By James McNair
The Cincinnati Enquirer

President Joe Frederick (left) and CEO Jerry Kohlhepp are new in charge at the First National Bank of Northern Kentucky. (Leigh Patton photo) | ZOOM |

FORT MITCHELL - With federal regulators standing over its shoulder, First National Bank of Northern Kentucky is awaiting approval of a plan outlining how it will maintain an adequate capital cushion. If the plan is rejected, the bank will have to find a buyer or go out of business.

The institution, which has only one office, has been operating under supervision of the U.S. Comptroller of the Currency since July 2001. Because lending practices had put the bank's survival in jeopardy, the agency forced it to fire its former president, raise $8.8 million in capital and tighten loan controls.

Loan write-offs and higher expenses caused First National to post a net loss of $11.8 million last year. The infusion of fresh capital put the bank back on solid footing, but continuing write-offs in the first six months of 2003 have eroded that foundation by $3 million, forcing the bank to turn to investors anew.

"What we have done is identify a number of individuals and institutional people who have clearly given us an indication of investing in the bank," said Jerry Kohlhepp, a former U.S. Bank executive hired as First National's CEO last fall.

Kohlhepp said the bank meets the government's minimum capital requirements but anticipates a need for more money in the near future. He wouldn't specify how much.

"It's a little bit of a moving target because of the expenses we've burdened on the bank with consultants and lawyers," he said.

Meanwhile, the bank is carrying out demands from a 47-page order agreed to by the government and First National Feb. 11. It has purged and set aside reserves for bad loans, hired new executives, reduced the number of board seats from 16 to 11 and created a compliance committee. It has rewritten policies; set up credit-risk monitoring systems; developed an internal audit program; and written a capital plan, a strategic plan and a profit plan.

The bank met an April 11 deadline to give the comptroller its capital plan, and the two parties are dickering over details. If the comptroller does not approve it, its order calls for a sale, merger or liquidation proposal.

Banking consultant Bert Ely of Alexandria, Va., said First National's survival hinges on a return to profitability.

"Despite the big bath for the loan losses and the infusion of capital last year, they're still losing a lot of money," Ely said.

"This bank really has to cut its spending level and get back to a profit mode if it's going to survive as an independent institution," he said. "They continue to have loan quality problems. On the surface, they look well-capitalized, but they're churning through that capital fairly quickly."

Kohlhepp, who came out of retirement to lead First National, concedes that the bank has a lot of work to do. Deposits have fallen 35 percent in the past year to $88 million and loans - a bank's life-giving serum - are down 39 percent to $60 million. The bank's $1.1 million second-quarter loss was its fifth in a row.

But Kohlhepp said the bank is six months past its "low point" and is being groomed to make money again in early 2004.

"We're not out of the woods yet, but we have made substantial improvement in the past year and we have five new members of top management in place," Kohlhepp said. The bank has "capital, and it's got management, and that's what you need to succeed."

Among the new officers is Joe Frederick, who started April 14 after having served as president of the ALLCO Credit Union in Milwaukee since 1989. For Frederick, now a Kentucky resident, First National is the third institution to which he has been recruited to restore to health.

One of his tasks will be to end the bank's heavy reliance on commercial loans and achieve a balance among commercial, residential and consumer loans.

An episode with a Boone County inventor perhaps sums up First National's near-fatal dance with commercial lending. The inventor, John "Rip" Van Winkle, borrowed $5.9 million from the bank through various entities, relatives and associates. Most went toward speculative inventions.

The loans went into default, and First National foreclosed on the patents and five homes. Although the bank wrote off the unpaid $4.9 million, it could recoup part or all of that if Van Winkle finds someone to commercialize his devices.

"We're not banking on that whatsoever," Kohlhepp said.

When the Comptroller of the Currency slapped First National with a "prompt corrective action directive" last September, the bank set out to find a buyer.

It spoke with other banks, but no deals materialized. Now the bank is intent to make it on its own.

"There's no question there's interest. One thing that drives it is the growth of Northern Kentucky," Kohlhepp said. "We've had people approach us and we're not at liberty to talk about it, but our primary focus is to remain independent."

E-mail jmcnair@enquirer.com.