Sonoma Valley Bank's downfall
Community bank's collapse can be traced to series of large, risky loans to developers with previous defaults
Chad Empey checks for tenants in condos he once owned in the foreclosed Park Lane Villas on Sebastopol Road. Empey, a glass contractor, testified last year that Marin County developer Bijan Madjlessi bought two Park Lane condos in Empey's name in an effort to defraud banks.
JOHN BURGESS / The Press DemocratPublished: Sunday, January 23, 2011 at 3:00 a.m.
Last Modified: Saturday, January 22, 2011 at 10:45 p.m.
CORRECTION: February 4, 2011
A previous version of this story and photo caption incorrectly described Chad Empey as current owner of two condominium units in Park Lane Villas. He lost the units to foreclosure in 2009, and developer Bijan Madjlessi is not currently collecting rent on Empey's behalf. Empey testified in U.S. Bankruptcy Court that Madjlessi had made mortgage payments on the condos, rented them out and collected rent when Empey was the owner of record.
The story also imprecisely referred to loans for the Sonoma Storage Emporium and Petaluma Greenbriar projects. The loans were made to entities operated by Madjlessi and developer Glenn Larsen.
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The collapse of Sonoma Valley Bank is now under federal investigation amid allegations of fraud, negligence and loose lending practices.
A wide range of federal agencies, including the Federal Bureau of Investigation, the Internal Revenue Service and the Treasury Department, are jointly investigating the bank and its loans, according to sources.
Regulators seized the community bank in August, eight months after discovering bank officials had provided financial statements that did not disclose nearly $15 million in bad loans.
At the center of the bank's downfall is a series of large loans made to a small group of North Bay developers who were behind three Sonoma County projects that fell into foreclosure over the past few years.
The bank continued to fund the projects even after it became public in land records and lawsuits that the developers were defaulting on multimillion-dollar loans from other banks and were not paying construction contractors.
Regulators seized the bank and its three branches in the Sonoma Valley because not enough money had been reserved to weather the recession, making it the only Sonoma County financial institution to fail during the extended economic slump.
Some of the bank's major shareholders are now accusing bank executives of funding deals to enrich themselves through a bonus plan that rewarded risky lending, but proved disastrous to the bank's financial health.
“Greed got into it. They wanted to get their bonuses by making loans,” said Gerald “Jerry” Marino, who owns about 80,000 shares of the bank's holding company that are now worthless, but that once were worth around $3 million.
The bank's former president, Sean Cutting, declined comment. Its former chief executive officer, Mel Switzer Jr., did not return repeated calls seeking comment.
At the time of the seizure, the bank's top leaders, including Cutting and Switzer, issued a public statement blaming the sharp real estate downturn for their troubled loans. They said the bank had been profitable in its most recent quarter and would have returned to financial health.
The collapse of Sonoma Valley Bank, and the projects it funded, has left a wake of financial devastation in the North Bay, ranging from dozens of building contractors stuck with unpaid bills to the bank's roughly 1,000 local shareholders who watched the bank's total stock value of $71 million evaporate in less than three years.
A risky concentration
In December 2008, the bank loaned a company operated by Marin County developer Bijan Madjlessi $9.2 million for a combination retail and residential project in west Santa Rosa, according to county land records. Seven months earlier, his company had defaulted on a $31 million loan from IndyMac Bank for the same development.
When it made the loan, Sonoma Valley Bank already had been sued by contractors who claimed Madjlessi was not paying his bills for construction of the mixed-use project, Park Lane Villas on Sebastopol Road.
Madjlessi's company eventually defaulted on the $9.2 million loan, in addition to another $24 million that Sonoma Valley Bank had earlier loaned him and his companies, according to county land records.
The bank would have needed back only half of the $33 million it loaned to Madjlessi and his companies to remain open, according to the capital requirements demanded by regulators in the months before they seized it.
“If they would have loaned him $15 million less, they would have survived the trauma,” said Ralph Hutchinson of Sonoma, a former federal bank regulator and critic of the bank's lending practices.
“They were too concentrated, and had too many eggs in one basket,” Hutchinson said. “Otherwise they could have saved the bank.”
Big borrowers
Companies run by Madjlessi and two of his business partners, Glenn Larsen and James House, received a total of $54.5 million in loans from Sonoma Valley Bank for three Sonoma County projects, according to county land records. They have defaulted on $45 million of those loans.
Lenders seeking to recover loan losses have filed lawsuits in Marin and Sonoma counties against Madjlessi's numerous companies.
David Lonich, Madjlessi's attorney, said his client is one of many developers brought down by the severe recession.
“I don't need to defend Bijan. He didn't do anything wrong,” Lonich said. “The economy failed. That's what happened.”
Madjlessi did not return calls seeking comment.
Chad Empey, a Petaluma glass contractor who had been a close associate of Madjlessi's since the early 1990s, was a plaintiff in a lawsuit last year that attempted to force Madjlessi into bankruptcy, a process known as an involuntary bankruptcy. Empey said Madjlessi still owes him $200,000.
