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Does Westsound Bank have a future?

Terry Peterson A statement filed with the Securities and Exchange Commission on April 3 — which was filed late — all but admits Westsound Bank’s future is in question. The annual 10K filed by WSB Financial Group Inc., the holding company for the bank, stated there is reason to “…believe there is substantial doubt about our ability to continue as a going concern.”

In a story first uncovered by the Business Journal in late 2007, WSB’s real estate lending practices, as well as its loose internal controls and somewhat casual approach to regulatory compliance, led to a Cease and Desist order being issued by the Federal Deposit Insurance Company and Washington Department of Financial Institutions on March 10, 2008. The order remains in effect, and its terms, combined with the current state of the economy, have severely restricted WSB’s ability to improve its deteriorating capital position.

Deposits in WSB are guaranteed by the FDIC up to $250,000 until the end of this year. The guarantee will drop back to $100,000 unless Congress extends the temporary increase enacted last year.

“The vast majority of our depositors are within the FDIC insurance limits. Therefore their deposits are safe,” said Terry Peterson, Westsound’s upbeat president. Peterson was recruited by the board last April to run the bank after the previous president, Dave Johnson, was ousted. Peterson’s main tasks have centered around bringing the bank back into regulatory compliance as well as restoring it to profitability.

In an interview with the Business Journal late last year, Peterson stated that the regulatory issues were simple compared to the profitability effort, but he was optimistic WSB could be turned around. That was before the current financial crisis hit.

As for the “going concern” statement in the 10K, Peterson said such a disclosure” in the current banking environment is not unusual. “In my 25 years of banking, I have never seen this level of scrutiny by regulators and financial auditors. It is not unusual for a bank in a turnaround situation to get a going concern disclaimer from its financial auditor,” he stated.

However, reading through the 10-K statement reveals that FDIC officials had also asked for an additional cease-and-desist order besides the one issued last year, but WSB successfully argued that under new management the bank had taken significant steps to comply with the original order, and that another one was not only unnecessary, but would be harmful as well — and that WSB would appeal if one was issued.

The bank’s problems surfaced publicly in September of 2007, when the Business Journal investigating why 33 employees in the residential loan department had been laid off, and why WSB vice president and head of the mortgage operation, Brett Green — a major WSB stockholder — had abruptly resigned. WSB was extremely close-mouthed about Green, with Johnson saying at the time he would talk about anything to do with the bank’s finances, the mortgage department layoffs, or anything else — except Green, or anything to do with him.

In a conference call with investors, Johnson later identified 146 construction loans as problematic. That was simply the tip of the iceberg. Shortly thereafter, in November of 2007, a number of large, out-of-state law firms specializing in class action work, began actively recruiting investors in anticipation of major lawsuits. However, as the bad news about WSB’s losses has continually worsened, it’s become clear that there may not be enough assets left for any kind of meaningful recovery.

The numbers that tell the real story. In the latest filing Westsound reported that 39.4 percent of its loan portfolio — $112.2 million — was considered non-performing at year- end 2008. According to American Banker Magazine’s April 4, 2009 issue, that figure had increased to $119.8 million, or 36.9 percent — the third worst in the nation. In comparison, non-performing loans totaled $25.3 million, or 6.1 percent of the bank’s portfolio on Dec. 31, 2007.

Assets — the majority of which are loans — lost 25.4 percent in value, dropping to $365.2 million at the end of 2008, with deposits dwindling to $330 million. Part of the decline in deposits can be attributed to the Cease and Desist Order, which prevented WSB from buying or brokering deposits — a common banking practice, and major source of both cash flow and profit for the bank previously.

In a communication to employees responding to a Kitsap Sun report after the financials became public, Peterson stated, “Accounting standards work under the assumption that a company will remain in business. If there is any doubt that the company can remain in business, the financial statements might not accurately reflect the company’s prospects, even when they adhere to accounting standards. In this case, the auditor will provide a “going concern” clause to the financial statement audit. So, the Auditors will always air on the side of caution. Of course, a Bank like ours, who is in a “turnaround situation,” carries more risk. The actual language found in the “going concern” disclaimer is very ‘harsh,’ and for non-business people it can be quite exciting. This is not to downplay the seriousness of our particular situation, but we will see many more banks whose financial statements will carry this disclaimer.”

Westsound Bank has moved forward, completing a three-year turnaround plan, adding a branch in Poulsbo and relocating the one in Silverdale since the Cease and Desist Order was issued. Peterson, who is clearly under a lot of stress, took a mental step backwards to assess the situation, and commented, “From my perspective, all banks are suffering financial distress. The industry is in unprecedented times. As long as our clients remain within FDIC insured limits, then we are as safe as any other Bank.”

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