The All-Out Effort that Saved a North Carolina Bank

Banks typically do not turn to worn-out tobacco advertising slogans to spice up marketing.

But in the unlikely event CommunityOne Bancorp was to go that route, there is an old tag line that would work well: "You've come a long way, baby."

After losing $276 million since the start of 2010, including nearly $8 million through midyear, the Asheboro, N.C., company says it will turn a third-quarter profit.

"This is a very exciting time for us. We're moving from a deep turnaround to a more normalized environment," Chief Executive Brian E. Simpson said Wednesday. "We've made a lot of progress cleaning things up … and that sets us up for where we are now, which is a return to profitability."

If the $2 billion-asset CommunityOne hits its mark, its recovery will have been nothing less than spectacular. On the verge of failure less than three years ago, CommunityOne — known then as FNB United — was rescued by a group of private-equity investors, led by The Carlyle Group and Oak Hill Partners, who pumped $310 million into the floundering company.

The PE cash was enough to move CommunityOne off of life support, and to provide the wherewithal to purchase another troubled North Carolina company, Bank of Granite in Granite Falls, but Simpson and president Robert L. Reid were left with an enormous turnaround job.

An indication of the size of the task: when the pair took over in October 2011, both of the company's subsidiary banks were operating under enforcement orders and its ratio of nonperforming loans to total loans was a whopping 16%, according to the Federal Deposit Insurance Corp.

CommunityOne eliminated a major source of expenses when it completed the integration of its banks, CommunityOne Bank and Bank of Granite, in June. CommunityOne spent about $2 million on merger-related expenses in the second quarter. It expects none going forward. Improving credit quality has also bolstered CommunityOne's bottom line. Nonperforming loans to total loans dropped to 4.7% as of June 30, and the improvement should continue, CommunityOne says.

CommunityOne's turnaround was slowed by the sluggish economy and the flat yield curve, but with the recovery picking up steam and net interest margins beginning to widen, the company is confident it has regained its footing. There is plenty of room for organic growth, Reid said, singling out mortgage banking and wealth management as especially attractive opportunities.

Merging its subsidiaries has given the bank "one consistent brand, one product set and one message in the market," Reid said.

But CommunityOne is considering other expansion strategies as it prepares to put the turnaround behind it. After years of retrenchment, it can begin focusing on moving into new markets — and acquiring banks.

It is almost a foregone conclusion the company will begin looking actively at some point. CommunityOne's private-equity partners have indicated a willingness to provide additional capital as it shifts to a growth mode, and its executives are mulling options.

"We believe we've built a very solid company, and we're willing to combine it with other banks in adjacent markets," Simpson said. He singled out Raleigh, which lies just to the east of CommunityOne's current footprint, as one possibility, but its ambitions may extend far beyond North Carolina's capital. In addition to eastern North Carolina, South Carolina and parts of Virginia all are attractive markets for potential expansion, James F. Burr, a managing director in Carlyle's global financial services group, said Wednesday.

He is not worried about a shortage of opportunities. "If the current regulatory environment continues, a lot of quality under-scale platforms" may seek merger partners, Burr says.

Oak Hill Partners did not respond to a request for comment.

CommunityOne's losses — the last time it posted a profit was the second quarter of 2008 -may leave it well-positioned to pursue acquisitions after it starts making money. The red ink has left a valuable source of funding — a deferred tax asset valued at $184.5 million — on its balance sheet.

Banks record deferred tax assets for a number of reasons, a major one being operating losses. Banks can use deferred tax assets to offset tax expenses, but that means, naturally, that they have to earn a profit. No profit equals zero taxes, which equals nothing to offset. Thus, if the string of losing quarters were to continue, CommunityOne might conceivably be forced to write down the value of its deferred tax assets. Conversely, returning to profitability means CommunityOne can begin tapping into that resource to offset the tax bill it believes is on the way.

CommunityOne has set no timetable for utilizing its deferred tax asset, but it represents "a very significant undervalued asset" nonetheless, Simpson says. "As we get them back on our balance sheet, they will directly increase tangible equity."

The prospect of CommunityOne capitalizing on its deferred tax asset was one of the things that made the turnaround effort so attractive, Simpson added. Indeed, deferred tax assets are a major factor behind virtually all bank turnaround efforts, according to Burr.

To be sure, deferred tax assets are not the sole factor, or even the most important one, investors consider when evaluating candidates for a turnaround. In CommunityOne's case it was the company's deposit franchise that convinced its private-equity backers that a salvage job was feasible.

"One of the core values we saw in the franchise was its deposit base," Burr says. "It had a stable, established deposit base that had been around and shown itself to be sticky in nature. At Carlyle, that is where we believe value starts."