Wake-Up Call in Sussex County

The year was 1988, and things had rarely been better for the folks in Sussex County, New Jersey. Tucked snugly into the state’s heavily forested northwest corner, the rural county’s tangle of towns and villages were experiencing an unprecedented boom of commercial and residential development that had property values soaring and local businesses flush with profits.

Few benefited more from the boom than the National Bank of Sussex County. The largest bank based in the county and the sole subsidiary of High Point Financial Corp., NBSC reported record income and growth the previous year, surpassing the $200 million asset mark for the first time. “The future has never looked brighter,” declared Chairman and CEO Robert Rough in an April 1988 letter to shareholders.

So bright, in fact, that High Point was launching a de novo bank across the state line in Pennsylvania and had paid $4.3 million for a piece of prime real estate to build a new 58,000 square-foot headquarters building. “Of course, a company like we had would need a new world headquarters,” one director recalls with a rueful chuckle. “We were riding high.”

Four years later, everything had collapsed. Rough was gone, having pleaded guilty to leaking sensitive discount-rate information to a crony when he was a director of the New York Federal Reserve Bank. Severe recession had taken hold of Sussex County, pushing land values down by 50%. And NBSC was hanging on by a thread, with a truckload of bad loans and overvalued collateral and a cease-and-desist order dangling over its headu00e2u20ac”all the result of the fast growth and loose lending decisions during the good times a few years earlier. Between 1990 and 1992, the bank reported total net losses of nearly $15 million.

For the bank’s outside directors, NBSC’s fall was a slap in the face. Respected local business leaders, they had signed on to the board largely for the perks of the jobu00e2u20ac”the junkets, the fees, the prestige that comes with running a financial institution. Suddenly, they faced the threat of civil lawsuits, the embarrassments of small-town whispers and being scolded by regulators, and the prospect of years of hard work to overcome the follies of the recent past. Eventually, however, they came out on top. Last December, NBSC was sold for $68 millionu00e2u20ac”a tidy price for a bank that many had all but written off only six years earlier.

During their decade-long odyssey, NBSC’s directors distilled some tough lessons about their responsibilities as directors and the dangers of blindly rubber-stamping management decisions. On a recent spring morning, four who rode out the storm shared their insights with Bank Director. Their advice to other directors: Don’t be afraid to ask tough questions, lest someday you be forced to walk in their shoes.

Like most of NBSC’s directors, Richard Roy has deep roots in the local community. A collector of classic cars, he owns a feed and implement store just a few blocks from the bank’s Branchville headquarters and has been a member of the board since 1971. Roy is a big bear of a man with a quiet voice and an ostensibly mild manner. But that voice rises with a sense of contempt and betrayal when asked about the years leading up to NBSC’s troubles.

“We had people working for the bank who, in retrospect, seemed to be working for the customer. They would come in as if to sell a loanu00e2u20ac”they’d say, ‘He’s a good guy [or] his wife’s a good customer,’ that sort of thingu00e2u20ac”instead of presenting us with the facts and how it would be repaid,” he says. “I always got the feeling that things were kept from us; that they weren’t laid out like they should have been. I mean, we’re all businessmen, and you don’t have to be a Phi Beta Kappa to understand that you’re going the wrong way.

“What we eventually found out was that we were going the wrong way fast,” Roy adds. “But it wasn’t until we had already gone over the center line that we had any indications.”

With hindsight, NBSC’s directors readily admit that they may have dropped the ball, trusting management too much, while not asking enough hard questions.

Through the mid-1980s, Rough and his lenders convinced the board to approve loans that clearly didn’t meet the bank’s underwriting standards. Some borrowers lacked the income to repay their loans. Others failed to provide the documentation most bankers demand. At the same time, the bank’s own loan-loss reserves were startlingly low. In short, the policies and proceduresu00e2u20ac”and the attention to detailu00e2u20ac”that serve as the underpinnings for good lending operations weren’t in place.

