August 30, 2009

How a board lost a bank

John Davie Waggett landed at least $18 million in loans to buy and build beach houses. His biggest lender was Cape Fear Bank – the bank where he sat on the board of directors.

As the coastal building boom swept this area's beaches, John Davie Waggett gambled for a piece of the action.

Waggett was a successful pharmacist in this historic port city, but he had no experience in real estate development. Nevertheless, in nine months during 2005 and 2006, he landed at least $18 million in loans to buy and build beach houses. His biggest lender was Cape Fear Bank – the bank where he sat on the board of directors.

Three years later, Cape Fear has failed, most of Waggett's loans remain unpaid and federal investigators are sifting through the wreckage, trying to pinpoint what caused the first N.C. bank failure since 1993.

Many people share blame for the country's financial crisis, from reckless CEOs to hands-off regulators to eager borrowers. The Cape Fear saga highlights another group – bank directors, who are charged with safeguarding their institutions and shareholders.

Already, regulators have said that Cape Fear's directors failed to do their job of providing direction and management oversight, and that the bank engaged in “hazardous lending.” An Observer analysis of court and county property records found that those directors continued lending to Waggett even after he amassed millions in debt in less than a year.

The Observer's examination of board meeting minutes, obtained under the Freedom of Information Act, indicates the directors often approved loans exceeding regulatory guidelines. For example, banks are generally not supposed to lend 100 percent of a property's value. That may have happened in at least one of Waggett's Cape Fear loans.

In the end, federal auditors may conclude a variety of factors led to Cape Fear's demise, including bad decisions, bad management and a bad economy. That report is due in October. Meanwhile, available records give insight into the board's appetite for risk and provide a rare look at the secretive world of insider lending.

Banks are not required to publicly disclose insider loans they make to directors, but the Observer was able to determine that Waggett's loans, approved by his fellow board members, totaled $5.5 million – $3.2 million of which he defaulted on.

One of Cape Fear Bank's biggest investors – and biggest losers in the failure – is critical of the bank's directors.

“They were just yes people,” said Maurice Koury. Waggett's loans, he said, are further evidence of a “loose-run board.”

Frustrated by what he felt were poor investment returns, the Burlington textile mill owner tried to buy the bank in 2007 and engineered a board shake-up last year. He criticized both longtime chief executive Cameron Coburn and the board, saying the bank needed more experienced leaders.

But the bank “was in such bad shape when we got there, it was too late,” he said in an interview.

Waggett and other bank officials wouldn't comment.

Koury, now 80, says the collapse cost him $3 million.

“It's a dead horse now,” he said. “Thank God it didn't put me under.”

Regulators estimate the collapse will cost the federal insurance fund $131 million. The fund is financed by banks, not taxpayers. According to regulators, no Cape Fear depositors lost money.

But investors lost everything. At the average 2008 stock price of about $7, their holdings totaled $26 million.

Spotlight on directors

Increasingly, directors of banks facing problems are under siege.

Shareholders still blame Wachovia's board for the Golden West acquisition that helped push the bank so close to collapse that it sold itself to Wells Fargo. At Charlotte's Bank of America, regulators have been forcing a revamp of the board of directors and management.

Cape Fear's post-mortem is under way with the Inspector General of the Federal Deposit Insurance Corp. Past reports on failures from this and other watchdog agencies have faulted directors.

“We found that many of the institutions were headed by a passive board of directors,” Treasury's Inspector General wrote in a 2004 summary of failures between 1993 and 2002.

Directors are intended to be shareholders' representatives, looking out for their interests. They oversee management, including hiring and firing the top boss. At banks, their duties include setting loan policies and approving loans and charge offs when loans go bad.

Waggett and seven other Cape Fear directors declined comment as did two former executives. One director could not be reached. Coburn, who also was a director, did not respond to requests for comment.

A lawyer for the Waggetts, Trawick Stubbs, said he knew of no “allegations of wrongdoing” by them.

Attorneys for Cape Fear said they didn't know of any shareholder lawsuits against the bank or its directors. Regulators can also take action. That's unlikely “because there has been no evidence brought to our attention of fraud, intentional misconduct or breach of fiduciary duties by any directors or officers of the bank,” said Todd Eveson, with the Raleigh law firm hired by the bank shortly before its failure.

The Observer examined more than 450 pages of Cape Fear board meeting minutes. Those minutes, spanning 2003 through the collapse, were released only because the bank had failed. Loan details, some names and other specifics are blacked out. Regulators said they were unable to locate minutes for what the Observer estimated were at least one-third of meetings.

What is clear is that the directors, Waggett among them, often approved loans exceeding lending guidelines. From 2003 through 2006, they granted these approvals at 29 of 34 board meetings for which minutes are available.

In one of Waggett's loans, court records show, the bank loaned him 100 percent of the purchase price for an ocean front lot.

That type of lending to a novice developer and a bank insider is “unreal,” said Ed Lawrence, a University of Missouri-St. Louis finance professor who 20 years ago linked bank failures and insider lending. “It doesn't smell right.”

Boom time

Waggett concentrated his buying in the Carolina Beach area south of Wilmington, in a narrow two-mile stretch along the Atlantic Ocean.

Overall, New Hanover County saw the price of home lots more than double from 2003 to 2006. Home building was soaring. Lenders lined up to profit.

Cape Fear's lending for construction – one of the riskiest loan types – nearly doubled in 2004 and jumped another 140 percent in 2005. By 2006, $158 million of construction loans accounted for nearly half the bank's total lending. The bank has said most of its loans were local, which would be typical for a community bank, but that further exposed it to a downturn in coastal development.

