Prosperan purchase is model of successful bank failure

On a Friday afternoon nine days ago, David Latta paced the lobby of the Best Western hotel in Oakdale, waiting for a telephone call from a federal official just two blocks away.

When the call finally came at 6:10 p.m., Latta walked straight to a bank branch across the street, where a dozen shell-shocked employees were absorbing some startling news: Prosperan Bank of Oakdale was being shut down after 11 years in business, and Latta's bank, Alerus Financial of Grand Forks, N.D., would be its new owner.

About 20 officials from the Federal Deposit Insurance Corp. would arrive later to coordinate the transition, which would last late into the night and through the weekend. The group ordered four dozen boxed lunches from a nearby Byerly's supermarket.

Latta, executive vice president and head of commercial banking at Alerus, pulled a sheet of talking points from his suit pocket. "I have tremendous empathy for what you're going through," he recalls saying to employees. "But I can't help but think that your situation right now is better than it was 20 minutes ago."

After weeks of secrecy and behind-the-scenes discussions, a dying bank with $200 million in loans and 2,000 customers had just been acquired by a much larger one with a solid balance sheet. Customers didn't stampede to the bank and demand their money like the panicked bank customers in "It's a Wonderful Life" or during the real-life shutdowns of IndyMac and Washington Mutual last year.

Yet, it wasn't until days later that the magnitude of the deal began to sink in for Latta and other executives at Alerus. In interviews with the Star Tribune, they offered a rare inside look into how the deal came together, while reflecting on the rash of bank closures that have become a Friday evening ritual during the past year.

In this case, the system worked as it should. But with the pace of bank failures accelerating, and the FDIC's insurance fund now officially depleted, the margin for error has grown razor-thin.

Experts say the FDIC desperately needs failed-bank deals to proceed smoothly for healthy banks like Alerus to continue buying zombie banks like Prosperan. The smooth sale of failed institutions is vital to maintaining confidence in the bank sector, and in keeping credit flowing to still-struggling Main Street borrowers as the economy sputters toward recovery.

"Think about it -- it's kind of amazing that the FDIC can shut down a bank on a Friday night and by Saturday morning it's back and functioning again," said Alerus CEO Randy Newman, whose bank has bought four failed lending institutions during his 30-year tenure at Alerus. "But a lot of things have to go right for these deals to work. And it's crucial that it keep happening."

Banks at risk

Though the first wave of bank failures largely involved lenders that made subprime home loans, the next wave has primarily been smaller banks that loaded up on loans to developers and backed by suburban strip malls, subdivisions and condo projects. With real estate values plummeting, many of the loans are for more than the underlying properties are worth, so banks have been setting aside more and more cash to cover the losses.

In Minnesota, 29 banks have dangerously high levels of commercial real estate loan portfolios, according to a review of third-quarter data by research firm Foresight Analytics for the Star Tribune. Regulators consider it a red flag if a bank's commercial real estate is 300 percent of risk-based capital, or cushion to cover losses, though it doesn't necessarily indicate a bank is in trouble. Prior to its collapse, Prosperan's commercial real estate portfolio had reached 500 percent of risk-based capital.

"No matter what bank you are, if you have a high concentration of loans in any one asset class, then you're at risk," Newman said.

Cleaning up banks is not cheap. The FDIC's insurance fund, which insures deposit accounts up to $250,000, officially ran out of money on Sept. 30 -- drained dry by the fastest pace of bank failures since the savings and loan debacle of the early 1990s. It had $45 billion in its coffers just a year ago. Though the FDIC on Thursday approved a plan for replenishing the fund by raising more money from banks, and has access to a $500 billion credit line from the U.S. Treasury, it can't afford a series of costly bank runs. IndyMac's messy shutdown last year, when upset depositors lined up for hours outside branches to withdraw their money, cost the agency about $10.7 billion.

Prosperan's collapse was particularly quick. Just seven months ago, the bank had solid capital ratios. But in the third quarter it was forced to write off $12 million in bad loans, wiping out all of its equity capital. "The bank took all the steps it could take to survive," Newman said. "They just ran out of time."

Knowing what's coming

Newman said he initially learned of Prosperan's impending closure about four weeks ago through a confidential e-mail alert from the FDIC, which the agency sends to lenders like Alerus that have expressed interest in buying failed banks. Newman had signed up for the electronic alert nearly a year ago after attending a national bankers' conference and hearing industry experts predict a wave of bank failures. "My job as a CEO is to know what's coming," he said, "and what's happening now was predicted."

Alerus is not new to the Twin Cities. Years ago, it bought a retirement plan administration business, and later a Pohlad family trust company. It also recruited two local veteran U.S. Bancorp executives, Latta and Chip Norris, to head up the market. Norris is now Twin Cities market president, and oversees the bank's operations from an office in Minnetonka.

From there, Alerus built a $6 billion business that oversees retirement plans for companies in 49 states, and a small commercial banking business. Then, earlier this year, Alerus acquired $140 million in Minneapolis-based deposits from another failed institution, BankFirst of Sioux Falls, S.D., in a deal negotiated with the FDIC.

But Alerus still needed branches to serve all those new customers, and building them from scratch would have taken years and cost hundreds of thousands of dollars. So last month, Newman signed a confidentiality statement and formally expressed his bank's intent to bid for Prosperan. That gave him access to a secure FDIC website with detailed information about Prosperan's loans and deposits.

Next the courtship moved to a nondescript office building near Prosperan's headquarters. There, under the careful watch of FDIC officials, five Alerus bankers spent 2 1/2 days analyzing Prosperan's loan portfolio -- including detailed information on the collateral backing many of the loans -- on computers provided by the FDIC. To prevent leaks, only those who had signed confidentiality agreements could enter or leave the room. Printouts and laptops were not allowed, nor was anything that included the bank's logo, such as shirts or pens.

As a final step in the process, Alerus was allowed to interview Prosperan's top executive, Bruce Bennett -- but only for 30 minutes. Alerus executives were prohibited from identifying themselves or their bank by name. Newman decided to stay in Grand Forks and let others handle the final interview. "At that point, whatever they tell me is not going to change my bid," Newman said. "They can tell me how good their people are, or how loyal their customers are, but those are emotional things and won't pass to us anyway. ... Besides, what am I going to learn in 30 minutes?"

Alerus offered the FDIC a premium of 1.02 percent of Prosperan's deposits, or about $1.8 million. It was the highest offer among just three bids received by the FDIC, though the agency said it solicited offers from 355 banks nationwide. As in most of the bank-failure deals announced this year, the FDIC and Alerus agreed to share losses on the loan portfolio. Terms of that agreement were not disclosed.

Immediately after the deal closed, the FDIC launched an investigation into whether any wrongdoing had occurred at Prosperan. Such investigations are required under FDIC rules if a bank failure costs the insurance fund at least $25 million, and the FDIC estimates that the Prosperan bill will hit $60.1 million. An FDIC spokesman said the result of the investigation will not be made public for six months.

Even after learning that their bid had been accepted, Alerus executives were not certain of the day or the hour when the bank would close. Initially, they assumed the closing would occur a few days after their bid was due, which put the date at Friday, Oct. 30. But travel plans from Grand Forks were thrown into disarray after the FDIC moved the closing date back a week without explanation.

For Alerus, $1.8 million bought it three branches and about $150 milion in deposits in a market it plans to develop. For the FDIC, it's one less problem bank to worry about. "They have an incentive to make sure the deals go smoothly," Latta said. "If we don't succeed, healthy banks won't be around to buy failed banks."

Chris Serres • 612-673-4308