‘Success’ Out of Failure : Banking: The liquidation of Valencia Bank in Santa Ana ended with all creditors and depositors paid off, and a surplus. So should it have been seized at all?

Federal regulators are about to close the books on Valencia Bank, a small Santa Ana institution they seized and closed five years ago. And the final ledger contains a little surprise.

After paying off all valid creditors and depositors the full amounts owed them, the Federal Deposit Insurance Corp. has about $6.7 million in excess cash and a few assets left to sell for itself.

“It’s very unusual to end up with excess money,” said Jerry Saylor, FDIC assistant regional director in San Francisco. “I imagine we’ve done it before, somewhere, but I don’t know when.”

FDIC liquidators in Washington do not know of any other bank liquidation in recent memory that recovered 100% of the money owed to creditors.

Such a rare event is heartening, although it barely scratches the surface of the national debt for failures in the banking and the savings and loan industries. Taxpayers face a 30-year, $500-billion bailout of the S&L; industry and the prospect of forking over an undetermined amount to fix the nation’s banks.

But the successful liquidation also has reignited debate that swirled around the bank at the time it was taken over in February, 1986: Should regulators have seized the bank in the first place?

“I never thought that it should have been closed,” said Gene Hobday, who, as president until mid-1984, implemented an aggressive growth plan that led to much of the bank’s troubles. “A lot of the things the FDIC did were to order writedowns in the value of loans when there weren’t even any bad loans. The loans were paying.”

The only major problem, Hobday insisted, was in Valencia’s trust department, where alleged mismanagement led to the squandering of $6.5 million in pension and profit-sharing funds.

“In today’s climate, regulators would have given the bank more time to correct the problems,” asserted James B. Macdonald, who was general counsel and a director at Valencia. “A lot of the problems already had been solved, including the trust department. I’m not sure to this day what the regulators saw as the problem.”

The California Department of State Banking, though, said there was good reason to act when it did. Even though most problems were corrected, Valencia still was insolvent and had no prospect for getting new capital, its final reserve against further losses.

In fact, a two-year search for new investors--which resulted in two publicly announced bids that eventually fell through--drained top management of the time and resources it needed to attend to the problems at Valencia, banking experts said at the time.

‘We Had No Choice but to Close It’

“We’re gratified that the FDIC in liquidation was able to recover enough money to make all the creditors and depositors whole,” said David Scott, deputy superintendent of state banking. “However, at the time, the bank’s books showed--and it was undisputed by management--that the bank was insolvent,” he said. “The best information we had was that it was operating in an unsafe and unsound condition. We had no choice but to close it.”

Scott pointed out that Valencia “hung on a long time” and was allowed by regulators to continue operating with little or no capital as it tried to find a buyer.

The state agency, which works with the FDIC in examining state-chartered banks, appointed the federal agency as Valencia’s receiver to sell off the bank’s assets.

Regulators don’t get much argument about the reasons for closing Valencia from the bank’s final management team, which was installed to try to rescue the bank after Hobday left.

“The regulators basically were following the marching orders at the time, carrying out their jobs,” said Harvey Ferguson, Hobday’s successor. “We were working very, very hard, and we were just not able to get the capital we needed. Basically, the bank was bleeding to death.”

In hindsight, it appears that the bank probably would have recovered had it been able to stay afloat for a few more months to take advantage of the turnaround in the real estate market, said Kenneth E. Slezak, who was the bank’s marketing director and now runs Vista Marketing Services, a Huntington Beach bank consulting firm.

Instead, the FDIC--and Valencia’s depositors and creditors--got the benefit of the turnaround.

Of the $6.7 million in extra cash, a few pennies might go to each of the 533 shareholders in Valencia’s parent firm, but they shouldn’t count on it, said Jan deLeo, assistant managing liquidator of the FDIC’s liquidation office in Irvine.

Most, if not all, of the money will be used to pay interest to unsecured creditors, and the agency is the biggest unsecured creditor because it covered the $98.2 million in insured deposits, deLeo said. The only major problem left, she said, is devising a computer program to calculate the interest that each creditor is owed.

Although the work is done, she said, it will still take about a year to officially wind up the receivership of Valencia. Liquidators must put together the final paperwork and apply for necessary approvals from agency heads and Orange County Superior Court.

The only other failed Orange County banks to be liquidated completely ended up in the red. The FDIC lost $12.3 million on Western National Bank in Garden Grove, which failed in 1982, and it lost $3.1 million on South Coast Bank in Costa Mesa, which failed in 1985.

