First Indiana Bank's sale timing paid off

August 27, 2007

First Indiana Corp.'s three most powerful leaders met on Friday, June 22, to discuss the company's future. Thinking a sale made sense, they set in motion a whirlwind of events that culminated with the July 9 announcement that the Indianapolis bank would be sold to Milwaukee-based Marshall & Ilsley Corp. for $529 million in cash.

The behind-the-scenes discussions are laid out in a draft of the proxy statement that will be sent to First Indiana shareholders in advance of the vote on the deal.

The document, filed with the Securities and Exchange Commission, says the trio had decided to review "various strategic options ... in light of recent changes in the economic climate in general and in the mortgage and credit markets in particular."

What it doesn't say is why the leaders--Robert McKinney, chairman of the executive committee; his daughter Marni McKinney, First Indiana's chairwoman; and Robert Warrington, the company's CEO--were hellbent on moving so fast. Announcement of the deal came just 17 days after sale discussions began.

"They reduced what usually takes six to nine months into less than three weeks," said Mike Renninger, principal of Renninger & Associates LLC, a Carmel consulting firm specializing in mergers and acquisitions.

Banking observers have speculated for weeks that First Indiana wanted to cut a deal before it would have to report second-quarter results. That speculation gained momentum Aug. 7, when First Indiana reported weak results for the quarter, with profit tumbling 40 percent. Had First Indiana not already announced it was selling to M&I for $32 a share, its stock likely would have slid.

Dragging down second-quarter results was a $3.4 million pretax charge that included $1.3 million in losses on home equity loans that First Indiana previously sold but was required to repurchase.

The charge also included setting aside $2.1 million in reserves for future home equity loan repurchases. Banking observers say the bank must have agreed to repurchases if borrowers failed to make required payments--a move that had allowed it to maximize the upfront sale price.

A week later, First Indiana announced more loan difficulties that will hurt third-quarter results. It said it was discontinuing making consumer loans originated by mortgage brokers--a pullout that will lead to $535,000 in expenses.

In a written statement at the time, Warrington said: "The general business climate for these types of loans has deteriorated to the point where the future outlook for this segment no longer makes economic sense for First Indiana."

First Indiana officials have not responded to repeated requests for comment in recent weeks. Whatever their motivation to sell the bank quickly, so far the strategy has worked out splendidly for shareholders.

Since the July 9 sale announcement, the meltdown of the nation's subprime lending sector has worsened, sending the broader credit markets into disarray. Assuming Marshall & Ilsley was fully apprised of First Indiana's loan problems and thus won't have grounds to renegotiate the deal, it's locked into paying a higher price for the Indianapolis bank than it could fetch today.

The $32-a-share price represented a 45-percent premium to where First Indiana traded before the July 9 announcement. Since that announcement, the broader stock market--and financial issues in particular--have fallen, and investors have turned jittery. The Standard & Poor's SmallCap Financials Index, for instance, tumbled as much as 14 percent before rebounding, shrinking the decline to 6 percent.

"Given the ripple effect of the subprime undercurrent in the marketplace, it was actually masterful timing," Renninger said.

It helped that Warrington had a potential buyer in the wings he knew well. Warrington and M&I CEO Mark Furlong worked together as executives at Old Kent Financial Corp. before it was acquired by First Third Bancorp in 2001.

After Warrington became First Indiana's CEO last year, he sold its trust division to M&I for $15 million. Later in the year, First Indiana began using software from M&I data processing subsidiary Metavante.

In fact, the very Friday that Warrington and the McKinneys decided to explore a sale, Warrington called Furlong to gauge his interest, according to the proxy draft.

The following Monday, First Indiana held a special board meeting. The board opted to charge ahead and to hire New York-based advisory firm Sandler O'Neill & Partners to auction the company.

Eight financial institutions thought to have interest in First Indiana were invited to make offers. But they would have to act fast. Bids were due Monday, July 3--giving them only about a week to put together proposals.

M&I and three other banks submitted offers, all between $30 and $31 a share. The SEC filing doesn't identify the other bidders.

According to the filing, Warrington then went back to Furlong, who upped his offer to $32. Warrington and the McKinneys then huddled, "and decided not to pursue further discussions with the other parties," the filing said.

M&I converged on First Indiana's offices on Saturday, July 8, and Sunday, July 9, to conduct due diligence. That same weekend, the boards of the two companies signed off on the merger and prepared for the public announcement Monday morning.

Banking observers say that if First Indiana hadn't extracted such a rich price, it would be vulnerable to criticism that it moved too swiftly.

After all, potential suitors might have stayed on the sidelines because they weren't comfortable with the timetable. Or they might have offered more if they'd had weeks to conduct due diligence.

Given what's transpired in credit markets since then, however, bank officials need not worry about second-guessing.

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