Insurance and Banking & Finance

Bank profit see-sawed before sale: Union Fed investors may have tired of volatile performance

February 13, 2006

Union Federal Bank's profits have gone up and down like an electrocardiogram since a group of elite investors bought a major stake in the privately held institution in 1999.

That wildly inconsistent performance likely played a role in the decision by investors to sell the bank, experts say. On Feb. 3, both the bank and its parent company were sold to Bowling Green, Ohio-based Sky Financial Group Inc. for $330 million. The bank had been the thirdlargest in town.

After earning $33 million in the third quarter of 2003, the bank lost $4.8 million the next quarter. It followed a $13.4 million loss in the second quarter of 2005 with a $21.3 million profit in the third quarter, filings with the Federal Deposit Insurance Corp. show.

The elite investors, led by Jeffrey Thomasson, CEO of Carmel-based Oxford Financial Group Ltd., bought at least a 30-percent stake in the bank in 1999 from the family of Fort Wayne financier Richard Waterfield.

Oxford is a fee-only financial planning firm that handles the fortunes of many of the state's wealthiest executives. Since Thomasson launched the firm in 1981, it has amassed accounts worth nearly $7 billion, regulatory filings show.

Those investing alongside Thomasson included Eli Lilly and Co. CEO Sidney Taurel, former Lilly CEO Randall Tobias, former Hillenbrand Industries CEO W August Hillenbrand, and Red Gold CEO Brian L. Reichart.

They aren't talking. Investors contacted by IBJ either declined to comment or did not return calls. However, Alvin "Kit" Stolen, CEO of Union Federal since 2002, confirmed shareholders' desire to cash out played a role in the sale.

"Two things came together at largely the same time," Stolen said. "The first would be that our investors have held an investment in an illiquid, privately held company for a very long time. And so for the benefit of the bank to be able to expand and for the benefit of the shareholders to have some element of liquidity, the transaction ... made good sense."

Stolen declined to say how much profit investors will reap from the sale.

The purchase will give Sky its first major Indiana presence. The publicly traded Ohio bank has more than $15 billion in assets and operates 290 offices, most of them in Ohio and western Pennsylvania. Union Federal has assets of $3.4 billion and 44 offices, most of them in central Indiana.

Sky expects to cut some of Union Federal's more than 600 jobs, but hasn't released specifics. After the purchase closes in the third quarter, Union Federal offices will adopt the Sky moniker. Stolen said he plans to stay on to oversee Sky's Indiana operations.

The purchase includes both the Indianapolis bank and its Fort Wayne-based parent, Waterfield Mortgage Co. Waterfield Mortgage announced Jan. 13 that it was selling its other main business, the mortgage-origination company Waterfield Financial, to Long Island-based American Home Mortgage, a deal valued at more than $450 million.

IBJ reported Jan. 9 that market observers were buzzing that both the Sky and American Home Mortgage deals were brewing.

Some of the operations of the businesses being sold separately had been intertwined.

"Our financials are a little complicated," Stolen said.

The ties between the businesses might partly explain the volatility of Union Federal's financial performance, bank analysts said.

"Banks are traditionally very consistent in their earnings," said Mike Renninger, principal of Carmel-based Renninger & Associates LLC. "Most local and regional banks don't have the same type of exposure to mortgage banking."

That's not the only explanation for wild profit swings, said John Reed, president of Chicago-based David A. Noyes & Co.'s Financial Institutions Group.

"There could be all kinds of reasons," he said. "They're a private company, so they're not worried about quarterly earnings. They don't have to appease [public] shareholders."

Further, he said, steps Waterfield Mortgage took to separate the businesses might have resulted in one-time adjustments to the balance sheet.

"They've been doing whatever they felt they needed to do to clean up [Union Federal and Waterfield Financial] for a sale," Reed said.

Some analysts would like more of an explanation.

"The fluctuations are significant and that's not the normal course of events for a savings and loan," said Karen Dorway, president of Bauer Financial Inc., a Coral Gables, Fla.-based bank rating service. "There's a lot of fluctuation and that's not what you'd expect to see."

Most notably, the bank took a $32.5 million loss on "sale of assets held for sale and available-for-sale securities" in December 2004, according to filings with the FDIC.

Two sources told IBJ that around that time the bank recorded major losses stemming from a bad hedge bet on interest rates. In effect, the bank wagered rates would go down, the sources said, but they went up.

In the previous two quarters, the bank had recorded gains of $4 million and $15.5 million in the same category. In the two quarters after the loss, the bank recorded gains of $5.6 million and $19.7 million.

Asked whether the bank had lost big on a hedge, Stolen said, "As we've mentioned before, the nature of our assets ... creates an amount of volatility in our earnings and those numbers will go up and down at any given point in time."

He said the volatility should decrease once Union Federal is owned by a commercial bank rather than a mortgage company.

The new owner also provides Union Federal access to capital to continue its expansion plan, which calls for adding two to three branches per year.

"In the last three years, the bank has launched a fairly aggressive growth campaign, both in terms of households ... and physical presence," Stolen said. "Both of those are pressure on your capital position when you are not public and do not have access to public capital markets."

Capital is exactly what the bank needs, Dorway said.

The bank's capital compared with its assets is 7.14 percent, she said. The industry average is 8.2 percent.

That's part of why Bauer Financial rates Union Federal a below-average bank.

Bauer gives the bank a three-star rating. That's below most banks, 80 percent of which are rated 3-1/2 stars or higher, Dorway said.

Wakefield, Mass.-based Veribanc Inc., however, gives Union Federal three green stars, its highest rating.
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