Behind the failure of Sonoma Valley Bank

Reader opinion by Ralph Hutchinson

As a former Federal Bank Regulator, banker and now bank consultant for nearly 25 years combined, I’ve followed the Sonoma Valley Bank story as it unfolded right here in our beloved Sonoma Valley, right up until August 20, 2010 when the FDIC swarmed in to seize control.

 Here’s how I see it.

 After extensive research of public records and numerous interviews with sources, it’s clear to me that principles of finance were violated.

Back in the mid-2000’s an incentive program was created to enhance shareholder value and amplify returns in order to set the bank up for merger or acquisition, most likely. 

 Executives and directors made large bonuses and compensation based on growth of the loan portfolio and potential earnings, without stop-gaps on credit quality. There were also instances of loaning too many dollars to one person, basically putting too many eggs in the same basket. This was counter to standard practices of diversification and risk management.

Compared to Northern California executives at similar community banks this compensation was as much as two-to-three times higher than average.  Over time more of the compensation was shifted toward cash and less to equity options.
SVB management and the board, determining there were no viable deals left in Sonoma Valley, approved considerable loans to projects on the Hwy. 101 corridor between Petaluma and Santa Rosa. Most of these loans were to one person, Bijian Madjlessi, who now has been indicted for four counts of insurance fraud, and has defaulted on numerous projects. 

It is my opinion that there were telltale signs of concern at the time of underwriting but internal systems were either too weak to identify risks, or they were bypassed in lieu of growth opportunity.  Recent investigative reports suggest SVB management intentionally structured loan terms to avoid legal lending limits, and loan even more money to this, its largest borrower. 

 SVB had been a typical community bank with strong core deposit stability and solid performance.  Character lending (focusing more on who they know versus detailed financial analysis and due diligence in background checking) was prevalent. Most all the loans were granted within Sonoma Valley for smaller dollars relatively, in the $250k to $2 million range — versus the tens of millions loaned to Madjlessi — so if there was a loss, no single loan would greatly impact the bank. 
The business model proved very successful for nearly two decades. But when assets were concentrated to one borrower (nearly the entire capital base between $35-$40 million), the bank violated a major principal of finance.

With Madjlessi, all the loans were so intermingled and related that once one toppled, they all were in jeopardy and essentially the entire capital base was put at undue risk.

In fact, banking laws are so concerned about this concept of diversification they limit all loans related to one borrower to just 25 percent of capital, which for SVB equaled about $9 million at the high point.  The bank exceeded that limit by three-to-four times that limit.

On large loans, community banks sometimes sell pieces (called “participations”) to their peer banks, as SVB did in the case of the Madjlessi relationship.  There were participations sold to banks like Charter Oak Bank of Napa which choked on more than $5 million in Madjlessi toxic assets and failed in February of this year, just six months after SVB went under.

 Madjlessi is accused of artificially inflating values of projects by arranging sales to his family, friends, and business associates – deals known as “straw-buyer” transactions. The asset values were then inflated, and the figures used to borrow more and more money. 
 Based on my experience, all this led to problems when bank management realized the projects were failing and the borrower was becoming “bigger” than the bank: weak monitoring, credit administration and underwriting, and unsatisfactory collection efforts.

 Furthermore it appears that bank officers and insiders accepted gifts and investments in side business ventures from the borrowers or their affiliates and family members. This created a relationship too close to make objective decisions, and set the bank up for co-mingled interests.  Ethically, it’s a poor practice and according to reports it may have influenced decisions. 

 With all the suspected “straw” activity and concentrations, regulators were left with little choice but to fail the bank.  When the SVB Board wrote the letter a week after failure, claiming they were victims of a poor economy, that wasn’t the reason. I believe the negligent mistakes are clear to see.


One Response to Behind the failure of Sonoma Valley Bank

  1. Ralph Hutchinson says:

    The Directors ousted the last two voices of reason when they formed the shell holding company around 2004-2005. The only two outspoken Directors had no chairs when the music stopped. With them out of the way, there were no more squeaky wheels. The remaining Directors had a free-for-all.

    Dale Downing (Sonoma Market) Chairman of the Directors Loan Committee along with Mel Switzer, Angelo Sangiacomo, Board Chairman Robert Nicholas (Nicholas Turkeys) and Suzanne Brangham (MacArthur Place-Saddles) listened to then Senior Lender Sean Cutting pitch deal after deal from Bijian Madjlessi and his associates and straw-borrowers, and they as voting members approved them all. They knew Bijian was the silent partner, why else would they approve these deals? They knew he derived benefit and the attribution rule of legal lending limits applied. But they apparently thought they were “Above the Law?”

    Enter Bijian Madjlessi. How did he get referred into the bank? From a local loan broker and sailing buddy of Bijian’s Insurance Broker (one involved in the 4 felony charges for fraud)? Through Cutting/Melland and their banking connections to M. Cary Calkin at PFF Bank (now USBank) after he loaned out $35 million to Petaluma Greenbriar Apartments, and 10′s of millions to the failed Reno project? Did Bijian just “case the joint” and swim up into the shallow waters off the 101 corridor and find a bunch of hungry, naive bankers? Or was their motive? Certainly Sonoma Valley Bank and the Officers were profiting. And later in the relationship, Loan Officers like Brian Melland even solicited investments into his Latino focused Magnus Innovations, Inc (aka Fuerza Energy Drink) side business. Any of which, the result is a major violation of business ethics.

    When these conflicts of interest were discovered, the Chief Operating Officer, Cathy Gorham, also Compliance Officer, should have required a “Suspicious Activity Report” (SAR) be filed (according to banking law) with the local District Attorney in Sonoma County, FinCEN the Treasury affiliate tracking Federal crimes, and the FDIC primary Regulator. The Execs like Cutting, Switzer and all the Directors also knew of this unethical and potentially illegal Insider Activity at least in February 2010 (perhaps years earlier?) and it appears, instead of reporting Melland (likely for risk the wheels would fall off the cart as they were on the ropes on the brink of failure), they elected to let him resign, involuntarily. That fact, in and of itself is a Criminal Act for failing to file Criminal Referral Forms (SAR’s). Who knew what, and when is what the Feds are likely focusing on.

    Just a couple months after Melland was fired in February 2010, Cutting granted extensions on his existing Rohnert Park home loan financed at SVB (sources say it was past due) and before he got his new job at Sonoma Bank in Santa Rosa in July 2010, while unemployed, Cutting signed loan papers and lien documents recorded in Sonoma County to allow Melland to buy a new home in Santa Rosa. Thus unemployed, and terminated, somehow he qualified for a renewal and to buy a new home…carrying two homes? Where else and under what conditions could a “regular Joe” qualify for such loan terms? Cronyism is more like it. Again, very suspicious activity that appear to be favors perhaps to maintain status quo and keep Melland happy? But why? Was there another reason another conflict of interest? Didn’t they realize these records are public? What does Bijian have on the Sonoma Valley Bankers?

    The timing of the 101 Houseco LLC loan to James House a known affiliate of Bijian Madjlessi is in question as it is close to the time of receiving TARP Federal bailout funds, the time Melland accepted hundreds of thousands of dollars from Bijian’s wife and partner Glenn Larsen (though Larsen denies, documentation shows otherwise). Favors look to be granted and Treasury funds earmarked for boosting small business economic growth, were diverted to problem loans (Bijian had already defaulted on previous loans and had Notice of Defaults filed and forbearance agreements granted. Appears very suspicious to say the least.