CSBS Examiners Forum

1. The Anatomy of a Troubled Bank CSBS Examiners Forum June 23, 2009 Presented by: Paul A. O’Connor Managing Partner (312) 771-0077 paoconnor97@gmail.com Angkor Strategic Advisors

2. Overview of First National Bank Regulatory Action Program Action Plan Case Study Table of Contents

3. History of the Situation Tab 1 Angkor Strategic Advisors

4. Overview of the Bank • First National Bank • $250.0 million Midwestern community bank • focused on low risk mortgages and rental properties • community provided stable, low cost deposit base • profitable company, well capitalized • Family owned bank for over 45 years • Third generation ready to take the reins • CAMEL one rated bank for 25 years • Expanded into a fast growing, but new market • Original market was slow growth, but provided significant core deposit franchise • Borrowed senior debt from its correspondent bank to repurchase stock • Formed ESOP to link employees with bank strategy and finance stock repurchases • Issued Trust Preferred securities to finance growth

5. The bank experienced rapid growth in its new market, primarily through commercial real estate lending Loan growth was funded by higher cost CDs Share repurchases continued and debt expanded Parent company only senior debt of $8.0 million, trust preferred $5.0 million and equity capital of $7.5 million. Used proceeds to buy-out older shareholders One year ago the Comptroller of the Currency (OCC) came in for a regularly scheduled examination The findings: A family member lent four times the legal lending limit on one real estate project. Loan is classified substandard and the bank has a legal lending limit violation Overview of First National Bank

6. Numerous violations of rules and regulations were found Now Texas ratio exceeds 140% 10 troubled relationships account for 90% of NPAs 4 relationships account for 60% of NPAs Family member responsible for most of the lending issues dies tragically. CEO in self admitted fog for two years OCC issues Written Agreement requiring 8.5% Tier 1/Average Assets and 11.0% total capital ratio Regulatory relations between the CEO and the examiner in charge became strained Structure

7. Overview of the Bank CEO and former director reach out to me • What do I find? • Inexperienced lenders given too much lending authority with minimal oversight • No one understood the complexity of the loans made in the new market • Loan renewals pile up and violations of law do not get corrected • Losses difficult to quantify, but progress being made through foreclosure actions • Key question: is the reserve for loan losses adequate? • Is there depth of management to handle the problems? • What is the board’s viewpoint on the bank’s condition and quality of management?

8. Triage • Due diligence focused on liquidity, asset quality, capital adequacy and management strength • To meet the tenets of the regulatory order, management needs to communicate findings to the board and the regulators • Prepare Regulatory Action Plan • Assemble team of experienced advisors, including investment banking, legal and regulatory compliance firms • Update regulators on management changes • Determine level of compliance with the Order, particularly with the bank’s asset quality issues/violations of law • Analysis of top 10 problem loans and current status • Capital alternatives - How we meet the regulatory requirements • Liquidity overview • Plan of Action on: • Non-performing assets • Liquidity • Capital • Financial implications of our Action Plan • Request from regulator • 2009 financial projections • Next steps

9. How do we fix the problems? • Complete independent assessment of the loan portfolio, a determination of the level of asset quality problems and the estimated loss potential • Assessment of the current management team and its strengths and weaknesses • Assess liquidity position; check lines with FHLB, Fed discount window , correspondent bank and our ability to issue brokered CDs • What are our options to meet regulatory capital minimums? • Senior debt, subordinated debt, trust preferred, convertible subordinated debt, non-cumulative perpetual preferred stock and common equity • Shrinking the balance sheet • Combination of the first two options • The environment facing bank holding companies today • Restricted or no payment of dividends from the bank to the parent company permitted • Company is likely to be in default of one or more covenants in its senior debt line of credit. Need to refinance, restructure or repay the note. Most correspondent banks have left or are leaving the business. To encourage banks to leave, correspondent banks now charging Libor plus 10% for 90 day renewals • Pooled trust preferred market is on life support. Many companies deferring trust preferred dividend • Board of directors unable or unwilling to put in more capital

10. What’s our game plan? Regulators are more forgiving about solving asset quality issues than raising capital. Survival mode includes: • maximizing liquidity • Establishing and testing lines of credit with the FHLB, the Federal Reserve Discount Window and possibly with a correspondent bank. Advance rates on collateral at FHLB, Federal Reserve Discount window and at correspondent banks have been reduced from 80%-90% to 50% on average. • Shrink as fast as is prudent, given the need to preserve liquidity. • Ideally, move out weaker credits, but the more likely scenario is to kick out your best borrowers which can refinance elsewhere. This leaves the bank with a higher concentration of troubled borrowers. • Using brokered CDs to lengthen your deposit maturities • Establishing and testing lines of credit with the FHLB and the Federal Reserve discount window. Get assets pledged to liquidity providers to ensure lines remain open • Hiring work-out specialists when available • Hunting for capital at every opportunity • Determine your public relations strategy to explain the regulatory agreement.

11. What the regulators don’t understand! • Increasing the bank’s capital ratios is the wrong solution to the problem in the near-term • The higher the capital ratio requirement, the harder it is to operate the bank in a safe and sound manner. Ironically, regulators give you more time to fix asset quality problems than to build capital. • Liquidity is strained because shrinkage is the first way to meet higher capital requirements • Ideally, move out weakest credits • Most likely scenario, best clients get kicked-out of the bank • Strain liquidity, increasing the likelihood of bank failing in the near-term. Banks more often fail from lack of liquidity than lack of capital. Ie: WAMU, Bear Stearns, Lehman • Doesn’t really improve your capital position, but the regulators feel better

12. Who are the capital providers? • Existing shareholders, friends and customers of the bank • Accredited investors who specialize in bank stocks • Institutional investors • Private equity • What are equity investors looking for? • The holding company senior debt and trust preferred really does matter when you are raising capital • Investors will not commit to situations where they cannot determine the value/safety of their investment • Fear of the correspondent bank foreclosing on the bank stock collateral prevents many investors from buying newly issued stock • BHC expenses, principally interest expense, lowers book value, the key measure of bank stock values in today’s environment