Two Sick Banks Progress Toward Healthy Merger

A pair of North Carolina banks surprised industry observers last week, finding investors willing to commit $310 million for an arranged marriage between the struggling companies.

FNB United Corp. in Asheboro said on Aug. 2 that its stock offering was fully subscribed, marking a key point for FNB and its private-equity-financed deal for Bank of Granite Corp. in Granite Falls. The union — proposed in April — had been in doubt as no undercapitalized banks had been able to come together outside the hands of the Federal Deposit Insurance Corp.

"Generally speaking, two wrongs don't make a right," said Derek Cunningham, a managing director at Commerce Street Capital. "If I sat around with $100 million in capital, I would just wait for them to fail."

Waiting for failure could have pitted FNB's newly formed managers against other potentially interested bidders, as companies such as BNC Bancorp in High Point, N.C., and North American Financial Holdings Inc. in Charlotte scout for opportunities.

Brian Simpson, FNB's incoming CEO, said his team began a shelf charter application last year "to rebuild" a relationship with regulators. The group, largely made up of former First Union Corp. bankers, quickly withdrew the application when they saw the "window" closing for blind pool investing.

"More importantly, it was becoming increasingly clear that the more valuable franchises with scale, a more mature customer relationship and a more stable deposit franchise — those organizations were either being acquired or recapitalized," Simpson said.

Simpson's team began talking with Granite and FNB a year ago but it wasn't until April, when the company got Carlyle Group and Oak Hill Capital Partners to commit $79 million each, that the deal came closer to fruition.

"The fact that they found a private-market solution without a loss-share agreement definitely signals that risk capital is willing to invest," said Tony Plath, a finance professor at the University of North Carolina at Charlotte.

First BanCorp in San Juan, Puerto Rico, just pulled off a $525 million raise with the help of private equity. The $14 billion-asset company searched more than a year before Thomas H. Lee Partners pledged $174 million in May. Shortly thereafter, funds managed by Oaktree Capital Management LP matched the commitment. On Monday, the company said it reached the full commitment and was waiting on shareholder and regulatory approvals. The company could not be reached for comment.

Observers warned that a few success stories does not mean others will follow. Other banks are still looking for capital, even as financial markets remain in limbo after Friday's downgrade of U.S. debt by Standard & Poor's.

First Mariner Bancorp in Baltimore is seeking $160 million, and Tri-Valley Bank in San Ramon, Calif., is pursuing $7 million. A representative for First Mariner declined to comment and Tri-Valley did not respond.

"You can't just have a troubled bank and think that PE is going to throw money at you," Plath said. "You want someone with street credibility, a compelling business model and the right franchise."

FNB's bank was operating with a negative-6% total risk-based capital ratio at June 30. Cunningham said regulators are likely letting the bank stay open because of the pending capital raise, that will save the FDIC time and money.

"The FDIC is probably loving it," he said. "I'd be shocked if it doesn't get approved."

Plath said combining the banks would create an institution located on an attractive corridor along Interstate 95 in North Carolina.

"It's not an easy environment" to raise capital, said Simpson, whose team spent nine months conducting due diligence and getting rid of some of the banks' problem assets. "But for most transactions that fundamentally make sense, strategically and financially, you can raise capital."

The $1.8 billion-asset FNB has 45 branches and the $807 million-asset Granite has 18 branches with little overlap. The banks agreed to a new team and board. Most of the new management came from larger banks, mainly First Union, Wachovia Corp. and BB&T Corp.

"This is not something where they're happy with 30 to 40 branches," Cunningham said. "A few years from now, it could grow to 100 branches, which is why they put the big-bank guys in place."

Observers said the big-bank ties likely helped the team reel in well-known private-equity groups. Carlyle would not invest unless there's a "belief that there's going to be enough size to be saleable in the next three or four years," said Christopher Marinac, an analyst at FIG Partners LLC.

"This is not 'Joe's capital,' it's Carlyle," Plath said. "They could write a check for the bank on the way to the break room."

Most observers said Carlyle was critical to gaining the other funds. Whether FNB can meet all the contingencies, complete the deal and expand two famished banks into a healthy Southeast power remains to be seen.

"No matter how many shares are outstanding, they are going to have to make the book grow," Marinac said.

The deal stipulates that FNB convert its Troubled Asset Relief Program funds and pay back junior subordinated debt held by SunTrust Bank. FNB will cash out at a 35% discount to the principal and 100% of the unpaid and accrued interest at the time the deal closes.

Simpson said he expects the deal to close by October.

Observers said that, if the deal closes, it will signal a new point of entry for investors beyond a shelf chartering or a failed-bank deal.

"This will help make the deals happen as long as everything goes through," Cunningham said. "I've actually looked at doing something very similar. It's not easy, but if they can make it happen, it could work for others."