Still, when management pushed hard for the loans to be granted, who were the directors to oppose them? After all, they weren’t bankers, and management typically dumped loads of loan applications on them at the beginnings of meetings, making it impossible to go over them in any detail. Was there really any other way?

“Even today, I say, ‘What do I really know about banking?’” says Daniel Campbell, owner of a local real estate agency and a director since 1988. Adds Charles Lain, a retired sod farmer and director since 1982: “I can’t put all the blame on [management]. It’s partially our responsibility to look at those loans.

“You find yourself saying [today], ‘Wait a minute, we should have been digging in when we didn’t…. We should have foreseen this,’” Lain says. “But you go by the recommendations of management. We as a board looked at the information that was presented to us, and we relied on our staff and administrators to check things out thoroughly. We trusted them.” The board has now certainly come to realize that the responsibility for selecting and retaining the right chief executive is a board’s most important duty.

Back in the mid-1980s,

of course, there was little room for doubters. The National Bank of Sussex County was viewed by its own directors as one of the industry’s high fliers. And why shouldn’t it have been? Rough and other senior officers massaged them with charts and statisticsu00e2u20ac”some the result of not reserving enough for bad loansu00e2u20ac”showing that the bank’s performance was head-and-shoulders above its peers.

In 1987, return on average assets was 1.01%, while return on average equity was 15.85%u00e2u20ac”both healthy figures for the time. More impressive, loan growth exceeded 30% for the year, while the dividend paid to shareholders rose 33%, to 50 cents a share. Such numbers provided ample justification for the big bonuses paid to management.

The good times were being shared across the county. Campbell recalls joking with counterparts that they’d all retire early because of the money they were making. “We all got caught up in this sense of euphoria, where everything was going so great it couldn’t stop,” Lain says. In that environment, no one wanted to rain on the parade or alienate customers. When one prospective borrower’s repayment ability was questioned by the board, Lain recalls, they were quickly rebuffed by management. “We were told, ‘He’s never missed a payment, we can’t turn him down.’”

“In retrospect,” says Rhea Fountain 3rd, a local insurance agent and director since 1988, “We got into trouble because we were too good to the community. We would give loans to people who maybe shouldn’t have gotten them. But we wanted to take care of the community, so we would make the loan anyway.”

But there’s no denying they also were taking care of themselves, garnering the perks of office while turning a blind eye to potential trouble spots. Rough, a former bank examiner, was chairman of the New Jersey Bankers Associationu00e2u20ac”for directors, a validation of the trust they placed in him. He treated members of his rubber-stamp board like royalty, flying them in private jets to national banking conventions in Boca Raton, Florida and Scottsdale, Arizona.

At home, Rough’s ego was even more evident. He was hungry for growth, regularly regaling directors with projections of a $400 million bank by the early 1990s. Being part of a company like that made the directors feel like big shots, so they went along.

Not everyone, however, was feeling quite so giddy. In 1987, Michael Dickerson was recruited by Rough to run the company’s new Pennsylvania subsidiary, The Pocono Bank. A 30-year industry veteran, Dickerson is a straight-shooting fireplug of a man and an avid horseman. He already lived in the rugged hills near Sussex County and was tired of the 45-minute commute to his job as president of a suburban New Jersey startup. So when Rough offered him a post near his home, he willingly accepted a pay cut.

Almost immediately, the outspoken Dickerson began raising questions. Past due loans were higher than peer averages, he said, and loss reserves weren’t high enoughu00e2u20ac”just $1.9 million in 1988, or 1.06% of the total portfolio. To Dickerson, it looked like management thought it was smarter than other bankers. “I’m pretty big on peer comparisons,” he says. “If I look at my competitors and they’re doing [things differently], … I have to say that my ego isn’t so great that I think I know more than they do.”

