BRADENTON -- As First Priority Bank prepared to open for business in December 2003, state banking regulators found everything in order.

The startup bank already had $7.9 million in capital, Florida Office of Financial Regulation examiners noted. They also recognized that half of First Priority’s dozen board members and three key senior executives had prior banking experience, some dating as far back as the mid-1980s.

“The board and executive management appear to possess the knowledge and experience to operate the bank in a safe and sound manner,” their report said.

Yet First Priority would fail five years later. The Bradenton-based bank was the first local bank and first Florida bank to close in the wake of the housing bust.

Previously confidential reports obtained by the Bradenton Herald revealed First Priority, like 11 other Manatee-Sarasota area banks that have collapsed since, dominated its books with real estate lending.

Real estate lending has always been the largest segment of bank lending in Southwest Florida. That strategy, however, proved treacherous for many banks when property values took a nosedive, leaving Manatee-Sarasota with 12 bank failures and the state with 47 failures since 2008.

Examiners warn of high-risk

In the case of First Priority Bank, regulators pinned the closure on bank management aggressively going after high-risk commercial real estate loans to increase assets, according to a material loss review by the Federal Deposit Insurance Corp.’s Office of Inspector General audit.

The records, which include three examinations by the Office of Financial Regulation, also detail problems within the bank that contributed to its demise, including inadequate loan underwriting; a lack of risk management controls; rapid expansion with new branches; and violations with some lending to bank officers and directors.

All were common banking practices in Florida during the real estate heyday, said Philip van Doorn, a banking analyst with TheStreet.com, who reviewed the state reports at the Herald’s request.

“This was not unusual,” said van Doorn, who previously was a bank monitor with the Federal Reserve of New York. “They were like any smaller new bank riding the crest of the real estate wave. They rode the bubble ’til it burst and there was nowhere to go. They were doomed.”

In an e-mail response to written questions from the Herald, former First Priority board members defended how they operated the bank. They said a dozen other banks either headquartered or with a presence in Manatee and/or Sarasota counties also fell victim to the fast-developing real estate crash, and either went out of business or were sold under duress.

“The largest banks in the nation were deemed to be slow to recognize and react to changing real estate market conditions,” wrote Frank Knautz, a Sarasota-based bank adviser speaking on behalf of First Priority’s former directors. “To singularly criticize the former First Priority Bank for failing to recognize what the majority of the nation’s banks also did not recognize is selective judgment.”

Knautz addressed the Bradenton Herald’s written questions late Friday after the Herald made numerous attempts last week to contact builder and former bank board director Alan Zirkelbach and First Priority board members.

Regulators note insider credit

State bank examiners began chronicling First Priority’s problems and ultimate downfall in June 2004, just six months after the bank opened. In their first complete review, regulators cited the bank for exceeding the Federal Reserve’s $100,000 Regulatory O limit on loans and credit extensions to insiders.

State regulators highlighted four loans -- for $1.08 million, $541,000, $250,000 and $231,000 -- made to insiders between February 2004 and April 2004. The $250,000 loan was to Zirkelbach. It could not be determined who received the other loans.

Knautz said the bank submitted those loans for regulatory approval before the bank opened and that regulators approved them because they were to outside directors, not bank officers.

“Directors can borrow from the bank at a higher limit than officers so long as these loans are consistent with the average amounts, rates and terms provided to customers,” he wrote. “As an outside bank director, the loan to Alan Zirkelbach was approved by regulators and not deemed to be outside of the guidelines of Regulation O. After opening, Alan Zirkelbach was officially recognized as Chairman of the Board, changing his status from director to officer, which has a limit of $100,000 in lending. The loan was paid in full, correcting the violation.”

Of the three other loans, Knautz had the same answer: “This loan is not outside the guidelines.”

Business professionals such as Zirkelbach are typically ideal for a bank’s board of directors, said Chris Cole, senior vice president of the regulatory council for the Independent Community Bankers of America.

“Most banks bring certain board members on because those board members are familiar with the community, know the community and can bring business to the bank,” Cole said. “It’s about bringing business to the bank. There’s plenty of insider lending among banks -- but don’t confuse preferential loans with insider loans.”

