The Road to Failure at Valley State Bank

Last New Year’s Eve, Jules Huppert was sitting alone in his Encino office. Three years had passed since he had taken over as president of Valley State Bank, and there was little to celebrate.

Valley State had charged off $3.7 million in bad loans over the past three years, a high figure for a bank with only $100 million in assets. The bank was also in trouble with the Federal Deposit Insurance Corp. for failing to disclose certain fees it charged borrowers.

Given Valley State’s weak finances, the FDIC had ordered Valley State to raise $3 million in capital by the end of September, 1987, if it hoped to remain open.

In his office, Huppert tried to find a silver lining in the bank’s $2.6-million loss for the year. Earlier that day, he thought he’d found it in the bank’s precious-metals division. Started just two years before, the division made loans to investors who wanted to buy gold and silver bars. It appeared that the division had made a profit in 1986.

But shortly before midnight, just as Huppert as getting ready to go to a party, word came that one of his precious-metals employees had embezzled $600,000. “We were going to show a profit in 1986, and that specific hit whisked it away in a quick few minutes,” Huppert recalled.

It was a bad omen for 1987. Valley State slogged through nine more months of hefty losses until Monday Sept. 28, when the California State Banking Department closed the bank. The following morning at 10 a.m., Valley State’s five branches reopened as Capital Bank of California, which had paid the FDIC $672,000 for the branches, $46.7 million in assets and $76.3 million in deposits and liabilities.

Chronology of a Failure

Interviews with Valley State’s executives, regulators and other bankers, offer a rare inside glimpse into a how a bank fails.

In many ways Valley State’s failure was symptomatic of the deregulation of the banking industry. Banks now have greater freedom to expand into new businesses. With that freedom has come an avalanche of failures: 601 banks have failed in the United States this decade. Valley State was the seventh bank in California to fail this year.

Valley State, which opened in 1979, was never a banker’s bank. Its first president, O. Monroe Marlowe, fled the country after he was accused of bilking elderly investors of $3 million. He was arrested this summer in Frankfurt, West Germany, and is awaiting extradition. Its second president, Mark deGorter, accused Huppert of making improper loans and using drugs. Huppert sued for defamation and libel. That suit was dismissed.

By the time Huppert arrived as president in 1983, Valley State had started expanding, and it was having a hard time meeting costs. He faced two choices: cut back or try to grow in a hurry. “I had no choice,” Huppert recalled. “I found myself with an Encino branch of $6 million in deposits and about $2 million in loans. That doesn’t even pay for the lights.”

The bank went on a lending binge. As the loan portfolio grew--from $36.6 million in 1983 to $96 million in two years--so did the bad loans.

Huppert also steered the bank into the precious metals business, lending to consumers who purchased gold, silver and platinum. Valley State worked with telemarketing firms who sold customers on precious metals and then recommended they take out a loan with Valley State.

At least two of the telemarketing firms are under investigation by the state of Minnesota, which has a reputation for strict securities regulations. A number of customers have also filed suits against Valley State, claiming they were misled in their purchases.

Federal Violations

The FDIC has said that Valley State broke federal truth-in-lending laws by failing to disclose all of its fees to precious metals customers. And, in an internal report, the FDIC also said that Valley State had only a fraction of the metals it was supposed to be holding for customers in its vaults. Diana Sherwood, former head of Valley State’s precious metals division, denied the charge.

A week after Valley State closed, Huppert sat in his Hollywood Hills home staring out the window at the San Fernando Valley below, recalling January when he realized things were desperate. “I thought the best thing to do was find a good merging partner,” he said.

One candidate was Capital Bancorp in Miami, which had set up a West Coast operation, now called Capital Bank of California in Century City. It had tried to acquire a failed bank in Encino three years before. Huppert called Capital to see if it still was interested in breaking into the Valley market.

It was, and on May 11 a tentative $2 million stock merger agreement was announced between Capital Bank and Valley State. But the deal hinged on a thorough review of Valley State’s books by Capital’s examiners, said Daniel Holtz, Capital Bank’s president.

Capital’s analysts spent the summer poring over Valley State’s books, turning up one problem after another. By Sept. 3, Capital Bank was having second thoughts. “If an agreement was not reached between us, Valley State would be closed in the very near future,” Holtz said.

He thought: Why pay retail when you can get the same bank a couple of weeks later at Salvation Army prices? On Sept. 15, Holtz told Huppert and Valley State Chairman John Bedrosian the deal was off.

FDIC Order

Valley State still faced an FDIC order to raise $1.5 million in capital by Sept. 30, just 15 days away.

Bedrosian started calling other banks that might want to buy a piece of Valley State. It was a fire sale, and Huppert worked out the price tags. He wanted more than $1 million for the Van Nuys branch and more than $650,000 for the Woodland Hills branch. That was ridiculously high, said Gerry Findley, president of Findley Reports, a La Brea banking newsletter.

Bedrosian talked to Mort Michaels, president of Independence Bank in Encino, and asked if he was interested in buying one or two branches. He spoke to Steve Markoff, chairman of A-Mark Precious Metals in Beverly Hills, to see if Markoff wanted to buy the precious metals division. Robert Kagy, president of American West Bank, said he’d take the Van Nuys and Woodland Hills branches for the right price.

