Troubled Lake Bank bank sets sail under new ownership group

An experienced group of bankers has acquired Lake Bank in Two Harbors and injected $3 million in equity capital, bringing the troubled operation back into regulatory compliance.

The group, which includes the majority owner of American Bank of the North based in Nashwauk — the region’s largest independent bank, and one of its most profitable — has hired longtime Duluth banker Peter Jeronimus to lead Lake Bank as its new president and senior lending officer.

“We’ve got a lot of experience on the board, and the right people in place,” said Jeronimus, who was a vice president and commercial lender at North Shore Bank of Commerce. “We have a good program, and we’ll be introducing new products to the bank. Our owners are committed to Two Harbors for the long term,” he said. The turnaround “is going to take a while,” he said.

Jeronimus immediately faces “workouts” of problem commercial loans, many of the biggest involving out-of-area debtors. The bank’s first quarter call report lists a $79,000 net loss with 40 percent of that red ink stemming from the sale of foreclosed upon real estate for less than the loans owed. At March 31, the bank was carrying $303,000 in residential loans past due 90 days or longer, and more than $1 million in delinquent commercial/industrial loans.

Lake Bank reported a whopping $2.7 million net loss to regulators in 2003 on the heels of a $32,000 net loss in 2002. During 2003, the bank’s total loans and other assets shrank to $67.5 million from $82.5 million on Dec. 31, 2002 as examiners forced Superior Financial Holding Corp., the former owner, and the bank’s then-President Thomas Kell to set aside reserves to cover loan losses.

The first sign of trouble came in April 2002 when examiners from the federal Comptroller of the Currency, which regulates FDIC-insured national banks, ordered the bank to hire an independent consultant to assess the quality of its loans. The bank also had to refile its first quarter call report, and was given a year to boost its equity capital — required cushion to meet future losses.

Six months later in its report of examination, the agency ordered the holding company to relieve Lance Schwanke, senior lending officer, from his duties and to limit Kell’s lending powers. It didn’t go well. The bank had to restate its third and fourth quarter call reports in 2002, and in March 2003 examiners ordered the board of directors to submit a plan for a merger, sale or liquidation.

Kell’s Duluth telephone has been disconnected and he couldn’t be reached. Schwanke, who left Lake Bank in mid-2003, is a vice president at Queen City Federal Savings Bank in Virginia. He declined comment for this story.

The sleepy Two Harbors bank operated as Commercial State Bank until it was sold in 1999 to the group that ultimately installed Kell as president. He had headed and owned a small chain of banks headquartered in Spooner. An influential advisor to former Wisconsin Gov. Tommy Thompson, Kell had a reputation within the banking industry for aggressive lending.

He fit the CEO profile the principals in Superior Financial Holding Corp. were seeking. Shortly before the closing, Twin Cities attorney Todd Duckson, chief financial officer for the holding company and a minority shareholder, said the bank’s conservative lending style needed an overhaul. “It’s fair to say we’ll be more aggressive. I think we’re going to be a breath of fresh air,” he told BusinessNorth in an interview.

None of the bank’s principal former shareholders were bankers.

By contrast, all six of the new owners are bankers, sharing 150 years of experience collectively as lenders, regulators, and investment and credit managers.

• Dennis Lind is the chairman of the holding company that owns separately chartered Midwest Banks in Detroit Lakes and Parkers Prairie, both in Minnesota. He has experience at U.S. Bank and the former Norwest Bank as an investment portfolio manager and in pricing funds, both loans and deposits.

• The presidents of those banks, Stephen Daggett and Bryan Rude, respectively, also are investors in Lake Bank. Rude is a former regulator with the Federal Deposit Insurance Corp.

• Charles Gesme is majority owner of American Bank of the North, based in Nashwauk, and one of Lake Bank’s new shareholders. He chairs its senior loan committee.

• His son Paul Gesme also is a Lake Bank investor. Paul was an investment banker for 10 years at Piper-Jaffray before joining American Bank. He lives in Minneapolis.

• U.S. Bank executive Richard Shepley was chief credit officer at the holding company of the former First Bank System before it was merged into U.S. Bank. He’s a member of several bank boards, including American Bank of the North.

Lind and Charles Gesme said Lake Bank’s problems are the result of high-risk commercial loans — ranging from airline financing to a car wash in Florida — made because they also commanded relatively high interest rates. Kell had introduced a cost structure at Lake Bank too high for local loans to cover, so the bank made those high-interest rate loans to raise its net interest margins, Gesme said. (Net interest margin is the difference between a bank’s cost of raising money from deposits and other sources and the lending rates it can charge borrowers for using that money.)

The 9/11 attacks devastated commercial aviation and set the stage for a prolonged recession that triggered a wave of commercial lending defaults. Lake Bank found itself underwater.

“The problem in Two Harbors was their imbedded cost structure. They needed those high-return loans to cover their fixed costs,” Gesme said.

While many of the details remain to be ironed out, Lind and Gesme sketched out a strategy for restoring Lake Bank to growth and profitability that will benefit their individual banks, as well. For instance, Gesme said Lake Bank has an expensive agreement for back office check processing that his bank’s branch in Calumet can provide far more cheaply. The Iron Range operation already provides back office and Internet banking services for 14 American Bank branches scattered across the Iron Range.

The new owners could have cut expenses further by merging Lake Bank into one of their existing banks and operating it as a branch. Instead, they’ve decided to maintain its independence and use its proximity to larger commercial customers in Duluth/Superior to generate additional business for all three banks. American and Midwest have pooled their lending capacity in several past “participation” loans, and both Gesme and Lind see Lake Bank as a beachhead into the Duluth/Superior commercial market. “By combining the loan capacity of all three banks we can do an individual loan of $8 million,” Gesme said.

Two Harbors and the North Shore have limited commercial lending opportunities. But Jeronimus thinks demand for residential real estate lending should continue, even though higher interest rates are damping the boom that began in the late 1990s.

“We hope to have real estate be a big part of how we grow,” he said.

“Pure re-fi (refinancing) is pretty well behind us, and a lot of opportunities aren’t like they were last year,” Lind said. “But developers still think people will buy, and we’ll be there to finance it.”