Less than a year after Dickerson arrived, Rough resigned under charges that he had provided Fed discount-rate information to a local bond trader. [He later pleaded guilty and was sentenced to one year in federal prison and 200 hours of community service.] While that had little direct bearing on NBSC, it may have said something about management’s character. Dickerson became president and CEO of the holding company. Senior lender Kenneth Spriggs Jr., a soft-spoken, mousy man who had been responsible for many of the previous lending decisions, was named NBSC’s CEO. Even then, the rapid growth didn’t stop. In 1988, assets rose to $249 million at yearend, while net income jumped 24%, to $2.4 million.

On the surface at least, that was probably as good as it got for NBSC. In 1990, holding company assets crept up to $286 million, but High Point reported an astonishing net loss of $4 million. About $4.4 million in loans were charged offu00e2u20ac”a number that would only increase the following year. Worse, the value of the collateral on those borrowings was evaporating.

That year, High Point’s stock price plummeted to $7 a share, from $21, as the company suspended dividends to grapple with the impact of a tough recession. But the economy, directors now concede, was only the wind that blew over the house of cards they had unwittingly helped construct. It was time to face the consequences of their earlier unwillingness to question management and face the fact that they had allowed the wrong management to remain in place.

By early 1991, the directors understood that the bank was in deep trouble. Already, a few regulators had journeyed to Branchville to discuss the bank’s deteriorating condition. But none of them grasped the true gravity of their predicament until they made a fateful visit to the Office of the Comptroller of the Currency’s office in Manhattan.

As directors funneled off the bus that carried them on the 90-minute journey to the OCC’s offices on the Avenue of the Americas one hot summer day, some noticed that the flowers of an adjacent park were in full bloom. “It was a beautiful setting, really,” recalls Fountain. The third-floor meeting room’s windows overlooked that park, but by then, most of the directors were too flustered to enjoy the view. Clustered around a 30-foot table was an intimidating, standing-room-only contingent of officials from the OCC, Fed, FDIC, and other regulatory agencies.

Over the next several hours, officials laid out the harsh reality of the situation: NBSC was within a hair’s-breadth of being shut down, and if that happened, the directors themselves might be held financially accountable for the mess. The bank might still be salvageable, officials added, but only under their conditions. “We were facing this crowd of regulators, with fingers pointing at us,” Roy remembers. “They said, ‘You guys screwed up royally, and now you’d better perform, or else.’”

It was like a trial, only with the potential for a stayed sentence. Directors were given an unyielding prescription for fixing the bank: boost capital levels, fire key people, re-underwrite every loan, and more. “They said, ‘If you want to get out of this mess, you do it this way. And we want you to know that if you slip up just once, it’s over. We will be watching every move you make,’” Lain recalls.

The meeting was both stunning and sobering for NBSC directors. The regulators, they felt, had been eminently fair, given the circumstances. On the bus ride home, not a word was spoken. Some seethed with feelings of betrayal. Others were numb with embarrassment. “We were a bunch of whipped puppies,” Lain says. But as a group, the regulators’ mandates served as a wake-up call. Their bank was, in effect, given what Fountain calls a “second life,” and they were resolved to not let it die, no matter what the pain or cost.

“From that time on, our whole attitude as directors changed,” Roy says. “We no longer just accepted what was given to us. We began insisting on further information and made the changes we had to make.”

In November 1991, the bank entered into a consent order with the OCC, requiring it to boost its capital ratio to 6%, improve its lending policies and procedures, revise its methodology for calculating loan-loss reserves, and enhance its asset/liability management procedures. It also was barred from paying any dividends without OCC approval. A year later, High Point entered a similar agreement with the Federal Reserve.

First among the board’s tasks was installing a new CEO. The regulators had been firm: Lenders who had helped get NBSC into the mess had proven themselves incapable of leading its transformation. Within days, a group of directors took Dickerson, already CEO of the holding company, out to dinner and offered him the job as head of the bank. He accepted, and Spriggs was out. Others were soon to follow, until only one holdover from the old management team remained.

Today, directors make no bones about Dickerson’s role: “The people in my circle thought the bank was going to go under, no question about it,” Campbell says. “And I’m certain it would have if not for Mike.”