Expansion-minded banks were attracted to some of Valley State’s offices because it can cost $600,000 to set up a new, full-service branch in the Valley, Findley said. Taking over an existing one might cost half that, he said.

Huppert, 48, had more than a parochial interest in Valley State’s survival. He had invested $1 million in the bank’s stock and was its largest stockholder with 16%. That commitment had convinced others to invest as well when Huppert was named president, despite the fact that Huppert’s only other banking experience was as a young loan officer.

“Jules Huppert pretty much had his life savings in there,” said Sam Greenberg, 78, owner of Sam’s U-Drive in Van Nuys and a self-made multimillionaire. Greenberg bought $700,000 worth of Valley State stock. “I figured he had to produce. But it didn’t work out that way.”

When the bank closed, Greenberg and Huppert lost $1.7 million collectively. “I can take a tax loss,” Greenberg said. “I guess I can look forward to that.”

While Huppert and Bedrosian worked to save Valley State, the FDIC already had decided it was going to close the bank. The state Banking Department’s examiners, on a routine annual audit, had discovered that as of June 30 Valley State’s liabilities exceeded its assets by $76,000. They deemed it insolvent, said William Adams, assistant deputy superintendent of the Banking Department.

That’s all the FDIC needed to hear. In mid-September, it invited 47 California banks to attend a secret meeting at 1:30 p.m. on Sept. 17 on the Banking Department’s 11th-floor offices in Los Angeles. The FDIC was going to auction off two sick banks, Valley State and Commonwealth Bank in Torrance.

Confidential Meeting

“When we open the meeting we tell bankers that what is transpiring here is confidential, and we expect them to keep it that way,” said Anthony Scalzi, regional director for the FDIC.

Ten banks sent representatives, including First Interstate, Security Pacific, Bank of Industry and Capital Bank. FDIC review examiner Walter Thompson spent two hours going over Valley State’s financial statements contained in a 50-plus page bid package that he had distributed at the meeting. This was a limited-time offer. Bids for Valley State were due at 11 a.m. on Sept. 28.

“We were breaking it down piece by piece,” said Vernon Sorensen, chief financial officer of Bank of Industry, who attended the session. “It’s literally picking over the bones.” Huppert knew the bid packages had been distributed.

(The FDIC did not offer for sale Valley State’s precious metals division because it might have scared away too many banks, Scalzi said.)

Holtz of Capital Bank stayed up until 3 a.m. the following day studying the bid package. “I was trying to satisfy myself that I understood the details of the format,” he said. “It’s a rather complicated transaction.”

Later that Friday, Sept. 18, Huppert resigned. Valley State didn’t announce Huppert’s departure for another week. “It was not my job to put out a press release,” he said.

The next week Valley State’s 1986 annual report started arriving in shareholders’ mailboxes. The report was six months late because problems kept popping up that forced the bank’s auditors to refigure the results, Huppert said. Inside the report was an ominous warning. Because of loan losses and FDIC complaints, the report said, Valley State “may be unable to continue in existence.”

More Grim News

It was more grim news for shareholders. Valley State’s stock, which was issued in 1978 at an adjusted price of $4 a share, had always been thinly traded, but by July it stopped trading altogether. There weren’t any buyers.

By Monday, Sept. 21, word of Valley State’s imminent collapse had trickled down to depositors, and there was a run on the bank. Huppert said approximately $20 million was withdrawn in just five days by big companies and small-time investors.

It appeared Valley State might have trouble honoring the checks drawn on its customer accounts. By Wednesday, Sept. 23, it had to borrow $1 million from the Federal Reserve to meet its obligations, Huppert said. He said Valley State repaid the Federal Reserve the following day.

On Monday, Sept. 28, Independence Bank in Encino and Capital Bank turned in the only two bids that would be made on Valley State. “Fifteen minutes before it was due, I still had not completed the adjustments I had wanted to make,” Holtz said. The last-minute run on the bank forced some quick refiguring of the bids. Capital Bank bid $672,000, easily beating out Independence.

Bank of Industry decided not to bid. “I didn’t have an ability to guess the potential losses if we took it on,” Bank of Industry’s Sorensen said.

The same day, at 3 p.m., the Washington office of the FDIC called Holtz to accept his bid. Three hours later, a Superior Court judge approved Capital’s takeover.

On Tuesday morning, Sept. 29, depositors were given new checks and deposit slips emblazoned with the black signature of their new bank, Capital Bank of California. By 11 a.m., workers had covered up all of the Valley State signs, and the receptionist had grown accustomed to saying, “Capital Bank” when she picked up the phone.

Two weeks later, it was hard to tell Valley State Bank had ever existed. Even Huppert’s parking space had been painted over. “The bank didn’t pay for it,” a garage attendant said, “so we sold it to someone else.”

THE COLLAPSE OF VALLEY STATE BANK

September 15: Merger negotiations end between troubled Valley State Bank and Capital Bank of California.

September 17: The Federal Deposit Insurance Corp. holds a secret auction to find a buyer for Valley State.

September 18: Valley State’s president, Jules Huppert, resigns.

September 21: Valley State’s clients start a run on deposits.

September 28: Valley State is closed by banking regulators.

September 29: With FDIC approval, the bank re-opens as part of Capital Bank.

Los Angeles Times