First Financial, which have meetings set for next Thursday.

John Palmer, who co-founded PL Capital, is willing to discuss the thought process for activist investors, since his firm is largely on the sidelines this year. Palmer, along with partner Richard Lashley, has been involved in numerous skirmishes with bank executives and directors since founding their company in 1996.

So what happens when an activist wins?

"The day after we get elected, we start a dialogue with all the directors on the business issues," Palmer says. "A lot of these boards have good business people who just aren't bankers. … At first the relationship can be a bit combative, but it isn't about going in there yelling and screaming. I spend two days preparing for those meetings because it is all about the opportunity to share facts and set the agenda.

Change comes slowly, if at all. "At the end of the day, you only have a minority participation in the boardroom," Palmer cautions. Still, a dissident investor joins the board with backing of a majority of shareholders, it certainly provides some confidence. "We try to enforce that again and again."

What if a management team and existing board prevail?

"If we lose, we ask ourselves several questions," Palmer says. "Were we right on the business issues? If so, why did we lose? Is there a way to engage management or should we regroup and run again the next year?" He says that large institutional investors will often give bank management a year to fix problems, and that can embolden an activist to stick around.

Palmer and Sherman agree that their companies came together after PL Capital's second failed proxy battle, though each has a different memory of what led them to reconcile. Palmer credits Bancorp Rhode Island for successfully navigating credit. "Sometimes a bank will prove us wrong," he says. "My partner stood up at one of their annual meetings and expressed concern about potential credit deterioration, and they never materialized."

Sherman says financial performance improved because the company had made short-term investments that finally began to pay off. "We won more votes the second time around than we did the first time," she says, emphasizing the importance of the company's institutional investors. (About 63% of votes cast that the company's 2008 annual meeting backed the existing board, which was slightly more than those cast a year earlier.)

Before the 2009 annual meeting, PL and Bancorp Rhode Island reached a truce. The banking company agreed to reduce the size of its board to 12 directors from 15 over three years and it adopted a majority vote system for board elections. PL Capital agreed to halt its efforts to influence the board and management.

"It was not a productive use of their dollars or our dollars," Sherman says of the proxy battles. "We articulated what our plan was, what we were doing, and then we executed on it. That is why we were successful in the proxy contest and why we ended up on good terms with PL."

So there is always hope that dissidents and bank executives can come together and work out their problems. In the case of this year's contests, however, the tone has been particularly harsh. Joe Stilwell used a regulatory filing to call the leadership of First Financial "idiots." In Virginia, Cardinal has filed a lawsuit against a former bank CEO claiming, among other things, that he is in cahoots with Schaller's group.

For Palmer and Sherman, the bottom line when it comes to making up can be as simple as an improved bottom line.

"We tend to believe we never go into a proxy contest unless we have a sound business reason for it," Palmer says. "We are looking at things such as performance or situations where the corporate governance is flawed and can be corrected."

"You try not to take it personally," Sherman says of the sparring. "At the end of the day it is all about performance."