A Presbyterian lay minister with a compassionate, if somewhat abrupt style, Dickerson has a knack for bringing out the best in people. He also was well-known and respected in local banking circles, which garnered trust from the regulators and may have helped prevent competitors from trying to capitalize more aggressively on NBSC’s troubles.

Reviving a struggling bank was more than Dickerson had signed on for when accepting Rough’s offer four years earlier. “I was in semi-retirement,” he says. But he viewed himself as something of a hired gun and immediately set out on one of his most arduous tasks: convincing the directors they could tackle the difficult job before them. “We had people on this board who questioned their own abilities,” Lain says. “But Mike said, ‘Yes, you can do this.’”

Cleaning house was only part of the personnel duties. By the end of 1991, nonperformers accounted for a whopping 16% of the total loan portfolio, compared to 1% in 1987. (They would rise to near 18% in 1992.) Tackling the problem required hiring nine new staffers with distressed-asset expertise. At the same time, regulators said that all loansu00e2u20ac”even the good onesu00e2u20ac”needed to be underwritten again, with new appraisals to reflect dropping property values in the county.

The costs of such endeavors were astronomical. Between 1990 and 1994, $19.9 million in bad loans were charged off, while in 1992 and 1993, the bank paid out $2.2 million in legal fees alone to handle foreclosures and workouts.

Meanwhile, some long-time customers were taken aback by demands for current financial statements, tax returns, and appraisals. “We had people who didn’t want to turn over their tax returns, and we said, ‘Fine, we’re going to foreclose on your property. You’re in default on your loan because you’re not supplying the documentation that’s required,’” Fountain recalls.

This caused some bitterness. Lain remembers one customer pleading for special treatment. But most of the community understood, and the unflinching boardu00e2u20ac”especially members of an expanded compliance committeeu00e2u20ac”now had begun to get a handle on just how out-of-control things were. They also had a handy scapegoat. “You’d say, ‘the examiners have set out this standard, and we have to comply,’” Lain says. “It was actually good having the regulators tell us what to do.”

For the first time, the board began to immerse itself in the lending operations. The compliance committee met each Monday night, from about 6 p.m. to midnight, going over all the loans in the portfoliou00e2u20ac”a stark departure from the days when they had met only two hours a month. And directors were shocked at what they found: 35% of all loans didn’t have appraisals to begin with; 71% didn’t have credit reports, Campbell recalls. “These are things that have to be done on every loan application, and they simply weren’t done.”

Nine of the 10 largest loans in the portfolio were nonperformers, and the directors, emboldened by their new responsibilities, wrote some of them off. “It’s very important to bite as much of the bullet as you can early on,” Roy says now. Significantly, however, they opted to hold onto the loans, rather than sell them for a fraction of face value in the wholesale market. That ultimately would prove shrewd: Over time, the bank recovered not only the principal and interest from some of those loans, but also legal costs.

The other pressing task was on the capital side. “We were told [by the regulators], if our capital got below 6%, we were dead,” Fountain recalls. Actually, the bank was given two years to reach that level, but the directors got the message. Lending was limited and deposit rates lowered, in an effort to shrink the bank and thus raise the capital ratio. Even some of the directors took money out of NBSC. “I’m sure it raised some eyebrows, but I moved some of my deposits,” says Fountain.

But it proved harder than anticipated to shrinku00e2u20ac”a testament to the bank’s 60-year history in the region, and the directors’ own reputations. “People stayed with us,” Fountain says. “They knew we were in trouble, but they also had faith in us.” Eventually, holding company deposits declined, to $163 million in 1993 from $247 million four years earlier. Loans dropped even more sharply, resting at $109 million in 1993u00e2u20ac”down 48% from $209 million in 1990.

At the same time, the bank needed to raise moneyu00e2u20ac”both to meet regulator demands and to cover recovery-related expenses. In 1992, the Pennsylvania subsidiary was sold. A year later, so was the property for the once-lauded headquarters buildingu00e2u20ac”albeit at a loss. And in 1994, Dickerson told the directors they each needed to put $50,000 of their own money into the bank, as part of a High Point capital-raising campaign that ultimately garnered $4.5 million.

