A fast-growing Indianapolis bank that became one of the biggest U.S. Small Business Administration lenders in the state has returned to profitability after a harrowing stretch of massive losses that nearly led to its failure.
Bank of Indiana officials acknowledge their institution was buffeted by a barrage of borrower defaults and other setbacks, including falling victim to fraud involving an Illinois loan broker now in federal prison.
A Marion County jury last month found that Bank of Indiana’s former Lafayette division president breached his fiduciary duty to the bank in the episode, which cost it $2 million on a single loan.
Bank of Indiana officials gave IBJ rare access to examine the challenges they faced after the severe recession threw their aggressive business plan into disarray. Their odyssey is an extreme example of the wrenching pain felt by bankers across the state as economic turmoil tested old assumptions about what constituted prudent lending.
The institution’s story begins in 2006, when a group of mostly Indiana investors bought the tiny First National Bank of Dana in Vermillion County, rechristened it Bank of Indiana, and broadened its focus to include central Indiana.
Because the predecessor institution was tiny and saddled with troubled loans, Bank of Indiana didn’t have a large pool of seasoned, performing loans to fall back on when newer loans soured.
Indiana has had three bank failures—Irwin Union in Columbus, Integra in Evansville, and SCB in Shelbyville—since the economic crisis hit in 2007. Bank of Indiana likely would have suffered the same fate if not for millions of dollars in reserves stashed in its holding company, Indiana Bank Corp. The bank tapped those reserves in 2011 to beef up its provision for loan losses, money set aside to weather possible future borrower defaults.
The bank for the year allocated nearly $5 million for its loan-loss provision, a huge sum for an institution with a mere $108 million in assets. The conservative move left Bank of Indiana with a provision totaling 8 percent of loans—four times the average for Indiana institutions.
The bank board decided to take the hit last year after appointing a new president and CEO, Indianapolis attorney Joseph Montel, who led an effort to closely scrutinize the entire loan portfolio. Montel also made the tough call to sell real estate the bank had seized as collateral rather than holding onto it in hopes of a market rebound.
“New management, new direction, new culture,” Montel said. “If you are going to correct the course, you have to turn the ship. That’s painful.”
Montel, 43, has been on the board of the bank and bank holding company since the 2006 buyout. A partner in the law firm Coleman Stevenson & Montel, Montel replaced veteran Hoosier banker Dan Fehrenbach as CEO in April 2011 and as president two months later. He’s been putting in seven-day work weeks for months in a quest to own up to problems, resolve a thicket of litigation, and simplify finances so that it’s easy to observe whether the bank is really making money.
Bank officials performed the work with a skeptical eye, ditching the mind-set that a rebounding economy would allow many struggling borrowers to regain their financial footing.
“We discontinued taking an optimistic viewpoint of the economic condition and really abandoned the naïveté that this is a short-term recession that will resolve itself within a five-year period,” he said.
Since late 2009, the bank has been operating under a formal agreement with its regulator, the Office of the Comptroller of the Currency, requiring that it maintain certain capital requirements, including keeping so-called Tier 1 capital above 8.5 percent.
The 16-page agreement says the comptroller stepped in after bank examiners “found unsafe or unsound practices … related to credit administration.”
Montel acknowledges the shortcomings.
“We as an institution were processing very large, highly complex loans at a fast pace,” he said. “My interpretation was, the comptroller was concerned we did not have an adequate credit and underwriting department to handle that production.”
He said the bank began building a concentration of commercial real estate loans in the third quarter of 2006—enough lead time before the economic crisis set in that “you were really able to gain enough speed and size to hurt yourself.”
He said bringing nearly $3 million in reserves from the holding company down to the bank kept the Tier 1 ratio above 8.5 percent. But it also validated the OCC’s misgivings.
“If that does not suggest the OCC was on to something, I don’t know what would suggest it more starkly,” he said.
Montel said management “scrubbed the base” of Bank of Indiana in 2011, setting the stage for improved performance in 2012. The bank eked out a $39,000 profit in the first quarter, and Montel expects it to earn more in the second.
“I would call 2012 a ‘zombie’ year,” he said. “You will see a slow, controlled, steady walk, and then when we pass into 2013, that’s when things start to get real interesting.”
Whether that optimism is justified hinges on whether the bank truly has gotten its arms around its loan problems, said Mike Alley, a veteran Indianapolis banker who led Integra in the months leading up to its shutdown by regulators in July.
Many bankers believe the worst is behind the industry. Just 15 U.S. banks have failed this year, a sharp drop from the 389 that succumbed to government takeover from 2009 through 2011.
In addition, the ranks of institutions on the Federal Deposit Insurance Corp.’s problem-bank list have thinned to 813. The number now has fallen for three straight quarters after increasing for 18.
“I do think, as a whole, bank balance sheets are getting stronger, and many banks feel there is increasing stability in their loan portfolios,” said Gregory Lyons, co-chairman of the financial-institutions group at law firm Debevoise & Plimpton in New York.
But bolstering Bank of Indiana’s health has come at the expense of the holding company, which now has depleted its reserves.
It lacked the resources to pay $166,000 in interest due in the first quarter on the more than $12 million in convertible notes the company issued in 2007 to help fuel growth. Because of the missed payment, those notes now are in technical default.
Indiana Bank Corp. in the first quarter also exercised its right to delay paying interest on the $1.3 million in Troubled Asset Relief Program, or TARP, funding it received in 2009.
Montel said the holding company is preparing to restructure and simplify its balance sheet, setting the stage for a push to raise additional capital from outside investors. At the company’s annual meeting on April 18, shareholders will begin that effort by voting on changes to its articles of incorporation that would smooth the way for converting notes into common stock.