When the bank failed, N.C. Banking Commissioner Joseph Smith acknowledged his office could have addressed the bank's loan concentrations “sooner and more firmly.” But, he said, the real estate market was healthy, and the bank was growing a few years before it crashed.

Federal auditors have routinely reported that loan concentrations are a major cause of bank failure, but they also acknowledge it can be hard to foresee potential hazards.

Last week, Smith said regulators are “going through a period of self-analysis.”

The question is, he said, “how do we identify what we need to be doing to take the punch bowl away when the going is getting a little too good?”

A pharmacist gambles

Waggett helped fuel Cape Fear's lending surge.

The 54-year-old operates two neighborhood pharmacies in Wilmington. Property records indicate he prospered, with a house pegged at nearly half a million dollars, as well as a boat and a plane.

In 2003, Waggett and childhood friend Jerry Sellers were unanimously elected to the board of the bank, which was founded in 1998 and originally called Bank of Wilmington.

“Davie Waggett is the salt of the earth, a successful guy, somebody you'd be proud to call your friend,” said Sellers, who declined to talk about the bank. “I'd trust him with anything I have.”

Waggett declined multiple requests for interviews. Reached Friday at one of his pharmacies, he said people “don't know all the story,” but he wouldn't elaborate and referred questions to his attorney.

About the time Waggett joined the board, he and his wife, Charlene, began the first of several real estate investment and rental companies.

Their first deal, in the spring of 2005, was a $2.4 million oceanfront duplex, according to county records. Duplexes, usually side by side, are popular for beach rentals. Countrywide was the lender.

The next deal, their first with Cape Fear, brought a plunge into developing. They paid $1.25 million for an oceanfront lot and built a mint green duplex. One unit sold within a year for $1.3 million. The other unit didn't sell until December 2007 and for only $700,000, according to court records.

During the summer and fall of 2005, they bought nine lots, on or near the ocean. Cape Fear financed one of those deals: $2.2 million to buy a $1.3 million lot and build a pastel duplex, according to court records. That property fell into foreclosure late last year.

In January 2006 – after the Waggetts had bought almost $10 million of property using other lenders – Cape Fear loaned $1.3 million for an oceanfront lot. About three years later, the bank foreclosed on that property, too. In April, a flier on the sandy lot advertised it for $795,000.

On that loan, it appears from court records, Cape Fear exceeded guidelines by lending 100 percent of the property's cost.

Typically, banks want a down payment so the borrower has a stake in the property. Federal guidelines call for loans on raw land to be no more than 65 percent of value, and 75 percent for land development. Banks are allowed some exceptions, for good customers.

In Waggett's case, there's no way to say for sure whether the loan was for 100 percent of the value because appraisals are not public records. But court records are clear that the loan was for the full purchase price.

Regulators rarely comment on specific banks, let alone individual loans. Speaking in general, Ray Grace, the N.C. deputy banking commissioner who heads bank supervision, said lending for a speculative venture to an inexperienced borrower “should make the hairs on the back of the examiner's neck stand up.”

Waggett's loans are likely getting a close look from federal investigators examining Cape Fear's demise, in part because they are insider loans.

Curbs on insider loans?

Loans to company directors, executives and other insiders were largely banned in 2002, following the collapse of Enron and other accounting scandals. Banks were excluded from the ban because they're in the business of lending. They're allowed to make the loans provided insiders don't get better terms and are creditworthy.

Regulators say the loans get extra scrutiny during bank exams. In Waggett's case, all the loans were made after Cape Fear's 2005 regulatory exam and before the one in 2006.

Insider loans are controversial because of the potential for conflicts of interest, especially when directors are in debt to the bank they're overseeing. No disclosure is required for loans to directors and their businesses, often the biggest insider borrowers.

Investor Koury said the bank should have told investors about its big loans to Waggett.

“The shareholders are the owners,” he said.

The end

In November 2007, Waggett stepped down from the bank's board as he struggled to repay loans.

In a letter to lenders soon after, the Waggetts' attorney said their monthly payments were more than $120,000, and their loans needed to be modified. Cape Fear reduced their loans' interest rates and allowed them to make interest-only payments.

The letter, part of a court filing, also says the Waggetts hired W. Lee Crouch, a real estate broker to “recommend and manage a strategy to extract them from the loan postures.”

Crouch was very familiar with the loans. As a Cape Fear director since 1998, it was his job to sign off on them. He also served at times as the board's lead independent director and chairman. Crouch declined comment.

All told, the Waggetts bought 13 properties, all but one in Carolina Beach, according to court records. They sold a few, but not enough to pay all their debt. Many fell into foreclosure.

With Cape Fear alone, they had more than $3 million in default late last year. A month later, the bank has estimated it had $18 million in problem loans.

“The whole world got caught up in it,” fellow director Sellers said of the coastal land rush. The collapse has “been humbling for a lot of people.”

By summer 2008, one of the Waggetts' companies, had filed for bankruptcy protection.

“Frankly, they have run out of money to pay the monthly debt service and are not paying any lender, except their house mortgage lender,” one of their attorneys wrote. They received all those loans, he noted, even though neither of the Waggetts had “ever developed any real property or been a member of an entity which developed any real property anywhere.”

This year, the couple filed for bankruptcy protection listing assets of less than $1.3 million and liabilities of nearly $17 million.

Stubbs, their attorney for the bankruptcy, said the couple chose a certain type of filing because “they want to repay creditors best they can.” Staff researcher Maria David contributed.

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