He said extending credit to a bank insider is acceptable as long as the loan is on the same terms as other customers may receive.

Zirkelbach was that business creator for First Priority. The bank had eight branches that required either renovations or new construction, and his company, Zirkelbach Construction Inc., took on four of those projects.

A 2007 examination reported First Priority financed $1.48 million in construction work to Zirkelbach Construction.

Knautz said the bank sought bids on seven of eight construction projects during its existence.

Fast growth plus losses

The 2004 examination also found First Priority had grown faster and lost more money than anticipated. The bank’s assets jumped from $11.1 million through Dec. 31, 2003, to $34.8 million through March 31, 2004, but the bank lost $300,000 more than its business plan projected because of higher overhead and loan loss provisions.

Examiners at the time said the loss was typical for a startup bank and called First Priority’s overall condition “sound,” giving the bank the second-highest bank rating on a five-point scale.

But they stressed bank officials needed to become more familiar with banking laws and regulations.

That warning was repeated in the next examination, conducted in November 2005.

Regulators pointed out the bank had used e-mail to approve 17 loans totaling $37.9 million between January 2005 and August 2005, even though regulations require board approval at a meeting.

Bank officials responded to examiners that e-mail was used for efficiency, but pledged to make improvements including revising or implementing policies.

The former board members said they could not respond to the Herald’s question about the issue, saying they “did not receive sufficient information or a reference to regulatory criticism to address this issue.”

Still, at that November 2005 review, performance and operation of the bank was “satisfactory.” Management, too, was listed as satisfactory.

Asset quality and capital remained strong and the sensitivity to market risk was manageable, regulators said.

The issue was in loan growth. It was outpacing deposit growth.

Regulators said the bank’s loans-to-deposits ratio, which was 98 percent, warranted management’s attention.

Regulators’ liquidity policy considers 70 percent to 95 percent as an acceptable loans-to-deposits ratio.

Declining earnings

By the time state regulators returned in September 2007 -- the Federal Deposit Insurance Corp. conducted the bank’s 2006 review, which is not public record -- First Priority was in critical financial shape. Regulators attributed the condition to a severe decline in asset quality and earnings.

The bank’s commercial real estate loan portfolio exceeded capital by nearly 400 percent, fueled by a surge in new real estate acquisition, development and construction loans, regulators found.

“These guys were allowed to do the type of lending that they did, and this bank failed because all of their eggs were in the real estate basket,” van Doorn said.

Examiners said those loans had high loan-to-value ratios and carried risky terms, such as interest-only payments until the full amount became payable upon maturity. Also, many of those loans were secured by real estate that was rapidly losing value.

Bank officials made those loans “without apparent regard to the potential risk of a severe market downturn,” regulators wrote in their report. The bank also inadequately downgraded non-performing loans, leaving a loan-loss contingency fund more than $6 million short.

Bank officials attributed First Priority’s precarious position to outside market forces, a stance they still hold today.

“Real estate lending has always been the largest segment of bank lending in this area,” Knautz wrote. “As stated above, no less than twelve banks either headquartered in the Sarasota/Manatee area or with a significant presence here were severely impacted and eventually closed as a result of the downturn in real estate values and subsequent unemployment and other recessionary factors. To specifically criticize First Priority Bank for concentrating its lending in real estate is selective judgment.”

There were 25 bank failures nationwide in 2008. The Bradenton-based Freedom Bank was the second local bank to fail. It closed Oct. 31, 2008, and First Priority and Freedom were the only Florida banks to close that year.

Freedom Bank, too, failed due to the dramatic decrease in property values, as the bank had a high concentration of high-risk commercial real estate loan, according to a material loss review by the FDIC’s Office of Inspector General Audit.

The Bradenton Herald obtained previously confidential state regulator reports in the case of Freedom Bank, as well.

Those records, which also include three examination reports by the Office of Financial Regulation, show a bank whose rapid loan growth proved too much to handle.

