Buckling under a bevy of bad real estate loans, Lake Country Community Bank of Morristown was hit with a cease-and-desist order from Minnesota regulators and ordered to clean up its balance sheet.

The state Department of Commerce said it has reasonable cause to believe that the bank "is engaging, has engaged, or is about to engage, in unsafe or unsound practices and/or violations of law."

The 80-year-old community bank, located about an hour south of Minneapolis, was ordered to write off loans classified as bad by regulators and to replenish its allowance for loan losses -- money set aside to cover loans that may go into default. Regulators also told the bank to have management in place with the requisite skills to "operate the bank in a sound and safe manner."

William Pye, the bank's president and owner, did not return telephone calls Friday seeking comment, but issued a written statement noting that the bank authorized a $200,000 injection of capital in the first quarter "in response to regulatory concerns about a further deterioration of the national real estate market" and the bank's potential exposure.

The bank, Pye wrote, "weathered the Great Depression, and we will weather this downturn in the economy. We are a sound, stable, well-capitalized and well-managed bank."

Pye added that the bank's holding company is able to provide additional capital if needed.

Lake Country, with three branches in Rice County and assets of $44 million as of Sept. 30, saw its so-called "non-accrual loans" -- on which the bank is no longer collecting interest from borrowers -- more than double, to $2.05 million, or 5.9 percent of its loans, up from $1 million a year ago, or 2.6 percent of loans. In the quarter ended Sept. 30, Lake Country lost $235,000.

It is unclear precisely what led to the sharp increase in Lake Country's problem loans. The bank was cited for deficiencies in its loan policies in a June bank examination report. But the Department of Commerce declined to share details of that report, citing a state statute that says information obtained in bank examinations is not public.

In its cease-and-desist order, state regulators ordered the bank to maintain a Tier 1 capital to total assets ratio -- a key indicator of a bank's financial health and its ability to absorb losses -- of at least 7 percent. Generally, any ratio below 7 percent is considered too low. As of Sept. 30, Lake Country's Tier 1 capital was 7.16 percent of assets.

Lake Country is the third community bank in the state to receive a cease-and-desist order since September, as the credit crisis spreads beyond the large financial institutions and the subprime mortgage market. Many of the community banks that have received such orders in recent months have high concentrations of commercial real estate loans, which are turning sour at an accelerating rate as the recession deepens. Last year, 120 banks received cease-and-desist orders from the Federal Deposit Insurance Corp. (FDIC), compared with 77 in 2007.

In Minnesota, regulators' so-called "watch list" of problem banks has nearly doubled, to 50, from 26 just 18 months ago. In September, BankCherokee of St. Paul received a cease-and-desist order from federal regulators and was cited for "unsafe and unsound" banking practices after sustaining losses on its real estate loans.

"Obviously, the banking sector is going through a very difficult time," said Bill Walsh, a state Department of Commerce spokesman. "So you're going to see more corrective actions from us."

A cease-and-desist order is one of the most serious forms of enforcement actions bank regulators take, and is typically issued after repeated warnings, said Tony Plath, a professor of finance at the University of North Carolina at Charlotte.

"This is the equivalent of getting hit upside the head with a 2-by-4," Plath said. "Basically, what the regulators are saying is, 'If you don't do these things, then you won't have a business, because you're running it into the ground.' "

A cease-and-desist order does not suggest that a bank is about to fail.

Lake Country is insured by the FDIC, which means that even if the bank were to fail, customers' deposits are insured for as much as $250,000 per account.

Chris Serres • 612-673-4308