When Less is More

By Ian Wyatt, Big Idea Investor | WFC | Aug 15, 2006 | comment

When Less is More 

By Peter D. Henig, Market Columnist, Growth Report

In the battle between banks, the little guy sometimes wins. 

I've got two banks, one big, the other - not so much. The big one - some might call it huge, others might call it, well, Wells Fargo (NYSE: WFC) - has been largely lousy across the board. Poor rates, lots of charges, spotty service and a serious bout with identity theft that was neither pleasant nor ever fully resolved. The smaller one is Bridge Bank (Nasdaq: BBNK), all of three years old and barely an afterthought on the international banking scene, with a market cap 1/1000th the size of Wells Fargo.

But here's where Bridge wins and Wells loses - service, reliability, commitment. Sounds pretty squishy. But in banking, those were the things customers used to expect, and for so long have not received that we just assume they don't exist anymore. At Bridge, that emphasis on the customer is in such abundance that I think it creates an interesting investment thesis in how a small bank, much like any other small cap high-growth company, can achieve exceptional returns for shareholders.

Taking the high road

Barely public since Q1 2003, Bridge Bank's stock has been on a tear. Shares have risen more than 200 percent in three years and now trade just shy of $20. Over the same period, Wells Fargo has appreciated less than 50 percent - respectable for a large cap stock but one could argue still severely lagging in performance when it comes to two institutions providing essentially the same products and services.

And though its numbers are still tiny by comparison, Bridge recently proved its mettle in terms of quarterly performance with results clearly outpacing the banking industry's plodding ways. Bridge reported net income of $2.0 million, or $0.29 per diluted share, for the three months ended June 30, 2006, as compared to net income of $1.4 million, or $0.21 per diluted share, in the year ago quarter.

On its balance sheet, Bridge reported total assets of $641.6 million, as compared to $498.5 million one year ago - a 29 percent jump in just 12 months. For the same period, the company's deposits rose to $573.8 million, compared with $446.3 million for the previous year. And on the loan side, the company reported total loans outstanding at $477.3 million, representing an increase of 37% over $349.0 million for the same date last year.

Wells Fargo can't match that growth, though for a large cap bank it certainly holds its own. Revenue growth year over year (ending in the December quarter, 2005) was just over 20 percent, from $33.9 billion to $40.5 billion. Profitability increased from $7 billion to $7.6 billion, with Wells raising its quarterly dividend rate from $0.52 a share to $0.56 a share. Shares have risen nicely over the last nine months, and the company - much like many other large institutions - has announced an aggressive stock buyback program.

But when matching service with investment performance, the little guy wins here hands down. Though some might argue it's unfair to compare such two diverse companies, as Wells, with its 6200 offices worldwide and $492 billion in assets, is certainly in a different league than Bridge Bank -- which bills itself as the business bank of choice for small to middle-market and emerging businesses - I think the comparison is indeed reasonable.

If the name of the game going forward is finding those ever more elusive growth stocks that can sustain competitive advantages in niche sectors through quality products or services, companies like Bridge are a rare and valuable find. And with strong momentum and a reasonable market cap, investors could indeed find far more upside here than they could with a Wells Fargo investment that's far more exposed to broad swings in economic conditions and vulnerable to the whims of fickle retail banking customers. In this context, Bridge Bank has much to offer - both to its customers and its shareholders.

Peter Henig is a Growth Report columnist and regularly contributes to Big Idea Investor. In addition to covering Growth Report portfolio companies including Bridge Bank, he brings subscribers news and information on other leading growth companies.

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CEO Pay - a Window into Corporate Governance?

By Nancy Zambell, Staff Writer, Big Idea Investor

Last week, we discussed stock options and what the back-dating scandal may say about the quality of corporate governance. This week I would like to continue that thought with the relationship between corporate governance and excessive compensation of Chief Executive Officers.

Lets start by taking a historical view of compensation.  In the 80's CEO's on average earned 42 times the average employee. But this was before stock options entered the picture, allowing windfall gains for execs (and early employees). By the early 90's, CEO's earned some 200 times the salary of the average U.S. worker, and today that multiple has increased to 450 to 1. Simply put, in the past 25 years, CEO compensation grew 6-fold.

Everyday the media is filled with stories of outlandish CEO salaries and pay packages, including these excesses: 

• UnitedHealth granted its CEO stock options worth $1.6 billion
• In 2005, Verizon paid its CEO $48 million, as the company saw its stock price drop 5% and its earnings by 25%
• Carly Fiorina, former Hewlett-Packard CEO, watched the company's stock price decline by more than 2/3, from 1999-2005, while she made more than $16 million in non-stock pay. HP also paid for her personal travel, retirement expenses, $1.6 million in mortgage and relocation expenses, then gave her a severance package worth $21 million.
• Former NYSE chairman and CEO Richard Grasso had a pay package worth $187.5 million
• Exxon chief Lee Raymond makes $405 million

According to CNET, some studies show that the average CEO was paid $10 million - $15 million in 2005, and that doesn't count the tremendous perks like personal trips on corporate jets, extravagant club dues, housekeepers, pet grooming, even the taxes on the CEOs' excessive compensation.

And while some CEO's who are raking it in may well deserve it - in terms of the benefits they bring to their companies, shareholders and employees - most of those fabulous pay packages don't seem to have much correlation with how well their companies are run.  In fact, when you see the problems at Tyco International, Enron and WorldCom - all preceded by excessive compensation packages - it's no wonder that shareholders are up in arms.