Whether shareholders--other than the directors and officers who were sued by the FDIC for negligence--will take any legal action against the agency to recover more money is uncertain. Former directors say they have talked to shareholders who are upset at the idea of not getting the extra cash returned to them. Shareholders do not receive any money until everyone else is paid off.

The directors and top officers certainly will not see any of that money.

A year after the takeover, the FDIC sued Macdonald, a Fullerton lawyer, for malpractice over advice he gave and advice he failed to give on trust department investments. The suit was expanded to accuse all officers and directors of negligence in supervising the trust department.

In mid-April, the insurance carrier for Valencia’s directors and officers agreed to pay the agency $4.5 million to settle the lawsuit. The settlement terms do not allow the defendants to take part in any distribution of a surplus from the liquidation.

In the last three years of its 15-year existence, Valencia lost nearly $10.5 million from three general areas.

“The first problem was that the business loans were supposed to be backed 90% by the federal government, but the documentation wasn’t complete. So the loans weren’t covered when there were defaults,” Slezak said.

“Then the bank aggressively made real estate loans when the market and the economy in Orange County was going into a recession in the early 1980s,” he said. “Then the real hit came from all the expenses and legal fees from our trust department problems.”

As part of its fast-growth plan engineered by Hobday and then-Chairman Ray Smith, Valencia acquired a trust operation managed by people known to top bank officers. But because of alleged mismanagement and self-dealing in the unit, the trust department lost $6.5 million in deposits from 62 pension and profit-sharing plans.

The trust department also made some unusual investments, such as loans secured by a Christmas tree farm in Oregon and by an orchid farm in Hawaii. The bulk of the assets, though, were real estate and commercial loans and investments in Texas and Oklahoma, where the oil glut at the time sunk those economies.

After Hobday and Smith resigned and Ferguson was promoted, a new management team was able to stem much of the red ink from bad loans and ended the hemorrhaging from trust department losses by reaching a settlement with the trust customers.

Under that settlement, cash and specific assets and loans were turned over to former Superior Court Judge Bruce Sumner as trustee to liquidate. His son-in-law, bankruptcy expert Robert Mosier, took charge of the asset sales and eventually made enough by selling assets--$8.5 million--to pay off all the trust account holders with 11% interest, pay administrative fees and turn some assets back to the FDIC.

Ferguson and his team also reduced the bad loans in the bank’s portfolio and sold assets to raise cash and pay off debts.

Downsizing Boosted Revenue

“I think the regulators were quite surprised when they came in and found out how clean the bank was,” Slezak said. “We actually performed the liquidation that the FDIC would normally do.”

The management team cut the six-branch operation from a high of $177.3 million in assets in 1984 to $98.7 million at the time it was seized. Such downsizing provided the bank with needed revenue while at the same time reducing the amount of capital needed to save the bank.

“The loans left at the end were mostly being paid on time,” said deLeo, who worked at Valencia until it was seized and who later joined the FDIC liquidation office. “It was not a poor-quality loan package.”

Barclays Bank of California, a subsidiary of Barclays Bank in Britain, picked up the insured deposits and 57% of Valencia’s assets. Barclays California was eventually sold to Wells Fargo Bank.

THE LIQUIDATION OF VALENCIA The Federal Deposit Insurance Corp. has paid off all Valencia Bank depositors and creditors in full and found itself with $6.7 million in excess cash--the first time anyone at the agency can recall a 100% recovery. Assets at closing: $98.7 million Bought by Barclays: $56.1 million Left with FDIC to liquidate: $42.6 million Assets for FDIC liquidation in millions of dollars: Real Estate Loans: $20.0 Commercial Loans: $5.6 Consumer Loans: $0.6 Other Assets: $8.3 Assets Returned by Barclays: $8.1 How the FDIC Earned Money on the Valencia Liquidation

1. Sale of Assets: $35.9 million Institutions and individual investors buy loans and other assets at discount

2. Interest Income: 16.0 million Money earned from paying loans and sales proceeds

3. D&O; Settlement: 4.5 million Suits filed by FDIC against directors and officers

4. Pending sale of remaining assets to close receivership: 1.5 million

Total Earned: $57.9 million

5. Less appraised value of liquid assets: 42.6 million

6. Less Expenses: 8.6 million Cost of selling off assets

Total Excess Cash: $ 6.7 million Excess cash will be used to pay interest to unsecured creditors. Any surplus will go to shareholders.