Cardinal Bankshares Douses 'Hottest Fires,' Aims for Growth

The wild roller-coaster ride that dominated Michael Larrowe's professional life this year could be nearing an end.

Still, completely transforming Cardinal Bankshares (CDBK) in Floyd, Va., remains a work in progress.

Larrowe, tapped in June to replace Leon Moore as Cardinal's chief executive, endured a series of highs and lows in 2012. A proxy battle uprooted half of Cardinal's board in May, including Larrowe and Moore. Moore left Cardinal a few weeks later. A reconstituted board mended fences with Larrowe, making him the CEO and reinstalling him as a director.

Since then, Larrowe and the new board have taken steps to prove to investors that the $280 million-asset company and its bank — nestled in a sleepy southwestern Virginia town with a population of 400 — can flourish without selling. Larrowe even feels confident talking about growth.

Cardinal should emerge as "a considerably larger player" in its market, he says. "There are, to be sure, challenges … but we're not looking at it from a 'woe is me' standpoint. We're going to get up every morning and say, What's next?"

Reinvention isn't easy, and it has a cost. Cardinal posted losses totaling more than $4 million in the last two quarters as it took hits to clean up its balance sheet.

Larrowe is overhauling the bank's internal operations. He is replacing a decade-old system to add products that a typical community bank should have, including mortgages, remote deposit capture and online banking. Cardinal will introduce those products in coming weeks; it plans to phase in more services during the first half of 2013.

"It's definitely going to be uphill battle for these guys, but at same time they're doing what they've got to do," says D. Anthony Plath, a finance professor at the University of North Carolina at Charlotte and a consultant to the company. "I've never seen a bank make so many changes all at one time."

Cardinal's proxy battle was a bitter contest, led by the company's biggest shareholder, Schaller Equity Partners in Winston-Salem, N.C. Only one of the company's existing directors remained after the contest ended; three directors were removed and two others resigned in protest.

Cardinal, however, has managed to stay in business, despite the past vitriol and outdated business model.

"I've seen [banks with] a couple of skeletons in the closet, but boy, I've never seen a whole cemetery in the closet," Plath says of the bank. "If you had asked me about this bank a year ago, I would have said they never would survive."

Most of the bank's loans involved real estate space. Growth was hard to come by and largely involved out-of-market lending or loan purchases from other banks. The strategy quietly escalated credit risk at Cardinal; many of those issues were overlooked until Larrowe stepped in this summer and began marking down certain loans.

Cardinal was profitable through the first quarter of this year. It has since reported back-to-back quarters involving red ink. "We tried to fix the hottest fires first," Larrowe says.

The company hasn't heard any complaints from investors about its aggressive turnaround strategy. Even Doug Schaller, who led the investor revolt earlier this year, seems content.

"They're doing a good job," Schaller says. "Even after the losses, they still have a lot of capital and should be able to grow. It takes time, but they're on the right track."

Schaller's view of Larrowe has evolved considerably in the past year. Schaller raised concerns about Larrowe when he was hired in July 2011 as Moore's hand-picked successor. Larrowe was Cardinal's external auditor when it was involved in the first whistle-blower case filed under the Sarbanes-Oxley Act of 2002.

Schaller, who once indicated that Cardinal might be better off selling to a competitor, now heaps praise on Larrowe. "There's just been so much to deal with that I know he's been working 80 hours a week," he says. "He's doing a good job and he's working hard."

Larrowe's banking experience led the retooled board to hire him as the new CEO.

"We knew the first thing we needed to do was to pick a great leader," says John Paul Houston, Cardinals chairman and one of three directors who joined the board in May. Promoting Larrowe "was the most important thing we did, and that's bearing great fruit now."

Larrowe "filled two big holes in the ship," hiring an experienced chief credit officer and chief lending officer, Houston says. Cardinal has also built out its lending team in areas such as commercial and mortgage originations. This quarter, Cardinal's pipeline for new loans grew "for the first time in a long time," Larrowe says.

"Before, we were not doing a whole lot in the credit area as far as reaching out to the community to make loans locally," Houston says. Houston, who has been a Bank of Floyd customer since he was a teenager, had to turn to another bank to get a mortgage on a second home.

The bank's relationship with the community had become fractious in recent years. Houston says the bank had started limiting use of its "community room" — a large space that once hosted events such as family reunions — for internal business purposes.

The bank had also shuttered an external teller window that had accommodated its walk-up customers.

Houston says Cardinal will reopen the community room and the teller window to the public as part of a plan to improve customer serves and the bank's image.

Schaller said his time as an activist "is over" and that he now believes Cardinal can grow independently.

Management has asked every employee to "own the moment," especially when solving problems, Larrowe says. Nearly all of the employees who worked under Moore have remained at the company during its difficult transformation.

"If you put the right people with the right skill set and services in place, you're going to be relevant to the customers," Larrowe says. "If you're relevant to the customers, you're relevant to shareholders. And then, you have a great case for being independent."