Barnes Bank's end leaves trail of victims

Community bank's end leaves trail of victims
Shareholders, executives blame one another for the demise of venerable Kaysville lender.

By Paul Beebe
The Salt Lake Tribune

The first inkling of trouble came in a letter to Barnes Bank shareholders on June 1, 2008.

Signed by chairman, president and CEO Curtis Harris, the letter said the board of directors had approved a dividend of 45 cents per share for the first six months of the year.

The news sent shivers through many of the Kaysville community bank's 400-plus shareholders. Previous payments in June and November 2007 amounted to $3.56 per share -- the biggest annual dividend ever paid by the bank, then in its 117th year. Barnes, Harris said at the time, had a very good year.

This time, though, the ground was shifting, and Harris was not so pleased. Late in 2007, the real estate bubble that had lifted Barnes to record profits had started to sag.

The 45 cent dividend was to be the last payment shareholders would ever receive from Kaysville's biggest employer. A string of profitable years making loans to land developers and builders had ground to a halt. Barnes was entering a nightmare period of losses and crumbling capital reserves that Harris and his subordinates would prove powerless to stop.

The ordeal would continue for 19 months until regulators, certain there was no hope for the dying bank, confiscated Barnes on Jan. 15, wiping out shareholders and staining the reputations of Harris and other top executives. The closure also set off a surge of accusations and recriminations among an inner circle of influential shareholders and bank managers that continues unabated today.

"Five years ago, Barnes Bank was one of the best banks in the country. It had a great franchise. But somewhere in the last five years, the board of directors started making very risky decisions," said Stephan Peers, an investment banker and Barnes family member who joined the eight-member board in September.

Judy Jenson doesn't know why the bank died or who is responsible, but the 62-year-old widow feels suddenly vulnerable. The financial cushion bequeathed to her by her late husband is gone.

"All I know is the bank has squandered my inheritance, which was what I considered to be my future security and get me over the rough edges of retirement," she said.

"The economy is an easy out," wrote blogger Greg Christensen, whose great-great-great grandfather, John Barnes, founded the bank in 1891.

"I believe it was mismanagement, exuberance, nepotism and opaque communications from the board of directors. Our family lost a lot of money. But the wrenching part is feeling we lost a legacy."

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CFO assigns blame » Like Peers, Christensen blames bank managers for thinking too narrowly. Instead of building a portfolio with a mix of loans, they focused on home building and land development. Such loans are profitable but can be risky because they are tied to the vagaries of the economy.

Harris declined requests for comment. But Chief Financial Officer Douglas Stanger defended the bank.

He repeated an oft-cited claim that credit unions have exploited a federal income tax advantage to pull consumer lending away from banks, forcing them to shift more to business loans.

"And a big business in this state was development and construction," Stanger said.

Moreover, based on history, real estate loans didn't seem particularly hazardous. As recently as 2007, losses on real estate-secured loans amounted to less than 1 percent of the bank's loan portfolio, he said.

"I don't think there was ever any decision made at the time that seemed like it was high-risk or the wrong decision," Stanger said.

Instead, he assigned much of the blame for Barnes' collapse to Peers, whose deceased wife was a member of the Barnes family, and Susan Barnes, another descendant of founder John Barnes. Both, he said, engaged in inflammatory actions that scared shareholders, frightened depositors and touched off a $100 million run on deposits that probably forced regulators to close the bank before Harris and others could save it.

"I don't really think Stephan or Susan really understood the impact of what they were doing," Stanger said, adding the media should share the blame for reports that fueled the bank run.

In a letter dated Dec. 2, Peers told shareholders of his effort to gain a seat on the board earlier in 2009 after learning of the bank's dire condition. Peers said he was opposed by every board member with the exception David Barnes, also part of the extended Barnes family, until finally being seated in September.

Peers urged shareholders to attend a special meeting with Barnes management Dec. 18. In the letter, he mentioned an agreement reached with the Federal Reserve in May. The legal document was a formal acknowledgement that Barnes was in trouble. It commanded Barnes to increase its capital reserves, which had been decimated by stacks of construction and land development loans that had gone bad during the previous two years.

The situation was dangerous, but Stanger wasn't alarmed. The bank had racked up $22 million in loan losses during 2008, but had set aside more than $50 million to cover them, he said. Barnes had been working to comply with corrective measures suggested unofficially by regulators during previous meetings.

