Indiana Bank Turns to Diplomacy as Proxy Battles Heat Up Elsewhere

Surviving proxy season often boils down to knowing which battles to fight and, perhaps more important, the ones to avoid.

Several community banks are preparing to lock horns with dissident shareholders, including MutualFirst Financial in Muncie, Ind., which recently decided to forge an alliance with an activist investor as it braces to do battle with two others.

The $1.4 billion-asset company agreed last month to put Richard Lashley, a principal at PL Capital, on its board. In return, Lashley's firm agreed to support management and board as they face pressure from Ancora Advisors to sell the company. PL Capital owns nearly 10% of MutualFirst's stock.

The truce with PL Capital was designed to pressure Ancora to back down, said David Heeter, MutualFirst's chief executive. "There's no substitution for good communication and a trusting relationship," Heeter said.

The battle at MutualFirst began when Ancora, a Cleveland investment firm, requested that the bank remove a provision in its bylaws requiring directors to live in the same county. Ancora, which has a nearly 5% stake in MutualFirst, eventually launched a proxy challenge designed to add nominate two directors to the company's board.

MutualFirst joins a short list of community banks, including Fraternity Community Bancorp in Baltimore, Cheviot Financial in Cincinnati, to make peace with an activist investor. Others, however, are putting their faith in shareholders and drawing a harder line.

Shareholder activism remains strong among community banks, despite a sharp decline at bigger banks in recent years, according to a 2014 report from New York law firm Schulte Roth & Zabel.

Activists have been successful using the proxy process to push for consolidation at small banks, which face increasing pressure to raise capital and cut costs. "This strategy has not yet translated into activism at large banks," the report said.

Metro Bancorp is Harrisonburg, Pa., is gearing up for a fight with PL Capital, which is seeking to put Lashley on the board. PL Capital is upset about supposed underperformance at the $3 billion-asset Metro.

Joseph Stilwell, a mainstay during proxy season, has at least two activist challenges under way. The New York investor is seeking a board seat at the $77 million-asset Fairmount Bancorp in Baltimore.

Stilwell's firm also recently launched its fourth consecutive bid for seats at the $164 million-asset Harvard Illinois Bancorp. Last year's contest took a bitter turn after Stillwell circulated a picture of the company's former chairman taking a nap at the 2013 annual meeting. (Harvard Illinois could be more vulnerable this year after losing more than $10 million in 2014 after falling prey to a fraud scheme.)

Commerce Street Investment Management, an affiliate of Dallas advisory firm Commerce Street Capital, is pursuing board representation at the $206 million-asset Orange County Business Bank. The investment firm, a relative newcomer to shareholder activism, wants governance changes and a potential sale of the Irvine, Calif., bank.

"We're doing what activists traditionally do — we're forcing them to make hard decisions," said Mark Ruh, a managing director at Commerce Street Investment Management. "We hope they do that."

Ruh declined to comment on whether his firm plans to pursue challenges at other banks that are in its investment portfolio. Orange County Business Bank did not respond to a request for comment.

As proxy season heats up, however, major players throughout the industry are encouraging management teams and boards to address the concerns of long-term investors outside of the proxy process. Directors at JPMorgan Chase and Ally Financial, for instance, recently joined a group that advocates for increased communication between shareholders and boards.

"Engagement between public company directors and their shareholders is an idea whose time has come," the group, known as the Shareholder-Director Exchange, said in a July letter to the nation's biggest companies.

So far, no directors from community banks have joined the group, an SDX spokesman said.

Recent research also points to the benefits of working with investors. Collaborative settlements with activist investors have resulted in higher shareholder returns across several industries, according to a report published last spring by McKinsey & Co.

But negotiations aren't easy. The proxy fight at Orange County Business Bank, for instance, was sparked when the bank's board declined to meet with Commerce Street. Since then, it has caused a bruising public relations battle for the bank that was recently covered in the Los Angeles Times.

"We could have avoided a public fight," if the bank "had agreed to meet, and if we could have privately reached an agreement," Ruh said.

As for MutualFirst, management and the board opted to work with one activist rather than face a fight on multiple fronts. In addition to pairing with PL Capital, the company removed its residence requirement for directors.

Ancora seemed "a little surprised when we took that step" of removing the eligibility requirement, Heeter said. "My perspective is that they were satisfied that we listened to them."

Representatives for PL Capital declined to comment, citing an agreement it signed with MutualFirst. Ancora did not respond to requests for comment.

MutualFirst's efforts paid off. Ancora withdrew its board nominations a few days after the agreement with PL Capital was announced. As a result, MutualFirst avoided a costly proxy battle and its first activist challenge, Heeter said.

In the process, MutualFirst secured an assurance from PL Capital — one of the banking industry's most aggressive activist investors — that the firm will not push for the company's sale or solicit proxies while Lashley is on the board.

"We think we partnered with the preeminent financial institutional investor, and we think he will add to the success of our company," Heeter said.