It takes special circumstances for one bank to foreclose on another.
A rarity in the industry, but such an event took place this year, leading to last month's sale of Generations Bank to National Bancorp Holdings Inc.
The buyer, run by brothers Stephen and John Calk, navigated through the uniform commercial code to snag the Overland Park, Kan., thrift after its owners defaulted on a loan from a unit of Dickinson Financial Corp. And some observers predict more foreclosures on the horizon that will force lenders to make tough choices.
"People forget this can happen," said Walter Moeling 4th, a partner at the Atlanta law firm Bryan Cave who represented SunTrust Banks Inc. when it foreclosed on Bay Bank and Trust in Florida in 1993. "We just haven't seen it recently because the lender has to see some value in foreclosing on the bank. I think this is going to be a real issue for a lot of banks."
Generations is an interesting case to scrutinize — the thrift's former owners are in the midst of bankruptcy, its principals are banned from banking indefinitely and on Thursday the Securities and Exchange Commission charged six of the parent company's former executives with fraud.
As unique an example as it is, lawyers said it is a tale that other troubled borrowers ought to heed. During the current cycle, banks that made loans to bank holding companies have appeared limited in their ability to collect as the loans go bad. In most cases, a lender agrees to a forbearance or it cuts its losses. Those loans are usually secured by all the stock of the bank. So, a lender has the right to foreclose.
Defaults most often occur at companies that are hurting for capital after taking significant losses on problem loans. Bank stock lenders are not interested in taking on a troubled bank to make up for a company's bad debt.
"From my perspective, the scenario where this is likely to happen is when a bank is healthy or moderately healthy, and the bank holding company is distressed. In the current environment, it is often just the opposite," said Edwin del Hierro, a partner at Kirkland & Ellis LLP. Del Hierro, who represented the Calk brothers, declined to discuss specifics of that transaction.
Moeling, however, said there is a shift afoot. Credit quality is improving — or at least stabilizing — across the industry. That means the value of the bank can be determined, but holding companies are still overlevered with debt from both lines of credit and trust-preferred securities.
"I would not be at all surprised to see more of this as the market firms up," Moeling said. "Debt at the holding company was a hugely popular way to capitalize a bank, but now those companies are stuck and can't move cash up."
Still, del Hierro and Moeling both said that the lender's preferred option would likely be a sale arranged by the company itself. The lender could then collect from the proceeds.
In the case of Generations, its parent company was in the midst of bankruptcy proceedings. The $44 million-asset thrift was owned by Brooke Bancshares Inc., which was owned by Brooke Corp., an insurance company in Phillipsburg, Kan. According to November 2009 prohibition orders by the Office of Thrift Supervision, Robert Orr and Leland Orr, executives of Brooke, were banned from banking for unsafe and unsound practices that caused significant losses to the thrift.
On Thursday the SEC also charged both Orrs, along with four other Brooke Corp. executives, with hiding critical information from its investors and conducting a financial fraud. Five of the six executives have agreed to settle with the SEC.
Since 2008, Generations has tried to address the problems allegedly caused by the Brooke executives. The thrift shed more than $100 million of assets and was well capitalized at Dec. 31, 2010. Its nonperforming assets totaled about 0.87% of total assets.
The work was enough to attract the Calks, who also own Chicago Bancorp, a mortgage bank that will remain a separate entity from the thrift.
Stephen Calk, who is now chairman of Generations, said the brothers were only interested in "pristine banks" that would serve as a natural extension of the family business. He said that while the transaction seems complicated, given all the parties involved, he and his brother's service in the U.S. Army helped smooth the process. (Stephen was a combat pilot, while John was a tank commander.)
"The process appears complex on paper when you think of everything that is involved," Stephen Calk said. "It is all about staying organized and following the procedures. Following a checklist is something my brother and I do very well."