Slumping Coast Draws Big Investor

Franklin Templeton Investments, one of the country's largest mutual fund families, has acquired an 8.11% stake in a small Florida banking company that has been rocked by troubles in its lending portfolio.

The investment would make the fund family the third-largest shareholder in the $676 million-asset Coast Financial Holdings Inc. of Bradenton.

The disclosure, made public in a Federal Register filing Tuesday, came as a surprise to Tramm Hudson, an adviser to Coast's board and senior management.

Mr. Hudson said that while Coast has "a large number of institutional shareholders," he was "not aware of any conversations between bank management and Franklin Resources Inc." (Franklin Resources of San Mateo, Calif., is the parent of Franklin Templeton Investments. It has $500 billion of assets under management.)

Coast's market woes began in earnest on Jan. 19, when it said in a Securities and Exchange Commission filing that it had committed $110 million of loans to 482 borrowers on a construction project — only to discover that the builder had "indicated that it may not have sufficient financial resources to complete its existing construction contract commitments." Coast said the problem would likely have a material effect on operations.

The company later clarified that the loans were collateralized and the borrowers' repayment obligations were still in force, but the disclosure that the builder had suspended operations took its toll: Coast's shares dropped to half of their value in two trading sessions, from $16.07 a share on Jan. 18 to $8.68 a share on Jan. 22. They closed at $7.13 Wednesday.

The company hired Mr. Hudson in early February, shortly after James K. Toomey, its chairman, was hospitalized for chest pains. Mr. Toomey remains on leave of absence.

On March 2 the company reported an additional loan-loss provision of $21 million, or roughly $13.1 million after taxes, which pushed it to a loss of $17.3 million for 2006, or $2.65 per diluted share.

Citing an incorrect media account about its maximum exposure, Coast issued a clarification Tuesday. It said that the additional provision was based on judgments and assumptions from the best information available and that "the allowance may not be sufficient to cover the loan losses that actually occur."

The company said it would release more details in its Form 10-K, which it expects to file March 15.

Matthew Walsh, a spokesman at Franklin, said in an e-mail that the Coast shares are held in funds advised by Franklin Mutual Advisers LLC, a subsidiary of Franklin Resources. He declined to offer additional substantive comment about the investment.

Coast's largest shareholder is St. Denis J. Villere & Co. LLC, a mutual fund company in New Orleans, which reported ownership of 15.11% of Coast's outstanding shares on June 13. St. Denis J. Villere 3rd, a portfolio manager and partner at Villere & Co., said his firm bought shares in Coast's 2003 initial public offering and has continued to purchase shares in recent days.

"People are extrapolating that there is another shoe to fall, and we don't think there is," Mr. Villere said. "We think the noise is over and they can go about their daily business."

He said a likely rationale for Franklin's investment is that Coast's business and locations make it attractive to a potential buyer. Days after it disclosed the problems in its loan portfolio, Coast announced that it had hired the investment bank Sandler O'Neill & Partners LP to help it review its strategic options.

"Value is going to come one way or the other," he said. "If they can't get it done, someone else is going to come along."

Other large shareholders include OZ Capital Management LLC, a large hedge fund manager in New York, which owns an 8.9% stake; and Private Capital Management LP, a hedge fund manager in Naples, Fla., which owns 7.3% of Coast's outstanding shares.

Investment partnerships controlled by James Dierberg said in a Feb. 26 filing that they had dropped their stake in the company to 4.1%, less than half of the 9.7% they reported Feb. 8. Mr. Dierberg and his family own First Banks Inc. of St. Louis, which has made a number of substantial investments in banking companies in the Midwest and California.

Though Coast's problems have come to light only since mid-January, there were earlier hints about shortcomings in its internal controls and procedures.

The company said in the annual report it filed with the SEC last March 24 that control systems had "inherent limitations," including faulty judgment.

"Controls and procedures also can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management or employee override of the controls and procedures," Coast said in the filing. "The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions."

In a Dec. 8 letter to Coast, the SEC acknowledged that company officials only had to offer "reasonable assurance" about controls, but said its disclosure "appears to extend beyond the description of reasonable assurance with respect to the effectiveness of controls and procedures as defined in SEC guidance and current auditing literature."

The agency asked Coast not to make such qualifications in the future. In a Dec. 27 letter, the company confirmed that it would conform its qualifications to SEC requirements.

Mr. Hudson said in an interview Wednesday that the company believes the SEC highlighted a "routine matter" based on filing reviews the agency does every three years.

"We were not requested or required to amend the 10-K, because the items were not considered material," he said.