Steeling herself for the debate to come, Mary Lynn Lenz stepped into the boardroom of Professional Business Bank on a January day and presented its private-equity owners with what she saw as their only remaining option.

"I think you need to liquidate all your other investments and contribute them to this bank," she told them.

The stunned silence that followed soon gave way to tense debate.

It wasn’t supposed to have come to this. Only nine months earlier, in March 2009, Lenz arrived in Pasadena, Calif., to lead the roll-up strategy envisioned by Professional's owner, Belvedere Capital. But the sharp downturn in real estate interfered with the investment firm’s plans.

Lenz ordered a third-party review of Professional's books shortly after her arrival, and went to federal and state regulators with the findings: the bank had taken huge hits to the value of its commercial real estate loans after building up concentrations in excess of 600 percent of its total capital, and the necessary loan-loss reserves had dragged down its capital ratios. 

"I'm always a believer in being upfront with the regulators. Come to them before they come to you," Lenz says.

Working under a cease and desist order beginning in the summer of 2009, Lenz and her chief financial officer met with more than 50 investors, private-equity funds and potential acquirers. They kept walking away empty-handed. "Everybody was just waiting to see if the credit hole was going to get larger [and] whether the credit crisis was going to get bigger," Lenz recalls.

Would-be backers told Lenz and her CFO, Jim Westfall, that they preferred to wait until they felt confident the value of Professional's real estate loan portfolio had truly hit bottom. They wanted to be sure their contribution would help make the bank viable again.

But the $300 million-asset Professional didn’t have that kind of time left. The regulatory order required the bank to have a leverage ratio of 9 percent. By yearend, its leverage ratio still fell short at 6.08 percent.

So at that fateful board meeting in January 2010, the recapitalization needs were urgent. Standing before the six other board members—the three partners of Belvedere, headed by Richard Decker, and three independent directors—Lenz introduced the only alternative she saw left: to have Belvedere sell all of its positions in better-performing banks and put the proceeds into Professional, or risk that regulators would close Professional and seize the rest of the banks to cover the costs.

"This wouldn't have been their first preference," she says sympathetically. "Their priority is return to their investors, to their limited partners. So they wanted to focus on that, and they thought the best way to do that was to maintain their interest in those healthy banks, and to not contribute the money from the healthy banks into the failing bank."

But Lenz had precedence on her side. Just months earlier, the Federal Deposit Insurance Corp. had closed all nine banks affiliated with the $18.3 billion-asset FBOP Corp. in Oak Park, Ill., including one healthy institution and one with just some stress, the $4.7 billion-asset Park National, which had a total risk-based capital ratio at the time of 9.03 percent, considered adequate. However, seven other FBOP-owned banks, in California, Arizona and Texas, were undercapitalized, some significantly so, because of continued losses from commercial real estate and construction loans. 

Between its credit woes and its high exposure to preferred stock in the government-sponsored enterprises, FBOP couldn’t raise enough capital in time to satisfy regulators, who then exercised the cross-guarantee provision of FIRREA—the Financial Institutions Reform, Recovery, and Enforcement Act of 1989—requiring the FDIC to seize all of a holding company’s banks if that appears to be the most cost-effective solution for the Deposit Insurance Fund. Minneapolis-based U.S. Bancorp assumed FBOP's $15 billion of deposits and about $18 billion of its assets. It later sold FBOP's three banks in Texas.

Lenz couldn't help envisioning a similar endgame for Professional's owners. If the bank failed, "we believed the regulators would come after Belvedere as our "source of strength," and force them to liquidate to help to pay for the costs."

Her solution was no easy sell. Belvedere's executives viewed the firm’s other bank holdings as solid investments. They worried that if it were known that Professional was in trouble, the market would perceive the sale of the firm's minority stakes in other banks as a fire sale—pressuring prices to the point that the proceeds would fall short of what was needed to fulfill Professional's capital needs, Lenz says. "We were all united in fighting to save the bank, but we had different interests in how we were going to get there."

Given FBOP's fate, there wound up being little to argue over. Belvedere ultimately agreed to liquidate its minority investments in the $870 million-asset Green Bank in Houston, the $704 million-asset Seaside National Bank & Trust in Orlando, Fla., and the $294 million-asset Presidio Bank in San Francisco. (All three are still in existence). Decker now has a new fund, Belvedere Capital Fund III LP, specializing in buyouts and middle market investments in the financial sector.

Joseph Vitale, a partner with the New York law firm Schulte, Roth & Zabel, who represents private-equity funds that invest in banks, says Belvedere appeared to have few other options at its disposal. In addition to the FDIC's authority under FIRREA, the Federal Reserve also would have had the authority—recently codified by the Dodd–Frank Act—to bring additional penalties against Belvedere, potentially even barring the firm from controlling banks in the future.

