Regulators Fell One Bank, Spare a Rival

By DAVID ENRICH and DAMIAN PALETTA CLEVELAND -- When federal regulators forced National City Corp. to sell itself in October, the head of another struggling bank right across the street watched from his office window as television crews swarmed. "That could be us," Robert Goldberg, AmTrust Financial Corp.'s chief executive at the time, recalls worrying. Both banks were reeling from real-estate loans made before the housing market crashed. Both had asked federal regulators for a financial lifeline from the Troubled Asset Relief Program. National City got the cold shoulder. The government threw billions of dollars at PNC Financial Services Group Inc. so it would buy the 163-year-old bank. AmTrust, however, got a second chance. In late February, regulators agreed to a turnaround plan proposed by AmTrust, according to people familiar with the matter, even though its capital was much thinner than its Cleveland rival's was last fall. The starkly different fates of the neighboring banks show how the U.S. government's approach to dealing with the industry's worst crisis in a generation has shifted. The decision to allow only one of the two banks to survive has fueled criticism that regulators are picking winners and losers, without disclosing their criteria for making the calls. That, in turn, has shaken the confidence of bankers and private investors trying to decide whether to wade into the troubled sector. Government officials were "trying to make an example" out of National City, complains Cleveland Mayor Frank Jackson. "I don't want the same thing happening to AmTrust." Uncertainty about the condition of U.S. banks has roiled financial markets for months, prompting the Obama administration to take the controversial step of performing "stress tests" on the country's 19 largest banks. Government officials plan to begin meeting with banks on Friday to go over the results. AmTrust's survival owes something to timing. Last fall, federal officials hoped that shoving the industry's weakest institutions into the arms of stronger banks, with financial aid from TARP, would solve the problem. Since then, it's become clear that shaky banks outnumber potential buyers. Now, the Obama administration is pinning its hopes largely on the creation of a public-private entity to buy bad assets from banks. The evolving strategy can be confusing even to banking regulators. The Office of Thrift Supervision, or OTS, which oversees AmTrust, recently told lawmakers it has been slow to take action on some troubled institutions because of uncertainty about what its parent agency, the Treasury Department, might do next. National City, AmTrust and KeyCorp, another regional bank based in Cleveland, together established the city as a Midwestern banking center. The three banks had 51,050 employees at the end of 2007. As manufacturing slowed, they began looking toward faraway states to fuel growth. All three banks became nationwide mortgage lenders. That brought them big profits when times were good. Privately held AmTrust, founded in 1889 and majority-owned by Mr. Goldberg's family, branched into Florida and Arizona. National City expanded in Florida. When home prices tumbled and foreclosures ballooned in those two states, both National City and AmTrust were hammered. Last spring, National City executives and directors considered seeking a buyer. They decided instead to raise about $7 billion in capital from a group of private investors. Bank officials said the infusion made National City one of the best-capitalized banks in the U.S. Meanwhile, AmTrust was under pressure from the OTS to shrink. The bank sold assets and eliminated hundreds of jobs. Executives told dispirited employees the restructuring would put AmTrust on solid financial ground. Behind the scenes, both banks were sinking deeper into crisis. As of last June 30, about 7.2% of loans at AmTrust, which had $16 billion in assets and about 70 branches, were classified as "noncurrent," meaning borrowers were behind on payments. About 2.8% of its loans had been written off as hopeless. By comparison, the average bank or savings institution had a noncurrent rate of 2% and a charge-off rate of 1.3% in last year's second quarter, according to the Federal Deposit Insurance Corp. By Labor Day, AmTrust was nearing a deal with private investors to pump hundreds of millions of dollars into the bank, according to people familiar with the matter. But the investors balked shortly after the federal government seized Fannie Mae and Freddie Mac, and Lehman Brothers Holdings Inc. sought bankruptcy protection. National City, which had $144 billion in assets and more than 1,400 branches, didn't look quite as sick, although it was significantly worse off than the average institution. About 3.8% of the bank's loans were noncurrent as of June 30, and about 2.2% of loans had been charged off. As concerns grew about the health of many U.S. banks, the two Cleveland banks tried to reassure customers and regulators. National City executives grew alarmed that some trading partners were reluctant to do business with the bank, potentially threatening a crucial source of day-to-day funding, according to people familiar with the situation. ReutersAmTrust executives say their bank wasn't facing a cash crunch. But both AmTrust and National City advertised interest rates on deposits that were well above local averages, according to Bankrate.com, which tracks deposit prices. That's a common tactic for banks struggling to attract and retain deposits, a key source of low-cost funding. AmTrust cut its rates later in 2008. Congress's authorization of TARP in October offered a new glimmer of hope. In its original form, the rescue program called for the government to buy risky loans and other assets from banks, freeing up space on their balance sheets for new loans. Executives at National City and AmTrust were eager to participate. After consulting with federal regulators, they fleshed out plans to sell risky mortgage assets into the program at a loss. But in mid-October the Treasury announced it was revamping TARP. Instead of buying bad assets, it would inject hundreds of billions of taxpayer dollars into "healthy" banks. (KeyCorp eventually received such finds.) National City executives worried the emphasis on healthy institutions was likely to exclude their bank. Within days, U.S. Comptroller