“All possibilities are on the table,” Montel said. “We’ve had several interested parties contact us. Once restructuring of the balance sheet is complete, they would evaluate an investment in the holding company that could rise to the level of a change in control.”
The investors who plowed $10.5 million into Indiana Bank Corp. to launch it in 2006 so far have nothing to show for it. They have received no dividends or other distributions. Meanwhile, holders of the convertible notes—some of whom also are shareholders—collected dividends until Indiana Bank Corp. halted those this year.
Almost nothing has gone as the founders of Indiana Bank Corp.—Fehrenbach, veteran banker Jeff Salesman and Jay Reynolds, the deposed Lafayette division president—had hoped.
Within months of launching operations, bank officials became dissatisfied with Reynolds’ performance, and in 2007 he lost his spots on the board of the bank and the holding company. He remained an executive until his termination in February 2008.
Bank officials say they later discovered he had “made material misrepresentations or failed to disclose material information,” according to court papers filed in a legal spat that broke out over whether Reynolds was owed severance.
A judge dismissed Reynolds’ case. But the banks’ counterclaim alleging Reynolds breached his fiduciary duties and that he committed fraud went to jury trial. The jury found in favor of the bank on breach of fiduciary duty but not on fraud and awarded $250,000.
The bank’s counterclaim focused on Reynolds’ involvement with a soured Bank of Indiana loan that was brokered by Surinder Multani, an Illinois man federal prosecutors allege helped prepare dozens of fraudulent loan applications around the country. He’s serving an 11-year prison sentence after a guilty plea in 2010.
Reynolds, working with Multani, misrepresented to Bank of Indiana officials key elements of a $1.7 million loan the bank issued to fund the acquisition of a convenience store, gas station and car wash, according to the bank’s counterclaim.
Reynolds said, for instance, that the purchase price of the properties was $2.5 million when it really was $1.2 million. He also represented that the borrower would put $740,000 in cash into the deal when the borrower actually took out $461,000.
The actual terms would have run afoul of the bank’s lending standards and not been approved, said Mark Waterfill, a partner with Benesch Friedlander Coplan & Aronoff representing the bank.
“We believe Mr. Reynolds was motivated to make loans because he was under pressure to improve his performance,” Waterfill said. “We think the jury was convinced that Mr. Reynolds was providing information that was so far from the truth that he had to be liable.”
Kyle Mandeville, a Lafayette attorney representing Reynolds, said his client is preparing to appeal.
“We certainly dispute the bank’s version of the facts,” he said. “It was a bad loan that was reviewed by many officers of the bank.”
Bank of Indiana took a $2 million hit on the loan in 2009, contributing to a $4 million loss for the year.
Around the same time, the economy was beginning to take its toll on Bank of Indiana’s customers, straining their ability to repay loans.
Bank of Indiana focused largely on agricultural loans and those issued under SBA loan programs. While the federal government guarantees the bulk of the SBA loans, the lender is on the hook for the remainder if a borrower defaults.
Pressures were growing when Montel took the helm. An intense man prone to answering questions with a firm “yes, sir,” and “no, sir,” Montel said he brought to the job a willingness “to speak with candor to the board” about the extent of the bank’s challenges and a drive to change direction.
There was plenty to do, thanks to carnage wrought by the recession and previous management’s decision to launch lawsuits against a variety of parties.
Too many lawsuits, Montel believed, since they were costly to pursue and took management’s eye off running the bank. One case he dispatched quickly was a high-profile securities fraud suit the bank filed in 2010 against Estridge Cos. over its failure to repay the bank’s $1 million investment.
The suit accused the homebuilder and Indiana Securities, the underwriter of the offering, of securities fraud. It also accused Krieg DeVault—which provided legal services to the bank, Estridge and Indiana—of malpractice.
Montel said he has “enormous respect for Paul Estridge Jr. and Krieg DeVault,” where he practiced before forming his own firm.
He added: “Stakeholders in Indiana Bank Corp. invested in a financial institution. Nowhere was litigation a revenue platform. We are departing the litigation business and we are returning to sound conservative banking.”
Former CEO Dan Fehrenbach, who remains a member of Indiana Bank Corp.’s board, declined to comment.
Adding to the challenge, Montel said, were burdensome new federal regulations created in the aftermath of the financial crisis, as well as what he considers overly restrictive lending standards enforced by examiners.
“The regulatory environment—the paper that comes out of D.C.—treats commercial real estate lending as if it were wearing a hoodie,” Montel said. That “almost violent suspicion” prevents the bank from making some loans that not only would be sound but would help the local economy gain traction.
Crunch time for Bank of Indiana came in the second half of last year. The first challenge: Were there sufficient reserves at the holding company for the bank to tap to fund the massive provision for loan losses?
Fortunately, the answer was yes.
The next challenge: Because of the bank’s deterioration, if it wanted to continue holding public deposits, it needed to increase the collateral backing those deposits from 50 percent to 100 percent. Did it have sufficient liquidity?
Montel said that if Bank of Indiana’s performance continues to improve, it will be able to reduce the collateral again—freeing up capital to plow into making loans and fueling growth.
Jay Seeger, a Lafayette attorney who serves as chairman of the bank’s board, showered Montel with praise for the progress.
“I have every confidence in him that I could possibly have,” Seeger said.
“At this point in time, the bank is turning around. We feel our difficulties are behind us, and we are optimistic,” Seeger said. “But it is still going to be a long road to get the bank to where we would want it to be.”•