He testified that Madjlessi had intentionally set out to defraud the banks. He claimed Madjlessi purchased several condos in Empey's name so that he could show banks he had sold enough units to qualify for additional construction loans.
Empey said that he ended up with at least two condos at Park Lane Villas as a result. He also testified that Madjlessi rented out the units and collected the rent until the condos were foreclosed on in 2009.
However, in bankruptcy court documents, Madjlessi said that Empey willingly purchased the condos, and any disagreement about the issue had been resolved in a settlement agreement. Further, Madjlessi claimed he did not personally owe the money to Empey, but that his companies did.
Both sides agreed to dismiss the involuntary bankruptcy case because they disputed how much money was owed, said Doug Provencher, a Santa Rosa bankruptcy attorney who represented the plaintiffs, including Empey and Steve Scarpa, a Marin County real estate investor.
Empey said he is now cooperating with the FBI, IRS and other federal regulators who he said are investigating Madjlessi.
Failed projects
Westamerica Bank, which took over Sonoma Valley Bank after acquiring most of its assets from the federal government in August, is now in the process of seizing its share of Park Lane Villas on Sebastopol Road and has scheduled a foreclosure auction for Thursday.
In December, it foreclosed on a Santa Rosa storage facility, Sonoma Storage Emporium on Santa Rosa Avenue, to recover $11.1 million in unpaid debts. Sonoma Valley Bank had loaned a company run by Madjlessi and his Marin County business partner Larsen $10.7 million for the project in 2006.
The third project, Petaluma Greenbriar Apartments, a failed condo conversion in Petaluma that was spearheaded by Madjlessi, is in various stages of foreclosure.
The apartment complex was built in the 1970s, and Madjlessi had filed plans to convert the buildings into privately owned condos. But virtually no improvements were made to the complex during the time Madjlessi's companies received tens of millions of dollars in loans for it, according to residents.
Madjlessi's attorney said the loans were used to pay off previous loans that were already associated with the complex when Madjlessi purchased it in 2000.
Westamerica Bank has scheduled a foreclosure date of Feb. 14 for unpaid loans totalling $11.7 million made by Sonoma Valley Bank.
Another lender owed $34 million has scheduled its own foreclosure auction, while another owed $6.6 million already has foreclosed on some of the buildings.
Federal investigation
Federal investigators have launched a widespread probe of the bank and its practices, according to former bank employees and people close to the investigation.
Officials are investigating allegations of fraud, Securities and Exchange Commission violations, regulatory violations and negligence at the bank, according to Teresa Anaya, a senior investigator working on the case.
Anaya, who works for the U.S. Federal Deposit Insurance Corporation, posted details of the investigation on her profile page for a professional social-networking site.
She wrote that she is helping coordinate the Sonoma Valley Bank investigation with a wide variety of agencies, including the FDIC's Professional Liability Group that targets real estate professionals for shoddy appraisal work, the Special Inspector General for the Troubled Asset Relief Program that investigates misuse of bailout money, the IRS and the FBI.
Messages left on her cell phone were returned by Greg Hernandez, spokesman for the FDIC, who would neither confirm nor deny the investigation.
Overzealous regulators?
In the initial wake of the bank's closure on Aug. 20, executives and board members expressed shock and dismay that regulators had not given their small community bank more time.
They submitted an opinion piece published in local newspapers, signed by Cutting, Switzer and seven other board members, criticizing regulators for shutting down the bank.
“It was 22 years old and far too young for its untimely and unnecessary demise,” they wrote.
Bob Nicholas, chairman of the bank's board, still blames overzealous regulators, whom he referred to as “the forces of evil,” in an interview last week.
Nicholas said the bank's lending practices were sound.
Nicholas disputed that the bank had loaned too much money to Madjlessi and said the Marin County developer was not involved in the west Santa Rosa development.
“Village Square was somebody else,” he said.
County records show that Madjlessi signed for all three loans totaling $21.5 million received by 132 Village Square, a development company registered in the developer's name, according to the secretary of state.
“I did not know that,” Nicholas said.
He referred additional questions to Cutting.
Initial signs of trouble
In December 2009, six months after receiving nearly $9 million in federal bailout money, Sonoma Valley Bank appeared to be relatively healthy. It reported a $495,180 loss in the third quarter, a relatively small loss at a time when the banking world seemed to be melting down.
Late that month, regulators began looking into the bank's $352 million in assets during a routine visit.
By February 2010, regulators had forced the bank to disclose that it was dangerously undercapitalized and needed to restate its third-quarter earnings report.
The bank increased its reported losses for the quarter to $19 million — up from $495,180 — and disclosed that it could not collect on about $15 million in loans.
With that action, the bank erased about $18 million of its equity, dropping its capital levels below federally required levels. That set the stage for its eventual closure six months later when the bank was unable to raise additional money and meet safety thresholds set by regulators.
Sonoma Valley Bank is among 300 banks nationwide that have closed since 2009.
Executive bonuses
The failed bank has come under fire for its executive compensation.