of the Currency John Dugan told CEO Peter Raskind the company probably wouldn't qualify for federal aid, say people familiar with the talks. The message: Find a buyer -- and fast. On Oct. 24, National City announced that PNC was buying it for about $5 billion. The Pittsburgh bank received $7.6 billion in government funding in return for buying National City. Within hours of the shotgun marriage, Ohio politicians were howling that regulators had acted capriciously. They feared thousands of lost jobs. Clevelanders were rankled by the loss of a local institution to Pittsburgh. In a letter to then-Treasury Secretary Henry Paulson, Ohio Republican Sen. George Voinovich complained about "the lack of transparency" in how TARP money was being doled out. Without more clarity, Mr. Voinovich wrote, people will "start questioning whether Treasury officials are picking winners and losers." At congressional hearings and a rally in downtown Cleveland, politicians argued that National City didn't deserve to die. AmTrust's CEO, the 70-year-old Mr. Goldberg, didn't have much hope that things would turn out better for his institution. His family has run AmTrust since 1961, when his father, Leo, bought a controlling stake. Nine family members work at the bank. In mid-October, AmTrust executives approached the OTS to express interest in getting a capital infusion from the federal government. AmTrust officials figured they would be eligible for as much as $295 million, according to people familiar with the matter. They were crestfallen by the agency's response: To get taxpayer money, AmTrust would have to raise an equal amount of capital from private investors. David Goldberg, Robert's brother and the company's co-chairman, says he knew immediately "that would be hard to do....The fact is, there's no outside capital." On Sept. 30, AmTrust's Tier 1 capital ratio, a closely watched gauge of a bank's financial health, had fallen to 5.4%. To be considered well-capitalized, banks need a ratio of at least 5%. By comparison, National City had a Tier 1 ratio of about 9.1%. Concerned about AmTrust's declining capital cushion, the OTS slapped the bank in November with a cease-and-desist order demanding that it increase its Tier 1 ratio to 7% within six weeks. It also barred AmTrust from making construction loans and certain mortgages, citing "unsafe and unsound banking practices." Robert Goldberg fumed to colleagues that the order was unnecessary, since the bank had stopped making construction loans about a year earlier. Finding new outside investors "was a joke," he said at the time, concluding it would be impossible. OTS officials decline to comment on their oversight of AmTrust. "The OTS uses the same supervisory approach for all of its regulated institutions," a spokesman says. The agency was under pressure not to appear soft on the banks it supervised. Lawmakers and rival regulators had accused it of neglecting to clamp down on risky lending before the failure of such lenders as Washington Mutual Inc. and IndyMac Bank. One of the few things AmTrust had going for it was the backlash over National City. An Ohio agency created to help banks and insurers get federal aid arranged meetings between AmTrust executives and lawmakers. The Goldbergs bent the ears of lawmakers to whom they had donated money. Republican Rep. Steven LaTourette, who received $4,800 in contributions from the Goldbergs the week National City was sold, offered to help AmTrust. An AmTrust spokesman says: "As demonstrated during the height of the nation's financial crisis, the congressman has been a strong advocate for jobs and growth for Northeastern Ohio." In a Dec. 2 meeting with Neel Kashkari, the Treasury official who heads the TARP program, Rep. LaTourette maintained that National City had been well-capitalized when it was forced to sell. "If you're going to screw one Cleveland bank, don't screw another," Rep. LaTourette recalls saying. Mr. Kashkari responded that Treasury only considers applications forwarded by federal regulators, and in AmTrust's case, the OTS hadn't formally recommended that it receive TARP money. On Dec. 1, as the capital-raising deadline neared, a senior AmTrust official sent a 7:30 a.m. email summoning about 100 employees to a meeting, where they were laid off. Other employees faced an across-the-board salary freeze. The Goldbergs took unspecified pay cuts. Battered by defaults on large construction loans, AmTrust posted a net loss of $513 million in 2008. The bank's Tier 1 capital ratio sank to 4.9% as of Dec. 31. In early January, the FDIC began contacting banks to gauge their interest in bidding for parts of AmTrust, say people familiar with the matter. AmTrust wasn't aware of the FDIC activity, and executives submitted new plans to the OTS, hoping to win the bank more time to raise capital. On Jan. 27, Rep. LaTourette attended a White House reception held to give lawmakers a chance to mingle with President Barack Obama and top aides. Rep. LaTourette says he pleaded with an official, whom he won't identify, about AmTrust. Since then, the OTS has told AmTrust that it is willing to give the bank's restructuring strategy a chance to work, even if the bank can't attract additional capital, people close to AmTrust say. AmTrust is reducing its assets and deposits by roughly one-third, selling branches, trimming its work force and launching a loan-modification program. "This isn't a plan they dictated to us," one top AmTrust executive says. "We came up with it, and they bought it." AmTrust executives say they've even talked to regulators about possibly selling bad assets through the government's planned public-private bank-cleanup initiative. The OTS won't say why it backed off with AmTrust. Asked about AmTrust, Tim Ward, the agency's deputy director in charge of examinations, said that the OTS tries to avoid shutting down banks "if you have the liquidity and the capital to work down the risk in your portfolios." Peter Goldberg, the 39-year-old son of co-chairman Gerald Goldberg, took over as AmTrust's CEO in March. "We have been implementing actions to significantly reduce the bank's risk profile," he says. Meanwhile, PNC is cutting about 4,000 jobs at the former National City. The Cleveland bank's name and logo will begin disappearing from branches later this year. Write to David Enrich at david.enrich@wsj.com and Damian Paletta at damian.paletta@wsj.com