Are All Banks As Shady As Goldman?

| April 28, 2010 | 0 Comments

Bank has become a four-letter “swear word”.

It’s understandable when we see companies like Goldman Sachs (GS) being sued by the SEC for fraud.  And bankers aren’t helping themselves by continuing to deny any responsibility for the credit crisis.

And then there’s the problem of more and more bank failures.

In fact, the FDIC shut down six more banks in Illinois last Friday.  That brings the number of failed banks to 57 so far this year.

But one closure hit close to home with me.  You see, I used to work at Desert Hills Bank.

Desert Hills Bank was the 41st bank to fail this year on March 26, 2010.

To be honest, I’m not really surprised Desert Hills Bank failed.  But some of the stories I heard from former colleagues were shocking. More about those in a minute…

Why am I not surprised about Desert Hills Bank failing?  One word, geography.  The majority of their business is in Arizona.  And the Arizona economy has been hit hard by the real estate bust.

I’d be surprised if many Arizona based banks survive the real estate boom and bust.  The losses on foreclosed real estate loans are just too big to overcome.

But Desert Hills Bank suffered from another failure.  They lacked strong senior management.

Don’t get me wrong, these were experienced bankers.  But they lacked leadership from the CEO on down.  It’s just hard to respect a CEO who shows up to work in a flower print Hawaiian shirt…

I believe it was the lack of strong senior management that led to the most shocking story I heard.  It’s so shady and unethical it makes me sick.

Here’s what I uncovered…

Desert Hills Bank made a huge blunder as loan losses on foreclosed residential construction loans, lot loans, and commercial loans mounted.

Here’s the problem.  There just weren’t any buyers willing to pay more than a few cents on the dollar for these properties.  And the property values continued plummeting even after they were repossessed.

The market value of the foreclosed properties was only a fraction of the loan amount.  In other words, these loans were deep underwater.

This is where things get weird.

Instead of biting the bullet and taking their losses, management decided to get “creative”.

They created a separate company owned completely by the bank. Then management “sold” all of the foreclosed real estate they owned to the new company.

They basically sold the properties to themselves.

Why would they do such a thing?  They did it so they could collect deficiency balances.

A deficiency balance is the difference between how much the borrower owes and how much the property was sold for.

In order for the bank to collect a deficiency balance, the property must first be sold.  Since nobody else wanted to buy the properties, the bank effectively sold the properties to themselves.

Now they can start suing the borrowers for deficiency balances…

I’m no lawyer but if this isn’t illegal, it sure is unethical.

Apparently the FDIC thought so too.  The senior managers in charge of the bank owned real estate were fired about a week before the FDIC came in to shut them down.

I guess the moral of the story is, don’t underestimate the importance of strong management.  Make sure you take a look at who’s running a company before investing.  You’ll be glad you did…

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Category: Stocks

About the Author ()

Corey Williams is the editor of Sector ETF Trader, an investment advisory service focused on profiting from ETFs and the economic cycle. Under Corey’s leadership, the Sector ETF Trader has become one of the most popular and successful ETF advisories around. In addition to his groundbreaking service, Corey is the lead contributor to ETF Trading Research, where he shares his insights about ETFs and financial markets on a daily basis. He’s also a regular contributor to the Dynamic Wealth Report and the editor of one the hottest option trading services around – Elite Option Trader.

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