Growing pains plague Unity

The Star-Ledger, September 19th, 1999

The Star-Ledger Archive COPYRIGHT © The Star-Ledger 1999

Date: 1999/09/19 Sunday Page: 001 Section: BUSINESS Edition: FINAL Size: 2089 words

Growing pains plague Unity

Lower earnings, anemic share price and layoffs are the price for buying spree


When banking giant First Union Corp. put eight vacant CoreStates branches up for sale last year, tiny Unity Bancorp. couldn't resist.

Bank executives cracked open the champagne to toast their bold acquisition. The future was all anyone could talk about at the bank's modest Clinton headquarters in Hunterdon County.

Robert Van Volkenburgh, Unity's chief executive, described the rapid-fire expansion into Middlesex and Union counties as "an exciting period of growth and opportunity."

Almost overnight, Unity had twice as many branches.

Its stock was trading on the Nasdaq.

It was airing TV commercials on CNBC.

The possibilities seemed endless for a bank less than a decade old.

Fast-forward 13 months. Today, the bank looks like a dazed shopper the morning after a wild spending binge.

The bills are piling up and Unity, which operates 17 branches across Central Jersey, is struggling to pay the tab.

An alarming 160 percent drop in second-quarter earnings revealed the first cracks in the bank's seemingly rock-solid veneer.

That same day, July 23, bank president John Tremblay, a career banker and former bank examiner who joined Unity in 1997, resigned. Tremblay was the second president to leave the bank in as many years.

And then Unity, in an effort to slash costs by nearly $1.5 million, eliminated 25 jobs, including branch managers and lending officers. Just like that, nearly 20 percent of its 120-strong work force was out of a job.

Although Unity is by no means teetering on the brink of ruin, its current financial health "indicates something went terribly wrong with their growth strategy," said David Lackey, president of Weiss Ratings Inc. of West Palm Beach, Fla., a bank rating service that tracks the health of financial institutions.

Talk to any banker on the street and they'll recite a basic banking tenet: Rapid growth in assets, loans or deposits - the kind of growth Unity experienced last year - is always a red flag.

When banks grow too fast, they're more apt to get a little sloppy - make riskier loans or investments to beef up revenues, for example.

"Anything in excess is always a problem," Lackey said.

Van Volkenburgh insists the bank is on solid ground. He says Unity will reap the rewards of its expansion once more deposits start rolling in.

"Banking is risk," Van Volkenburgh said. "And we're very good at managing our risk."

Behind all of Van Volkenburgh's chest-pounding, however, is a small bank that Lackey said simply "grew far too fast for its own good."

And now, Unity is paying the price. On Sept. 13, shares closed at 7 - a 52-week low and well off the high of 123/8 a little over 10 weeks ago. On Friday, Unity's stock closed at 7-9/16, up 3/16.

Some rough patches

"Major growing pains is a good way to describe what they're going through," says Richard Wines, president of Capital Consultants, a Princeton-based investment banking and research firm.

A closer look at Unity's latest financial filing with the Securities and Exchange Commission reveals a number of rough patches which several analysts view as troubling:

The bank's operating expenses are exceedingly high.

Its capital cushion - the bank's own money, as opposed to depositors' money - is thinning.

It has an unusually large number of commercial real estate and construction loans currently on its books.

It increased its loan loss provision, money banks typically set aside to cover any problem loans, this quarter by nearly 800 percent.

The capital cushion Unity has on hand to cover unexpected losses has been on the slide for two years now, according to SEC filings.

Federal regulators don't like to see a bank's total risk-based capital ratio fall below 8 percent of its assets. Unity, with 8.26 percent, is right on the brink. The national average is nearly double that amount, at 16 percent, according to SNL Securities. The general rule of thumb: The higher the ratio, the more sound the bank.

But Van Volkenburgh said the bank plans to add more padding to its capital cushion in the near future.

In December, Unity raised nearly $6 million in new capital by converting 401,500 outstanding warrants that were issued at the time the bank went public in 1996. And the bank has hired Advest, an investment banking firm, to help raise an additional $20 million in capital to support its aggressive growth.

Opening omen?

Unity was created in 1991 when it purchased two branches of First Atlantic Bank, a saving and loan association that failed and was later taken over by the Resolution Trust Corp.

The bank officially opened its doors Sept. 13, 1991 - "on a Friday" in the midst of a recession, Van Volkenburgh likes to joke.

Its first two branches were far-flung geographically, linked only by Route 22. One was in Clinton, an upscale, bedroom community in Hunterdon County, the other in Union, a well-established blue-collar town some 35 miles away.

"We got what was left in the auction," Van Volkenburgh said.

Over the next eight years, Unity opened five additional branches in surrounding communities.

Unity viewed buying the vacant CoreStates branches last year and expanding the franchise further as a way to fill in the geographical gap and create more synergy, he said.

As a result of this latest expansion, the bank's assets as of June 30 had climbed 52 percent to $359 million in a single year. Net loans had jumped 62 percent to $224 million, and deposits soared 57 percent to $326 million. The rapid growth in the bank's loan portfolio is one of the reasons for the eye-popping 800 percent increase in the bank's loan loss provision, said Kevin Killian, Unity's chief financial officer. He said the extra loan loss provision has nothing to do with an increase in bad loans.

