Trust Not Enough for Integrity Bank By Kris Hudson and Lingling Wei Wall Street Journal 03-04-2010

Trust Not Enough for Integrity Bank By Kris Hudson and Lingling Wei Wall Street Journal 03-04-2010

Trust Not Enough for Integrity Bank
By Kris Hudson and Lingling Wei
The Wall Street Journal
March 4, 2010

The 125-year-old Casa Madrona Hotel & Spa housed military families during World War II, was a crash pad for beatniks in the 1950s and nearly collapsed from mudslides in the 1970s.

The quaint, 63-room hotel overlooking a bay north of San Francisco now is at the center of a messy postmortem involving a small Georgia bank that was seized by banking regulators in August 2008 after lending all its capital to the hotel's owner. The failure cost the U.S. deposit-insurance fund $295 million, and the hotel filed for bankruptcy protection before being sold by the Federal Deposit Insurance Corp. at a foreclosure auction last month.

The FDIC is investigating the loan practices at Integrity Bank, which opened in Alpharetta, Ga., in 2000 with the motto "In God We Trust." The Federal Bureau of Investigation and federal prosecutors also launched probes of the bank's lending practices; neither will comment on the status of those inquiries.

Integrity's overexposure to Casa Madrona's owner, commercial-real-estate developer Guy Mitchell, also has led to criticism of regulators in charge of overseeing the bank. The FDIC's inspector general concluded last year that "elevated and timely criticism of the bank's loan administration and underwriting deficiencies" might have prevented the bank's failure.

Mr. Mitchell declined to comment through his lawyer, Greg Ellis. Mr. Ellis blames the problems on poor management and record-keeping by Integrity. "If we were with a bank that operated properly, none of this would have ever happened," he said.

In a separate report issued Wednesday, the inspector general said a Jupiter, Fla., bank with the same name that failed last year was doomed partly by $22.1 million in loans it bought from Integrity. The two banks worked together closely and planned to merge.

The failures still resonate because of widespread fears about the commercial real-estate loans lurking on the balance sheets of U.S. banks, especially those that aren't household names. Federal Reserve Chairman Ben Bernanke said last week that such loans at small and medium-size financial institutions are "the biggest credit issue that we still have."

An FDIC spokesman declined to comment on the agency's supervision of Integrity. The FDIC has previously said that the Alpharetta bank collapsed mostly because its management pushed too hard to make risky loans. In its response to the inspector general's report, the FDIC didn't address criticisms of its supervision.

Rob Braswell, commissioner of the Georgia Department of Banking and Finance, which granted approval for Integrity to open, said the agency doesn't discuss individual institutions or ongoing investigations.

Under Georgia law at the time, it was illegal for banks to pour more than 25% of their total capital into a single borrower. According to regulators and an internal investigation before Integrity failed, Integrity worked around the borrowing limit partly by extending credit on different properties owned by Mr. Mitchell. That eventually led to losses of more than $44 million on the loans.

It isn't clear how Mr. Mitchell, of Coral Gables, Fla., found his way to Integrity, which had just five branches when it was seized. But in 2002 and 2003, the bank made loans on five shopping centers that he owned on Georgia. In 2005, Integrity helped Mr. Mitchell finance the $12 million purchase of Casa Madrona. He got a $29.5 million credit line to buy the hotel and convert it into condominiums, according to bank documents filed in the bankruptcy case.

By 2008, Mr. Mitchell had 14 different loans from Integrity that added up to $83 million, or 127% of the bank's total capital of $65.3 million as of the middle of that year, according to court and regulatory filings. The loans were secured by the hotel, shopping centers and his home in Florida.

Unlike many borrowers, Mr. Mitchell wasn't required to make payments on the loans out of his own pocket. Instead, according to Mr. Ellis, each loan had interest reserves, or money that is set aside to cover payments until a real-estate project starts generating cash flow.

Some regulators have criticized the use of interest reserves, claiming they can make it harder to detect troubled loans.

Bank documents filed in the Casa Madrona bankruptcy case show that unidentified Integrity officials dipped into some of Mr. Mitchell's credit lines to make payments on his other loans. Loan officers also arranged a rescue loan in a bid to save the developer's Royal Palm Hotel in Miami from foreclosure "without a loan package or documentation," the FDIC said in a report filed with the court.

Mr. Mitchell's loans suffered as the real-estate market weakened. At least several loans were in default by 2007, and Sausalito officials stalled his redevelopment plans for Casa Madrona with a moratorium on hotel-to-condo conversions.

In a 2007 exam, the FDIC cited Mr. Mitchell's loans as a problem. A subsequent internal report by the bank said they "were not properly approved, credit underwriting was lacking, loan approvals were not delivered or followed, interest was funded from construction loans and several officers may be implicated."

Integrity's board launched an internal investigation, which found that some Integrity executives lent more money to Mr. Mitchell in order to boost their own pay. "By continuing to loan Mr. Mitchell money, large loan fees were generated for commissions to the loan officers, as well as loan dollar volume goals to justify larger year-end bonuses for executive management," directors concluded in January 2008, according to minutes from a board meeting that were filed in the bankruptcy.

As a result, Integrity Chief Executive Steven M. Skow and an unknown number of other officers left the bank. Mr. Skow's lawyer declined to comment. Lawyers for the other former officers declined to comment or couldn't be reached.

Before it failed, Integrity scrambled to salvage Mr. Mitchell's shaky loans, according to documents filed in the bankruptcy. Bank officials hoped to sell the hotel and his shopping centers, and appraisals of Casa Madrona estimated the hotel was worth $30 million to $80 million. But the bank's overall losses had depleted its capital, and regulators swooped in to shut down the bank.

Integrity's deposits were sold to a unit of Regions Financial Corp., and the FDIC was stuck with 97% of Integrity's $1.1 billion in assets, according to the agency.

When the FDIC moved last year to foreclose on the hotel, Mr. Mitchell filed for bankruptcy protection for the hotel. A federal judge ruled that the agency could proceed with the sale.

On Feb. 1, MetWest SIMA Real Estate Advisors of Santa Barbara, Calif., won Casa Madrona with a bid of $1 more than the FDIC's asking price of $11.4 million. Georgia law now allows banks to exceed the 25% limit on loan renewals to existing borrowers as long as they haven't fallen behind on their payments.


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