Center Financial Goes Awry

Community bank Center Financial Corp. (NASDAQ:CLFCE) is finally getting the press attention it deserves, becoming, well, the center of some attention. Unfortunately, the attention is focused on its accounting problems rather than its many accomplishments.

The problems started back in August when Center delayed its second-quarter earnings release. The reason: Management needed time to restate earnings back to 2001 in order to correctly account for certain interest rate swaps. Center also delayed filing its quarterly report with the SEC.

The plot thickened when Center finally filed its 10-Q on Aug. 15, but didn't include a review from an auditor or certification from the CEO that the report was accurate.

As a result of this offense, the Nasdaq gave Center notice that it was subject to delisting. Nasdaq officials added an E to the end of the company's ticker, a scarlet letter of sorts. The company is appealing to stay on the Nasdaq and plans to complete the 10-Q by filing amendments in the near future.

Restatements can often be a serious issue, but in Center's case they won't affect the cash flow statement or shareholder's equity. Thus, the company's financial health won't be affected -- though they may inject a degree of volatility into reported earnings and reported earnings growth rates over the short term. There is a chance Center could be delisted from the Nasdaq, but in all likelihood it will get the necessary amendments filed in time. The downside to the restatements is that they will preoccupy management and may result in a short-term increase in accounting and auditing expenses.

A Cinderella story
These accounting problems are a blemish on an otherwise outstanding record: Center has been a small-bank success story. It has experienced tremendous growth while maintaining excellent credit quality, rewarding investors with a multibagger over the last three years.

The secret of this California bank's success is that it focuses on a niche market of Korean Americans: All banking services are offered in both Korean and English. Its 24 branches and loan offices are located in areas with dense populations of first- and second-generation Koreans. The majority of Center's branches are in Los Angeles, which has the largest concentration of Koreans outside of North and South Korea. In addition, most of its executives and directors are of Korean descent.

Demographics make this niche favorable for banking. The U.S. census bureau shows that the population of Korean Americans increased 35% from 1990 to 2000, with that trend expected to continue for the foreseeable future. Also, a relatively high proportion of Koreans own their own businesses -- providing strength to Center's commercial and small business divisions.

The numbers speak for themselves: Net interest income (a bank's main source of revenue) grew 30.8% compounded annually over the last three years. Net income and total assets grew 39% and 32% respectively, also compounded annually over the same time. Meanwhile, the company has been able to keep bad loans to a very respectable 0.2% of total assets, and an efficiency ratio under 50% shows that overhead expenses are under control. Center was recognized by research company Sandler O'Neill as one of the top-performing small-cap banks in the nation two years in a row.

Outlook
Increased competition from other banks honing in on the Korean niche is more worrisome than accounting issues, in my opinion. HanmiFinancial (NASDAQ:HAFC), Nara Bancorp (NASDAQ:NARA), and Wilshire Bancorp (NASDAQ:WIBC) operate in the same space and have experienced similar growth. These small community banks must also compete against larger banks like Bank of America (NYSE:BAC) and Wells Fargo (NYSE:WFC) that can offer more products and better rates.

Nevertheless, the growth in the Korean American population should give these niche banks plenty of new business over the next few years, and I like Center's prospects of beating the market. But at 21 times trailing earnings, Center's shares are expensive relative to peers. Risk-averse investors may want to take a closer look at Nara Bancorp if they wish to make a play in this market: It looks more attractive at 16 times earnings, though it hasn't experienced growth on par with Center's.

Banking is one area where you won't find many beauties, but these small-cap banks are a good place to start looking:

Source: Capital IQ

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Joseph Khattab is a financial editor at the Fool. He does not own shares in any of the companies mentioned.