So Stanger was surprised when the Fed issued the written agreement May 13, formally instructing Barnes to present an acceptable plan to increase its capital within 60 days. The Fed didn't say what might happen if Barnes failed to comply. But the message was clear: Regulators were worried.

"I thought we were doing what was requested and I thought we were following good procedure," Stanger said. "I didn't feel like the bank was under more stress than other banks that were in the same markets as we were."

What Stanger didn't know until informed by a reporter this month was that another federal agency, the Federal Deposit Insurance Corp., had secretly put Barnes on its closely watched "problems list" a month earlier. The list contained the names of more than 300 lenders, its highest level since 1994, testifying to the gravity of the U.S. financial crisis.

"That's not something they communicated to the bank," Stanger said.

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'Time is short' » Turmoil inside Barnes mounted over the spring and summer. By Sept. 30, as loans continued to sour, the lender had lost $210 million.

Shareholders were becoming uneasy. Barnes had not paid them a dividend for more than a year. Then came Peers' Dec. 2 letter. In it, he said the Fed was likely to issue a "prompt corrective action" letter at any time.

"Letters of this type," Peers wrote, "are written to banks that have engaged in such egregious practices for so long that the regulators deem the [FDIC] insurance fund better protected from losses than by a continuation of the same management and director team."

Peers also said he believed regulators would not give Barnes much more time to turn the bank around because of "management's continued lack of response over the past year and a half."

The FDIC letter arrived two weeks later and said Barnes was "critically undercapitalized." It ordered Barnes to find a suitable buyer or raise enough capital by Jan. 15. Although it didn't spell out the consequences, the implication was clear: Failure would mean the end of the bank.

Susan Barnes wrote shareholders on Dec. 26, urging them to assist efforts to change the board at an expedited annual shareholders meeting she hoped would occur before the regulators' deadline.

"Time is short," said Barnes, a librarian living in Seattle. She prodded shareholders to remember the Fed's Jan. 15 deadline. And she reminded them the bank's managers had told them at the emotional meeting Dec. 18 their shares had plunged from $125 a share in February 2009 to less than $3.

"They made it clear that they do not accept any responsibility for this decline," Barnes wrote.

CEO Harris immediately fired off a letter to Barnes. He said the media had caught wind of Peers' letter, and a run on the bank's deposits had ensued because of the resulting publicity. He said her letter would likely generate another harmful response by the public and depositors.

The shareholders meeting took place Jan. 14. Susan Barnes held proxies for more than 40 percent of 800,000 voting shares. Others at the meeting had not authorized Barnes to vote their shares for a proposal to change the bylaws to allow for the immediate election of directors, but promised their support, she said.

The vote was inconclusive. Three directors received less than 50 percent of the votes cast and were expected by Barnes and Peers to step down. But a day later, the Utah Department of Financial Institutions stepped in and closed the bank.

In a recent e-mail to The Salt Lake Tribune , Barnes said, "I felt that it was my responsibility as a shareholder to speak up, and I would do the same again."

CFO Stanger said the bank would have needed at least $30 million in new capital to stave off regulators. It could have used as much as $80 million. But raising any capital in such a heated environment was nearly impossible. Between mid-December and mid-January, depositors withdrew $100 million from the bank, he said.

Stanger had worked 30 years at Barnes. Its death was "devastating," he said in a recent interview. Because he was not on the board, he disavows direct culpability for its decision to focus too much on construction and development loans. Nor does he fault Harris or the board for their choices.

Stanger also does not criticize regulators. They closed Barnes because of the run on deposits. If the run hadn't happened, regulators probably wouldn't have felt the need to close the bank in January, he said.

"There is the likelihood that the bank could have found an investor or a group of investors to raise the capital to continue the bank as it was," Stanger said.

Board member Peers said bank executives have no one to blame but themselves. Instead of blaming him and Susan Barnes for writing to shareholders, executives should acknowledge three key mistakes which ultimately doomed the bank.

» Instead of diversifying its loans, Barnes focused on construction and land development, Peers said.

» It also expanded into fast-growing Utah and Washington counties, making loans to builders and developers it barely knew.

» Finally, it relied too much on brokered deposits -- funds raised by brokers from people in other parts of the country chasing high interest rates -- instead of on local depositors who would be more loyal to Barnes.

"Any blip will sink [such] a bank faster than a comparable community bank because they just have a much higher-risk profile," Peers said.