Jerry Marino, who was a founding director, and Gary Nelson, another former board member and founder of one of the largest temporary staffing companies in the country, were removed from the board after expressing concern about executive pay, Marino said. They both felt executives were placing their bonuses above the interests of shareholders.
Marino said in an interview that he pushed to have then-CEO Switzer removed from the board because he felt executive compensation had become too large and was resulting in risky lending.
Nelson, who has extensive expertise in employee compensation, was removed from the board's personnel and policies committee after repeatedly expressing concerns about the executive compensation plan. He backed Marino's call to have Switzer removed from the board.
“When they kicked us off, I should have sold my shares,” Marino said.
Marino said he and other shareholders are waiting for the government to issue a report to determine if they are going to sue any former bank executives or board members, who are covered by an insurance policy of about $20 million.
The bank eventually did eliminate its cash bonus program after increased scrutiny from regulators.
After the bank accepted TARP money in March 2009, it was required to review its compensation plan for senior executives to ensure bonuses did not encourage “unnecessary and excessive risks.” Board members determined the plan was safe.
But three months later, the bank reversed that decision. It did not publicly announce it had eliminated part of its compensation plan until May 2010, when it acknowledged in its proxy statement that it had ceased the “Cash Incentive Plan because the Committee believed it may encourage unnecessary and excessive risk taking.”
The plan had provided financial incentives to executives based on annual profits, and provided additional incentives every time annual profits exceeded the previous year. The bulk of a bank's profits are derived from its loans, meaning that approving more loans can increase earnings.
Defaulted SR project
Sonoma Valley Bank executives loaned money for Park Lane Villas shortly after receiving federal money from the Troubled Asset Relief Program.
The mixed-used project, which was completed in 2007, has 228 units in six buildings with storefronts on the street level and condominiums on the second and third floors.
After federal regulators closed IndyMac Bank in 2008, they began auctioning its assets, including the $31 million loan note on which Madjlessi had defaulted for the Park Lane Villas project.
The transactions are documented in FDIC and Sonoma County land records.
The winning bidder for Madjlessi's defaulted loan note was a company named 101 Houseco LLC, which is registered under the name of Madjlessi's business partner, James House.
The company received a loan from Sonoma Valley Bank so it could participate in the FDIC auction.
Lonich, Madjlessi's attorney, filed the paperwork to establish 101 Houseco in March 2009. Two weeks later Sonoma Valley Bank loaned the company $5.45 million. It was an unsecured loan, meaning the bank did not require collateral such as real estate, although the loan was eventually secured last year with property from Park Lane Villas.
A month after receiving the loan, 101 Houseco purchased the deed of trust for $4.2 million from the FDIC, considerably less than the $27.5 million Madjlessi still owed on it. The company foreclosed on Madjlessi and took title to a large portion of the Park Lane Villas complex, which includes retail space and condo units that the company now rents out.
To help 101 Houseco receive the loan, Madjlessi had met with a loan officer at Sonoma Valley Bank.
Over the next five months, the bank increased its loan to 101 Houseco to about $9 million, which was nearly the same amount of TARP money it had recently received from the U.S. Treasury Department.
At Madjlessi's bankruptcy trial, Empey provided photo evidence allegedly taken inside Madjlessi's office of a diagram draw by the developer to show how he secretly set up 101 Houseco to retain ownership.
Lodich denied his client had a stake in 101 Houseco.
“There is no ongoing or previous partnership between the two of them,” Lonich said.
Madjlessi walked into Santa Rosa's planning department two weeks ago and represented himself as an agent of 101 Houseco, according to city planners.
The city is trying to collect an unpaid $3.1 million in development fees owed by 101 Houseco for Park Lane Villas.
“We are trying to recover the fees,” said John Aguirre, who works in the planning department. “But it's been hard to determine who owns it.”
Last year, state and federal officials filed $1.1 million in tax liens against James House.
Westamerica Bank now owns the deed of trust to 101 Houseco, even as it forecloses on Madjlessi for other parts of the Park Lane Villas complex.
Criminal probe coming?
Cutting, the bank's former president, is now senior relationship manager at Rabobank's new Sonoma office. Cathy Gorham, former chief operating officer at Sonoma Valley Bank, is branch manager there.
Brian Melland, who was the commercial loan officer in Sonoma that worked closely with Madjlessi, is now at Sonoma Bank in Santa Rosa as a workout specialist.
Cutting, Gorham and Melland all declined comment.
John Davidovich, an attorney for the inspector general of the FDIC, said his agency is not preparing the report many people in Sonoma had expected, which would outline in part why the bank failed. Under a July rule change, the “material loss report” is no longer required unless the government incurs $200 million or more in losses from a bank failure, he said.
But a criminal investigation could still be occurring, Davidovich said, although he declined to confirm or deny if one was under way.
It is not unusual for a criminal investigation stemming from a bank failure to take a year or more, he said.
“Bank fraud cases tend to be very document-intensive investigations,” he said. “They do take more time.”
You can reach Staff Writer Nathan Halverson at 703-1577 or nathan.halverson@pressdemocrat.com. News Researcher Teresa Meikle contributed to this story.
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