Georgia Fraud Case Could Complicate Recaps at Small Banks

The sudden disappearance of former Montgomery Bank & Trust director Aubrey Lee Price is the talk of Georgia's banking industry these days, but for capital-hungry small banks the damage could go well beyond words.

Last week, the U.S. Attorney's Office for the Eastern District of New York charged Price with embezzling about $17 million from the Ailey, Ga., bank, which failed last Friday. The Securities and Exchange Commission obtained a court order freezing the assets of an investment fund tied to Price.

Price is missing. Last month he reportedly sent a note to acquaintances detailing his attempts to hide up to $40 million in trading losses by drawing on the bank's assets and those of other investors. Price also reportedly wrote that he planned to kill himself. Now authorities say he was last sighted boarding a ferry in Key West, Fla. and may have fled to South America.

Price's alleged actions appear to have pushed Montgomery into oblivion, but he was originally the bank's white knight. In January 2011, PFGBI, a Price-controlled firm, pumped $14 million into the critically undercapitalized bank.

Before he could do so, Price had to submit to a rigorous background check by state and federal regulators required of everyone who takes a control of a bank. Several deal advisors say they're concerned that the fraud case could end up making the process even tougher.

"The regulators do a really good job vetting people," says Chip MacDonald, a partner at Jones Day in Atlanta. "This could make it harder for small unknown investor groups to invest in smaller banks. … I don't think the regulators ever want to deny capital, but the fact is that this might make them more wary."

Other industry observers say the vetting has already hit maximum torque.

"I'm not sure that they could be any tougher," says Jeffrey C. Gerrish, a partner at Gerrish McCreary Smith. "You have to send your fingerprints in and they cross-reference that with the Department of Justice and other agencies."

The Federal Deposit Insurance Corp. and the Federal Reserve Board declined to comment for this story. The Georgia Department of Banking and Finance did not return a call for comment.

Montgomery has had director issues before. Last year, the FDIC slapped Greg Morris, a bank director and the chairman of the Georgia House of Representatives' banking committee, with a $5,000 fine for an unspecified rules violation. He agreed to pay the fine "without admitting or denying any violation."

Though advisors say that Price's actions do not imply that regulators did a poor job overseeing Montgomery, they believe the investor's alleged actions do represent a cautionary tale for banks desperate to raise capital.

Shortly after the capital infusion, Price joined the board and gained control of Montgomery's investment portfolio, according to a complaint filed by Michael Howard, a special agent with the Federal Bureau of Investigations. Price had told management that he planned to invest in Treasury notes. Instead between January 2011 to May 2012, Price had $21 million of the bank's money wired to trading accounts and investment in options.

Advisors say that Montgomery erred by giving Price so much autonomy and control.

"In essence, they gave him the keys to the vault when they appointed him the investment manager, either through a lack of sophistication or a willingness to trust him," says Byron Richardson, a senior consultant at Bank Resources, an Atlanta advisory firm.

"For a bank that size, the oversight of the investment portfolio should have been in the asset and liability committee," Richardson says. "Clearly, the committee did not have the proper controls in place."

The FBI is formally accusing Price him of embezzling funds. However, reportedly Price wrote in his letter, titled "Confidential Confession For Regulators," that the losses he suffered while trading did not involve taking anything from Montgomery. At the same time, Price reportedly admitted that he created fraudulent statements to buy himself enough time to earn back the losses suffered by the bank.

"I created false financial statements and defrauded investors, regulators, other work associates and bank employees," according to a portion of the letter published on the website for Southeast Georgia Today, a radio station company in Georgia. "I had hoped that positive equity trading returns could offset the losses incurred by the bank and losses incurred in bad real estate."

Things "really turned south when I got involved in the bank deal," he added. "I was in way over my head even though I was told by other professionals that I need to trust those with experience in banking to handle the banking business. Honestly, I had no idea how to handle the complexity of problems at the bank."

Montgomery was struggling enough without shoddy investments. At the time of its recapitalization, a quarter of the bank's assets were nonperforming and it was critically undercapitalized, meaning it was facing seizure.

The $14 million investment was enough to return Montgomery to well-capitalized status briefly, but it burned through the capital quickly as it tried to stem bad bets on construction and land development. As of March 31, its leverage ratio was 2.04%, just a hair above the threshold for critically undercapitalized banks.

Montgomery likely needed at least $30 million, says Walter Moeling 4th, a partner at Bryan Cave who says he had concerns about the Price deal when it was announced.

"I looked at it and thought it was one of the more stupid investments," Moeling says, adding that investors should be cautious to make sure they are bringing enough capital to a deal. "Doing a halfway fix is never enough."