Insurance and Banking & Finance

Bank's price fell $100M: Union Federal buyer cut offer as negotiations dragged on; investors pushed for liquidity

April 17, 2006

No wonder word leaked early this year that Union Federal Bank was about to be sold.

A new federal filing reveals that a deal had been brewing since early last year-spawned largely by mounting frustration among investors that they were unable to turn their stake in the bank's privately held parent, Fort Wayne-based Waterfield Mortgage Co., into cash.

"The concerns over liquidity were voiced by many shareholders at Waterfield Mortgage's annual shareholders' meeting in the spring of 2004," according to the filing with the Securities and Exchange Commission.

Union Federal, Indianapolis' largest locally based bank, announced in February that it will be acquired by Bowling Green, Ohio-based Sky Financial Group Inc. for $330 million in cash and stock. After the purchase closes later this year, Union Federal's 44 offices will adopt the Sky moniker.

The filing reveals it was an arduous process, with suitors fretting over becoming ensnared in liabilities stemming from the volatile performance of Waterfield's mortgage businesses, which were ultimately acquired in early 2006 by Long Island-based American Home Mortgage and Missouri-based CitiMortgage Inc.

Largely because of the disappointing performance of those businesses, in fact, Sky was able to negotiate a purchase price some $100 million less than it had said it was prepared to pay six months earlier, according to the SEC filing.

Lots of questions remain unanswered. For example, Sky expects to cut some of Union Federal's more than 600 jobs, but has declined to be more specific. In a February conference call with analysts, a Sky executive said the company expects to reduce Union Federal's expenses 14 percent.

Investors mum

Especially quiet have been the elite group of Hoosier investors who in 1999 bought a big stake in Waterfield Mortgage from the family of Fort Wayne financier Richard Waterfield.

They were led by Jeffrey Thomasson, CEO of Carmel-based Oxford Financial Group, a fee-only financial planning firm that handles the fortunes of many of the state's wealthiest executives.

Thomasson, a Waterfield director, declined to comment on the deal last week.

"The Sky filing needs to be the go-to place" for information on the deal, he said. "Anything we say that is not in that document creates all sorts of regulatory issues none of us wants to deal with."

Other directors-including former Indianapolis Mayor Steve Goldsmith and Timothy McGinley, founder of House Investments and a member of the Purdue University board of trustees-either did not respond to requests for comment or referred questions to Waterfield executives who did not call back.

"There are several issues that are still on the table. It's a bit premature [to discuss details of the sale]," said another director, Dan Dalton, former dean of IU's Kelley School of Business.

Indeed, Waterfield shareholders still must approve the sale, which has the unanimous blessing of the company's board, the SEC filing says.

If all goes off without a hitch, some big names will enjoy a handsome payday. Waterfield investors ultimately are expected to reap $220 to $240 a share from the sale of the company's businesses, according to the SEC filing, which doesn't disclose what insiders paid for their shares.

Other regulatory filings say Thomasson owns 48,832 shares, which would be worth at least $10.7 million. They say Alvin "Kit" Stolen, CEO of Union Federal, owns 13,197 shares worth at least $2.9 million.

Monumental task

The SEC filing shows that getting to this point has been a monumental task for Waterfield and its financial adviser, Bear Stearns & Co.

Investors in Waterfield who wanted to cash out didn't have the option of finding buyers for their shares on the private market, the filing says. The 1999 investors signed agreements restricting sales, to ensure Waterfield continued to qualify as an S corporation, an ownership structure that permits no more than 100 shareholders. S corporations pay no income taxes and instead pass through gains and losses to shareholders.

In response to shareholder unrest at the annual meeting in 2004, Waterfield's board that summer decided to launch a plan that included buying back shares and distributing more of its income to investors via dividends.

But by the next spring, mortgage originations were slowing. Around that time, Waterfield also was grappling with a few surprises, including a larger-than-expected number of homeowners paying off their mortgages early, which caused a big loss in the company's investment portfolio.

The setbacks "led the board to determine that, in light of regulatory capital requirements, it would not be prudent" for the company to move forward with the dividend plan, the SEC filing said.

In March 2005, Waterfield's board hired Bear Stearns to explore selling the company. By July, the investment firm had received seven "preliminary indications of interest" in Union Federal, six in the mortgage businesses and none in the entire company.

A sale to one party would have been simpler, banking observers say. A single buyer also would have been able to capitalize on synergies between the two business lines. Historically, for example, money that Waterfield Mortgage customers pay into escrow accounts for insurance and property taxes has flowed to Union Federal as deposits.

"The challenge they had was finding a buyer who was interested in both pieces. It's unfortunate they couldn't find someone who wanted to do that," said Mike Renninger, principal of Renninger & Associates LLC, which helps put together banking mergers but wasn't involved in the Union Federal deal.

Suitors scarce

The ranks of suitors for the two parts of the company quickly thinned. Four conducted due diligence on the banking business, and just two-Sky and an unidentified suitor-moved forward with "final indications of interest." Another four suitors conducted due diligence of the mortgage businesses but none submitted final indications of interest.

Waterfield's board gave Sky the edge for Union Federal-partly because it was dangling a richer price and partly because it was willing to work though the complex issues surrounding what liabilities would remain after the separation of the mortgage and banking businesses.

Those proved to be such sticky issues, however, that Waterfield decided it needed to find buyers for the mortgage businesses before it could strike a deal with Sky. It took another run at potential buyers, ultimately negotiating to sell the mortgage-origination business to American Home. After Waterfield put the mortgage-servicing business up for bid, CitiMortgage scooped it up.

Those deals, however, tied up more Waterfield cash. Under the pacts, Waterfield was required to put $60 million into escrow to reduce the buyers' financial risks.

In addition, as the months of talks rolled by, the mortgage businesses had continued to sputter, shrinking Waterfield's net worth. For 2005, the mortgage businesses lost $38.4 million, including a $23 million investment loss. Because the bank was profitable, the company ended up with an overall loss of $19 million.

The SEC filing says that, by mid-January, Sky had decided it would be willing to pay $413 million, not the $440 million it originally proposed.

But that deal required Waterfield have at least $160 million in net worth. On Jan. 26, the companies concluded Waterfield probably could not meet that condition, and they agreed on the final, reduced price, $330 million.
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