Work by Matthew Stone

July 7, 2010

AUGUSTA -- Border Trust, headquartered in downtown Augusta, has missed a number of benchmarks laid down by federal regulators to increase its capital holdings, after the bank came under heightened scrutiny last year.

But Border Trust President Earle F. Harvey says there's a plan in place to inject the needed capital and to reverse the losses.

Border Trust has reported net losses in every fiscal quarter but two since December 2006.

A turnaround, Harvey said, will start to show within a year.

"The model we have is, the bank for small-business families," he said recently in an interview at his office. "We have enough customers in our database to grow our business pretty respectably."

But before growth becomes Border Trust's primary focus, Harvey said, the first priority is cleaning up the balance sheet.

Since August 2009, Border Trust -- which has $81 million in assets and branches in Augusta, South China, Jackman and Topsham -- has operated under a regulatory order from the Federal Deposit Insurance Corp. that requires the bank to restore capital holdings, reduce debt and appoint new staff to address bad loans.

The 16-page order, known as a cease-and-desist, says the bank is carrying too many delinquent and at-risk loans without the capital levels needed to cover losses.

A separate agreement between the bank and its state regulator, the Maine Bureau of Financial Institutions, restricts dividend payouts to shareholders. Harvey and his family own about 60 percent of the company.

"By the time you get the cease-and-desist, you're being watched pretty closely," said Eric Higgins, the von Waaden chair of investment management at Kansas State University. "Whereas a normal bank exam might be every 12 months, every 18 months, (regulators are) going to be in pretty close contact with this bank on an ongoing basis."

The regulatory order, however, doesn't imply that the bank is close to being shut down, Higgins said.

"If it was really, really bad, they would have closed the bank," he said. Regulators "clearly don't feel that it's at that point, but they feel that there are issues that need to be addressed."

Before the regulators

Harvey said the bank's problems stem largely from a handful of loans to small-business customers -- including some longtime customers -- whose businesses went belly up.

"When our customers do well, we do well," he said. "We had a handful of customers who saw a major deterioration of their business. I don't think any of us anticipated the depth of this recession."

That deterioration happened, Harvey said, after Border Trust issued "a few too many" large loans.

"That's where we did make some errors," he said, "and we're working through many of those credits."

To Higgins, that story is common among smaller banks across the United States, where economic pain has reverberated after taking down some of the nation's largest banks.

"The longer this drags on, the more the failures become not necessarily problem lending, but economic problems," he said. "More defaults on loans, it just starts adding up."

The regulatory enforcement caused by the problem loans has rushed Border Trust into cleanup mode, Harvey said. "You have to put all stops out and tell the loan crew: 'No new loans. Work on these.'"

Cleaning up the balance sheet and addressing regulatory concerns require an investment, Harvey said.

"You have to throw resources at the problem," he said.

That includes more time from employees, lawyers and accountants -- costs that add up.

"All of this happens at a time when you can least afford it," Harvey said.

In Border Trust's case, according to Harvey, righting the ship has required something of a behavioral adjustment.

"We historically have worked with our customers and not been the heavy-handed guy," he said. "In this environment, we need to be more aggressive. We can't afford to sit back."

Part of that tougher approach includes reassigning three staff members to a credit team and appointing an internal loan committee. Those groups work on Border Trust's $60 million loan portfolio, addressing existing problem loans and attempting to prevent new ones.

The path to health

Border Trust has a two-pronged approach in the works when it comes to boosting the bank's capital holdings and returning it to solid footing.

First, Harvey said, a longtime Border Trust customer will join the bank's board after offering a flexible loan to the bank's holding company, Border Bancshares. That loan, Harvey said, will help boost the bank's capital to levels required by regulators.

"It's a very advantageous loan," Harvey said.

Border Trust can pay it back, he said, essentially at whatever pace works.

Harvey declined to name the investor and the amount he's lending.

Second, Border Trust expects to complete the sale of its Jackman branch to Skowhegan Savings Bank by the end of the summer. Through that sale, Border Trust will give up $22 million in deposits and $15 million in loans.

But, "we got paid a fair price," Harvey said. "Skowhegan (Savings) is the natural fit."

The Maine Bureau of Financial Institutions and the U.S. Department of Justice have blessed the transaction. The banks are awaiting one last approval, from the FDIC.

For Border Trust, the loss of the Jackman branch is an emotional one. Harvey's grandfather, Earle W. Harvey, founded the bank in Jackman in 1969, catering to loggers' business needs. Jackman is also the one market where Border Trust is the only bank.

"It was not an easy decision," Harvey said. But "when we needed to raise the capital, it was a natural thing to do."

The sale fits with Border Trust's overall business strategy, Harvey said, which is to shift the bank southward, focusing on the central and Midcoast Maine markets. Border Trust sold its Greenville branch in 2004 and closed its Albion branch in 2005 in favor of investing in the Topsham market.

"We believe we have a niche in the Midcoast area," he said. "There are a lot of banks there, but no decision-making there."

Border Trust, he said, doesn't have to work through a large corporation's layers to give a customer an answer.

In fact, the bank is getting smaller. Its asset size, now $81 million, has dropped almost $10 million in the last year.

"The asset size shrinkage is absolutely intentional," Harvey said. "During times of struggle, you shrink your assets."

Regulation's role

On paper, Border Trust's recapitalization is coming too late.

The cease-and-desist order issued last August required that the bank boost three measures of capital -- known as Tier 1 leverage, Tier 1 risk-based and total risk-based capital -- to 8, 8 and 10 percent of assets, respectively, by March 31 of this year.

Border Trust, however, reported ratios of 4.2, 6.5 and 7.6 percent, respectively, according to documents on file with federal regulators.

"We didn't meet the ratios," Harvey said. "We just simply could not get that together that quickly."

But as the bank's recapitalization strategy comes together by summer's end, that should change, Harvey said. "We anticipate getting there in September 2010."

The fact that Border Trust missed deadlines prescribed in a regulatory order isn't necessarily significant, said Higgins, the Kansas State University professor.

Regulation, he said, is a "dynamic process" aimed at encouraging corrective action to save a bank. The process allows for banks to implement their corrective plans.

"If they have an agreement in place to sell something, or issue some new equity, you're going to take some time for that to be accomplished," Higgins said.

Harvey said Border Trust faced no adverse consequences for falling short of the prescribed capital measures.

Donald Groves, deputy superintendent for supervision and examination at the Maine Bureau of Financial Institutions, declined to comment specifically on Border Trust's performance.

"The cease-and-desist order is public," he said. "A lot of the stuff we do around the cease-and-desist is not."

LaJuan Williams-Young, an FDIC spokeswoman, also declined comment on Border Trust.

"The process does work, as much as I don't want to go through it again," Harvey said of regulatory scrutiny.

A community banking future

Border Trust, which has 32 employees, will emerge from more than a year under close watch by regulators a slimmed-down institution focused on its small-business market, Harvey said.

Border Trust isn't shrinking in preparation for a sale, he said, though the bank board has occasionally entertained offers.

"I know we're really small," he said. "We probably always will be the smallest. (Harvey's grandfather) wasn't building it up to flip it."

Future growth, according to Harvey, could come from providing more fee-based services, such as insurance brokerage and wealth management. But the primary goal, Harvey said, is to remain a community bank in a market where that's a tough model to sustain.

"Banks like us need to survive and be vibrant in our communities."

Matthew Stone -- 623-3811, ext. 435
mstone@centralmaine.com

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