The FDIC's cross-guarantee provision is rarely triggered, Vitale says, and that’s because most companies with investments in banks aren’t structured like Belvedere or FBOP. "Although the FDIC has had this authority for some time, it isn't often that you have the same party owning multiple banks in that one of which is failing, and one or more are healthy," he says. 

Prior to the Riegle-Neal Act of 1994 that allowed banks to branch more easily across state lines, many bank holding companies had numerous subsidiaries in different states, Vitale says. Now, most companies tend to consolidate subsidiaries for economies of scale, regardless of whether they operate in multiple states. And though private equity has become a bigger player in the banking arena, most private equity firms that delve into the sector do so without acquiring control of depositories, Vitale says, because otherwise they would subject themselves to bank holding company regulations.

When Belvedere publicized its intention to liquidate its positions, it captured the attention of Carpenter & Co., a private equity firm in Irvine, Calif., headed by Ed Carpenter. Like Belvedere, Carpenter takes controlling interests in banks. Lenz and her CFO had earlier tried to persuade the firm to contribute capital to Professional. "Carpenter was intrigued by the idea, but just like the other investors, they couldn't measure the size of the credit hole and they didn't want to jump in until they had a firm hold on that," Lenz says

One of Carpenter’s banks was a de novo, the $58 million-asset California General Bank, that had opened in Pasadena in March 2009. Lenz convinced Carpenter to have this startup purchase the decade-old Professional, an institution more than five times its size. "It was a terrible time for a de novo to try and grow," Lenz says. "We went back to John Flemming, president and chief operating officer at Carpenter, and said, 'We're going to get the first-stage capital, and what do you think?' And that’s when he said, 'We’re interested.'"

Belvedere's $12.6 million in capital from the liquidation of its other stakes was infused into Professional in May 2010. Two months later, Professional's board signed the definitive agreement with Carpenter for California General to buy Professional, and the deal closed at the end of the year.

Professional's charter was retired and replaced with California General's. The combination immediately boosted capital ratios well above the requirements, and the C&D order was lifted. As of June 30, six months after the deal closed, Professional's leverage, Tier 1 and total risk-based capital ratios were a well-padded 12.51 percent, 16.84 percent and 17.6 percent, respectively.

Carpenter asked Lenz and her team to remain as top officers of the bank. "We were the larger bank and I already had two years' history with the bank, so I knew it inside and out," Lenz says. "We also retained the Professional name—again, more longevity, with almost 10 years of brand recognition in the marketplace."

Chip MacDonald, a partner in the financial institutions practice at the law firm Jones Day in Atlanta, says that Lenz' feats were impressive. "The ability to pull that off with investors and bring them around to sell, is a real testimony who’s got talent," MacDonald says. Moreover, "getting the de novo to buy the bank and remove the C&D was a good exit strategy. It takes a multitalented personality to do all of this, because you've got to motivate a lot of different constituencies."

Lenz, a banker for more than 35 years, had previously helped turn around Slade's Ferry Bancorp in Somerset, Mass., convincing the board there in 2008 to sell the company to Independent Bank in Rockland, Mass. That fall, she caught the eye of Belvedere's managing partner, Alison Davis, when both sat on a panel at an American Bankers Association conference, discussing whether community banks should participate in the government's Troubled Asset Relief Program or compete with one another for private-equity capital. 

Davis, now chairman and CEO of advisory and investment firm Fifth Era Financial in Tiburon, Calif., says she picked the right CEO for Professional. "She’s not afraid to roll up her sleeves and take on difficult challenges," Davis says. "She also has a lot of integrity and is very direct—you know exactly where you stand with her. Because of her skills, we supported what was needed to get done."

After the deal closed with California General, Lenz and her team launched an aggressive branding and advertising campaign for Professional, "solidifying the bank's reputation as an institution that is here to stay," she says.

Professional, now slightly leaner with $294 million in assets as of June 30, seems to have most of its credit quality issues behind it. Noncurrent loans to total loans was 3.99 percent at June 30, and the net chargeoff ratio was 0.01 percent—in line with the average noncurrent ratio of 3.68 percent and average chargeoff ratio of 0.39 percent for California commercial banks with assets of $300 million to $500 million, according to FDIC data. 

Loan demand finally has been showing signs of picking back up in southern California, particularly among the professional firms at the center of Lenz's focus. Just in time, Lenz says, Professional now has "the gas to accelerate the pedal."

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