After all, one of the primary tenets of good corporate governance is the focus on aligning shareholder interests with those of a company's executive management.

Sadly, that goal is often ignored, or just misused. Moody's Investor Services recently conducted a review of its rated companies. It found that 22 of the 43 companies rated B3 or higher that defaulted between 1993 and 2003 offered their CEO's much large than expected bonuses or stock option grants. And at 140 companies out of the 214 with large downgrades, (3 or more rating notches within 12 months), CEO compensation was higher than expected.

A recent study by Forbes of America's top 500 corporations, found similar results. The CEO's received a 6% raise last year and, on average, took in $5.6 million each from exercising options. Forbes ranked 189 executive who had been at the helm of their firms for 6 years. Their efficiency rating consists of: Stock performance (including dividends) for the past 6 years as compared to peer groups; stock performance during the leader's tenure; stock performance relative to S&P 500 during tenure; and total compensation for the past 6 years. Their conclusion: much too often CEO's are rewarded regardless of the company's performance. Here are the top and bottom 4 CEO's, based on Forbes' efficiency ratings: 

Source: Forbes

Unfortunately, these studies help substantiate the major problem with excessive CEO pay: Shareholders just aren't getting what they pay for. 

There are many reasons for the conundrum, but these three are primary: the board of directors is not doing its job, overseeing the company for the benefit of its investors; linking large pay packages to stock price instead of operating performance may create a springboard for taking greater risks; and huge incentives for stock performance may inspire execs to worry more about making their earnings estimates than making real money, creating a temptation for finagling the accounting. 

But the tide seems to be turning. Regulators are casting a more diligent eye upon such compensation and perks and investors, especially the large labor unions, public pension funds, and hedge funds which are growing more indignant and putting pressure on corporate boards to strengthen their oversight.  

The Securities and Exchange Commission (SEC) has proposed new rules for additional disclosure in public statements, including options dating, stock and non-stock incentive plans, perquisites, deferred compensation, retirement and termination benefits. Additionally, the SEC is asking for a detailed narrative, in plain English, that describes the compensation program's objectives, as well as how they are implemented and monitored. 

That's great, and it's about time. But individual investors cannot sit back and expect that these changes will suddenly decrease salaries, solve the accounting problems and automatically result in better corporate governance at all pubic companies. Instead, investors must continue to perform due diligence on every company in which they intend to invest.  

Fortunately, that's not as hard as it sounds. Here are a few tips to help you determine if the company's execs and board are looking out for your interests: 

Check out the company's corporate governance grade (please see last week's Big Idea issue for help with this). 

Select companies that have good performance and reasonably paid management. And make sure bonuses are for long-term performance, not just good quarterly numbers. Beware of votes on executive compensation plans being coupled with the vote on one or more unrelated proposals Severance packages that add up to more than three times an exec's annual compensation are too much. 

Review the options programs. Look at the potential dilution from stock options; more than 15% over the life of plan or 2% in any one year is too much. Beware of unspecified stock exercise prices or exercise prices below 100% of fair market value on the date of the grant. Review the company's options repricing plans that allow for the lowering of the exercise price of options already awarded when the market price of the stock has declined below the original exercise price (underwater options).   

The technology companies are the worst abusers; for example, in 2004, Broadcom repriced 18 million, or more than one-third, of the 48 million options (15% of the company's total shares outstanding) that it had issued. Find out if the stock options plan is limited to a small number of senior or higher-up management members. And look for full disclosure of the plan. 

Scrutinize the company's ties with related parties. Currently, nearly 40% of the S&P 500 companies have business deals with personal ties to the companies or their management. This is the area that helped bring Enron down. 

Make sure boards are not stacked in favor of insider executives or management cronies and relatives. Know that staggered, or classified, boards, whose terms expire at different intervals, can prevent the ouster of bad management, and make takeovers and proxy fights more difficult. 

Make sure the compensation committee is independent of company management. 

Now, you may ask, how does an individual investor find out this information? 

The best place is in the company's financial statements. The 10-K has a tremendous amount of information, including data on related-party transactions. But the company's annual proxy statement lays out the details of executive salaries, bonuses, pension plans, stock options, perks and other expenses. It is filed with the SEC right after the 10-K. compare with performance and peer companies. 

Just go to the SEC's Edgar site and select your company, then the proxy statement, called the Def 14A form, or the 10-K. Here is the web site: 

http://www.sec.gov/edgar/searchedgar/webusers.htm 

Then, to determine how your company stacks up in relation to its peers, compare its compensation plans with those of others in its industry.  

And as a rough guideline as to sizes of companies versus CEO compensation, take a look at last fall's survey by Moody's: 

Source: Moody's Investors Services

While this analysis does require a little extra time, it will go far in helping you avoid the Enron's, WorldCom's and Adelphia's that are waiting to help themselves to your pocketbooks. 

And it will assist you in uncovering the companies with the highest potential returns, which are often - as the Forbe's efficiency study shows - those with executives who are working for the benefit of their shareholders - not just themselves.

Nancy Zambell is a staff writer for Big Idea Investor as well as the Contributing Editor for Financially Fit, a complimentary weekly e-mail newsletter giving personal finance tips to investors like you.

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