"We are moving at a phenomenal pace for such a small company," said Killian, who joined the bank last year. "In the second half of 1999 we are going to reap the benefits of branch deposit growth."

In addition to adding eight new branches to its franchise in 1998, Unity also built a new one in Colonia this year.

Unity refused to disclose the total cost of its expansion. But consider these numbers, gleaned from the bank's own financial documents:

So far this year, the bank's expenses increased 74 percent to $8.8 million to cover the costs of opening new branches. Staffing all those branches also costs a pretty penny. The cost of employee salaries and benefits increased 86 percent to $4.5 million.

In addition to expansion costs, Unity is still reeling from an illegal check-kiting scheme after one customer, Michael J. Reddington, siphoned nearly $1.4 million from the bank's coffers last December.

Reddington, owner of M. Reddington Associates of Whitehouse Station, is currently serving a four-year sentence in state prison for the scheme and has been ordered to repay the $1.4 million.

All these factors have contributed to a general weakening of the bank, said Weiss Rating's Lackey, who grades banks much like a teacher grades students. In their latest report card from Weiss Rating, Unity received a D+, a grade currently held by only 4.5 percent of the nation's banks.

Unity's large number of insider loans to its officers, directors and principal shareholders has raised some eyebrows at another bank rating service, Veribanc Inc. in Wakefield, Mass.

By the end of 1997, Unity had $9.7 million in insider loans on its books, representing 65 percent of the bank's equity. That figure had declined to 24 percent as of March - a number still considered high compared to the national average of 8 percent, said Warren Heller, Veribanc's president.

Van Volkenburgh takes issue with Veribanc's assessment and defends the bank's insider loans, saying they are subject to the same terms and conditions as any other loans.

"The board of directors when organizing the corporation in 1991 felt, and I still feel, that the board of directors are the best qualified borrowers the company can have," he said.

Not one of those loans has ever gone bad, he said.

More consumer lending

Unity executives remain confident the bank's financial picture will start to improve this year.

For one thing, Killian, Unity's chief financial officer, said the bank is moving away from high-risk real estate and construction lending and more toward consumer lending.

Why the switch? According to Killian, the competition Unity faced from larger banks in the region simply got too tough. Bigger banks, like Fleet Financial, have the size and scale to offer better deals and get more of the business, Killian said.

As a result, the revenue Unity was counting on from its commercial lending business to help offset much of the high costs associated with opening so many new branches at once simply never materialized, he said.

One other reason for the decision to move away from commercial and construction lending: Even though these types of loans pay higher yields than consumer loans and the bank can potentially earn more money on them, they tend to be highly susceptible to economic fluctuations and interest rate risk - meaning the bank can just as easily lose money.

Indeed, Unity's delinquent loans - meaning those loans that are at least 90 days past due - started to creep up in 1998. Most were commercial loans.

At the end of last year, delinquent commercial real estate loans, nearly $3.9 million worth, accounted for 2.3 percent of the bank's total loan portfolio.

That far exceeds the nation's average of 1 percent.

The good news is, that number is falling. By March 31, bad commercial loans accounted for 1.7 percent of the bank's total loan portfolio.

Killian credits Tremblay, a one-time bank examiner, with "bringing big-bank credit standards" to Unity.

Unity says Tremblay quit to start his own bank consulting business and shorten a killer two-hour commute from his home in Jackson.

Tremblay replaced Jim Hyman, one of the bank's founding fathers, who resigned in August 1997. And now, Van Volkenburgh, a local businessman whose company designs and distributes packages for the pharmaceutical and cosmetic industries, has taken on the role until a replacement is found.

Communication gapBecause of its small size, Unity has yet to register a blip on Wall Street's radar screen. However, those few analysts who have tried to follow Unity complain they have had a tough time getting through to the bank's management.

For example, when it appeared that Unity was not going to meet its earnings expectations for 1998, one analyst, Ray Dirks with New York-based Security Capital Trading, said he tried to contact the bank.

"I left a long message on the phone that was rather detailed and I didn't get an answer," Dirks said.

Another firm that tried to follow Unity was Capital Consultants of Princeton, but they also hit a stone wall.

"They were very uncooperative," Wines said. "Once we didn't get return phone calls, we just said forget it."

Unity denies avoiding anyone and said it is eager for analysts to cover the bank.

So far, the only investment house to issue regular research reports on the company is Marlton-based First Colonial Securities Corp., whose chief executive, Michael Golden, sat on Unity's board of directors until recently.

In April 1998, First Colonial initiated coverage of Unity with a "buy" recommendation while Goldman was a board member.

One year later, in April 1999, two months before Unity released its poor second-quarter earnings, that recommendation was upgraded to a "strong buy."

Golden did not return repeated calls from The Star-Ledger. Unity says Golden has since stepped down from the board.

First Colonial says the analyst who issued both the "buy" and "strong buy" ratings on Unity is no longer with the firm.

For his part, Dirks currently has a "hold" rating on the bank. He said it's too soon to know if the bank can turn its financial picture around this year, considering all the costs it's trying to absorb.

But he said he is keeping a close eye on Unity.

"I'm going to be waiting and watching for probably another good nine months before I would make any changes in my valuation"