Significantly, Lakeland Bancorp, based in nearby Oak Ridge, New Jersey gave a boost to the offering, pledging beforehand to purchase 9.9% of the company. “When the public saw another bank buying the stock, that instilled confidence,” Campbell says.

Through it all, the directors presented something of a poker face to the community. Sure, they had small disputes, but those disagreements were checked at the boardroom door. In public, they would answer questions honestly, but not be too subdued. “If you walk around as a director with a long face, people see that,” Roy explains. “If you had a smile on your face, and acted like there was nothing seriously wrong, it rubbed off on people.”

Privately, however, the experience was at times disheartening. The directors had given up their own fees when dividends were cut and clearly had more on their plates than they had originally bargained for. And at one point, with share prices hovering just north of $1, they hired an investment bank to explore a sale. “The regulators were coming in, threatening them with civil money penalties and saying they had done a crummy job. They were very tired, and they should have been,” Dickerson explains. “What was the easiest way out of it? To sell.”

Dickerson believed the bank’s long-term value was much greater than what it would fetch in a sale at the time. And while no one claimed much interest in the idea, he worried that some directors secretly desired a sale but didn’t want to admit it to their peers. So he hired a consultant to conduct an anonymous survey. The result: Stay the course.

Ultimately, it proved to be a wise decision. With the diligent oversight of the directors, and strong support from the bank’s staff, NBSC slowly emerged from the darkness. By the end of 1995, only 6% of the loan portfolio was classified as nonperforming, and High Point reported net income of $705,000u00e2u20ac”its first profit in six years. In 1996, profits swelled to $4.8 million, and the bank’s written agreements with the OCC and Fed expired. The National Bank of Sussex County had rebounded in a manner no less stunning than its earlier decline, and was once again a regular bank, dealing with regular issues.

Last year, faced with dwindling growth prospects and Dickerson’s imminent retirement, the board decided to sell. The winning bidder: Lakeland, the same bank that had invested during NBSC’s darkest days. The $68 million purchase price amounts to more than $18 a share. The bank will retain its name for two years, and Lakeland has pledged to keep its nine branches open. Three High Point directors, including Dickerson, will sit on Lakeland’s board.

Today, the directors look back

on their experiences with a sense of enhanced wisdom. They question things more now, and aren’t afraid to make demands, such as getting loan applications in advance of meetings so they can examine the paperwork themselves. Most also say they examine their own companies’ operations more closely, looking for holes. “For me, it has reinforced that you can never have too much detail; every ‘t’ has to be crossed, and every ‘i’ dotted,” Fountain says.

Some offer words of warning to other bank directors. “If it’s too good to be true, then you’d better dig into the numbers harder,” Lain says. “We learned our responsibilities the hard way. Anybody who accepts a job as a director of a bank has a tremendous amount of responsibility on their shouldersu00e2u20ac”to the shareholders and the community. And I don’t like to admit this, but we were simply rubber-stamping management’s decisions. That’s not right.”

Adds Campbell: “Never take things for granted. Never get complacent. I think that’s what we did. You can’t just let management do whatever it wants. You have to question things. That’s what [boards] are all about.”

But more than anything, a justifiable aura of pride lingers over the group. “This bank has been a major presence in this community for 60 yearsu00e2u20ac”part of what we’re about hereu00e2u20ac”and we were able to preserve that,” Fountain says. Reward enough, it would seem, for the directors of the National Bank of Sussex County.

And as for the $50,000 that CEO Dickerson requested back in 1994 to jumpstart the bank’s recovery, it will be worth more than $250,000 when the acquisition by Lakeland Bancorp is consummated. Not a bad return on a five-year investment.

(Editor’s note: It’s rare that directors let their guard down long enough to offer the world a candid view of their shortcomings. It’s always easier to keep quiet than to own up to mistakes. For this reason, we’d like to offer special thanks to the management and board of High Point Financial Corp. for their cooperation on this story.)