“The overall condition of the bank is less than satisfactory,” stated a March 2007 report. “Asset quality is less than satisfactory. The excessive level of adverse loan and other real estate classifications for a two-year old bank indicates a critical need for improvement.”

At that March 2007 examination, regulators found three large loans totaling $8.2 million made up mostly of the bank’s adversely classified loans totaling $9.8 million.

Freedom Bank opened May 17, 2005, and closed Oct. 31, 2008.

Bank failures grew rapidly nationwide in the years after 2008. In 2009, the nation saw 140 bank failures, including 14 in Florida. In 2010, there were 157 failures nationwide; 29 in Florida.

Since 2006, at least 12 banks either based in Manatee or Sarasota counties or with a large presence in the area collapsed.

Among those headquartered in the area included Horizon Bank, Flagship Bank, Community National Bank, Century Bank, First State Bank of Sarasota and Peninsula Bank.

The banks failed after regulators repeatedly sent enforcement orders telling management to raise capital that had become jeopardized due to a high concentration of real estate loans.

“In each case, the drastic devaluation of real estate has been identified as the root cause (of closure),” said Knautz.

Officials named in failure

In the regulators’ reports on First Priority, officials shared much of the blame for the bank’s poor shape.

“The board and management have failed to operate the bank in a safe and sound manner,” examiners wrote. “A course has been pursued that has weakened the bank’s overall condition to such a degree that its future viability may be threatened.”

Examiners also singled out George Najmy, the bank’s president and chief executive, and Zirkelbach, saying both men “appear to dominate the current board.”

In their conversations with Najmy, he “did not appear to comprehend the seriousness of the bank’s overall condition,” regulators wrote. They also said the bank didn’t get into poor shape overnight and had “ample opportunity” to prevent it.

Najmy did not return repeated telephone calls for comment.

Regulators also stated Zirkelbach’s “involvement in many of the bank’s past and present construction projects gives rise to concern of undue influence and/or conflict of interest.”

They also noted it took repeated requests to get bank officials to produce records showing the bank sought competitive bids for all but one of the projects.

Brian Watterson, First Priority’s chief financial officer at the time, also had concerns.

Watterson, who did not return the Herald’s repeated calls for comment, told examiners he felt the bank had “severely overpaid” for a leased loan processing office in Tampa for which Zirkelbach arranged and provided build-out services. Examiners said Watterson also told them he had found a better location that was “larger, nicer and cheaper,” but the board rejected it.

Watterson resigned during the exam, saying “he was extremely frustrated with President Najmy making poor decisions for the bank,” examiners wrote.

In their written response, the former board members called Watterson’s comments an opinion and reinforced the fact that Zirkelbach Construction won only half of the bank’s eight construction-services contracts.

But regulators also found other problems. Among them were the bank’s failure to obtain appraisals before purchasing land in Ellenton and Port Charlotte for future branches, and what regulators called the “unacceptable practice” of Najmy reporting service activities to the bank’s internal audit committee.

They downgraded the bank’s rating to 4, the second-lowest level, and urged bank officials to take immediate, corrective action.

Trying to fix loans

In their written response to the Herald, the former bank officials said they tried a variety of ways to shore up the bank’s bottom line to avoid failure.

“Like any bank faced with a large dollar amount of unpaid loans, First Priority Bank sought to work with borrowers in every possible way to bring their loans up to date,” Knautz wrote. “These efforts included negotiating with borrowers whose loans were not performing to extend terms, accept additional collateral and other industry standard strategies to bring loans into compliance. The severe downturn in real estate valuations, coupled with recessionary factors caused loan defaults which were ultimately greater than the bank could overcome.”

The bank’s condition worsened, and the FDIC placed First Priority on its problem bank list in February 2008.

Following a May 2008 examination, regulators downgraded First Priority’s rating to 5 -- “indicating extremely unsafe and unsound practices or conditions; critically deficient performance, often with inadequate risk management practices; and great supervisory concern,” according to a material loss review by the FDIC’s inspector general’s office.

The following month, FDIC ordered the bank to take unspecified immediate corrective action.

But the end came Aug. 1, 2008, when state regulators closed the bank and placed it in the FDIC’s receivership.