Employees of Virginia Bank Join Squabble Against Activist Investor

Cardinal Bankshares Corp. in Floyd, Va., and a major shareholder have again turned to regulatory filings to take swipes at each other.

This time, Cardinal got its employees involved in an ongoing battle with Douglas Schaller, who wants to oust Leon Moore as the company's chairman, president and CEO, or force a sale. All of Cardinal's 51 employees signed a letter filed Wednesday with the Securities and Exchange Commission.

"If Mr. Schaller is so interested in the growth of our bank, then why is he creating such bad publicity for it? He seems to have no personal interest in the communities we serve or how many lives he disrupts," one unnamed branch employee wrote in the Dec. 30 letter. "He simply wants his money back by selling or merging our bank."

Schaller, in a Dec. 22 letter filed with the SEC, claimed that other investors have joined his efforts to change the $246 million-asset company's "dysfunctional" leadership or force a sale.

"To my knowledge, the bank has not developed any strategy, let alone a sound strategy, to navigate the current and future challenges of increased cost, increased regulation and decreasing profitability," wrote Schaller, of Schaller Equity Partners in Winston Salem, N.C. "A 'strategy' of staying the course and rationalizing inaction — which, apparently, is Mr. Moore's plan — is akin to driving a car by looking through the rear view window. With a few moore years of Mr. More at the helm, shareowner returns will get so bad that shareowners will have to look down to see up."

Cardinal's board again stated that it would not back down, cautioning investors about listening to Schaller's "negative and misinformed" view of the operational strategy for the company's Bank of Floyd. This time, directors were joined by several employees.

"The reality is that Bank of Floyd is attractive due to the fact that it has operated with careful and conservative actions," wrote an unnamed loan officer. "I urge all shareholders to consider the amount of personal sacrifices that have been made to achieve the capital position the bank has."

The bank has remained well-capitalized, with a total risk-based capital ratio of 16.7% at Sept. 30. Like many small banks in rural communities, loan growth is weak. At Sept. 30, total loans fell nearly 7% from a year earlier, to $134 million.

Moore said in an interview Thursday that he did not put his employees up to the letter. "That's their words, not mine," Moore said. "They are mad. They are concerned. They keep just wanting to know what they can do and asked if they could write a letter."

The battle began last summer, soon after Henry Logue resigned as Cardinal's executive vice president. Moore brought in Michael Larrowe, intending to tap the newcomer as his successor. That led Schaller to file his first open letter in September, questioning Larrowe's banking expertise.

In the most recent letter, Schaller also questions the delayed time it took for the company to disclose its loan classifications despite having a new accountant. He claimed Cardinal did not correct its first- and second-quarter reports until December, after he notified management of his concerns. Now that it is disclosed, he questioned the company about a spike in substandard loans and whether they came from participations with other banks rather than Floyd's small-town borrowers.

Cardinal's board admitted in their response that they amended the first two quarters of 2011 though it did not change any loss estimates or reserves. The directors strongly denied making questionable loans within the bank or with other financial institutions, including Bank of the Carolinas Corp. in Mocksville, N.C., which once employed Larrowe. Moore said he could discuss whether Cardinal had participated in loans with Bank of the Carolinas, due to client protection laws.

"No market, including Floyd, is immune from loan defaults — not because the borrowers are bad but because events affect their ability to pay even with the best intentions," the board wrote. "We may suffer out-of-market losses but Mr. Schaller's insidious efforts to slur the integrity of those lenders with whom we participate, as well as of Mr. Moore and Mr. Larrowe, needs to be factually corrected."

The board noted that it is performing better than peers by losing 33% less on loans compared to other Virginia banks, while generating a higher return on equity. Still, more than 4.5% of Cardinal's assets were nonperforming at Sept. 30, up from 2.9% a year earlier, according to a regulatory filing.

The board's main argument continues to be that Schaller's "true" focus is forcing the company's sale. They pointed to his brief four months as a Cardinal investor before public debate began in June.

Moore said the board is not considering selling. However, if they "ever feel there is an offer worth looking at during a later point in time &hellilp;we would engage that institution and not" Schaller, he said. "We look for what's in the best interest of our shareholders, employees and the community. Selling to somebody who would strip the organization down to 10-15 employees and move us somewhere else is not in the cards for the directors."

Schaller wrote in his most recent letter that he is not solely interested in forcing the bank to sell. He would rather the bank grow by hiring "new highly professional" management. "Strategic growth that creates value for the shareowners remains the preferred approach of my Fund, but that requires professional, visionary leadership at the bank," he wrote. "I do not believe that is possible with Mr. Moore in charge."

Moore expressed concern that the battle with Schaller has only prolonged his retirement plans. "I had a date set and it passed. Then I had another date and it passed," said Moore, who's been run the company for more than a decade. "Now, I'm back to the drawing board."

Schaller declined to comment further.