In my opinion, representatives of the initial banks violated numerous banking industry standards in connection with the underwriting, closing, and funding of the construction loan to the development company. Banking industry standards were also violated with regard to the selling of participations in the company loan to approximately 24 sub-participating lenders.
At the time the loan presentation was prepared, the land was encumbered by three liens representing approximately $750,000 in debt. Perhaps the most serious breach of banking industry standards, however, is the fact that funds from the first advance on the $15.2 million construction loan were used to pay off the liens against the land. This fact was not disclosed to the sub-participants, and based on my experience, it is my opinion that the sub-participants would have refused to participate in the loan transaction if they had known the true facts about the liens against the land and the method in which the liens were cleared.
The $15.2 million construction loan was also approved based on the condition that there would be a 15% cash down payment. The bank, building company owner and others participated in a series of inappropriate transactions that created the $1.7 million in CDs used as additional collateral. Such inappropriate transactions occurred after the construction loan was approved without the knowledge of the sub-participants. The CDs totaling $1.7 million were created by loans from an initial bank to various individuals involved in the apartment project. These loans were inappropriate and there is substantial evidence that some of the loans were illegal “nominee” loans. $1.5 million of the $1.7 million in CDs was funded by a loan that was collateralized, in part, by funds from the first advance under the $15.2 million construction loan. This was particularly egregious because it was not disclosed to the sub-participants, and prudent bankers would not expect loan proceeds from the construction loan to be used to create the additional collateral. In addition, the CDs to be held as additional collateral were not in place when the construction loan was closed.
This was a material deviation from banking industry standards and should have been disclosed to the sub-participants. Funds were used from the first advance under the construction loan to collateralize the $1.5 million loan that funded the $1.5 million CD which was pledged as additional collateral. These were material deviations from banking industry standards and should have been disclosed to the sub-participants. The manner in which the CDs were obtained for additional collateral was deceptive, misleading and a serious breach of banking industry standards.
Because of regulatory legal lending limits, the initial banks could not have made the construction loan without selling participations in the loan to sub-participants. Therefore, if the loan had not been made, there would have been no delivery of lumber by the building company for the construction of the apartment project, and there would have been no diversion of approximately $1.2 million from the builder’s accounts receivable.
The actions of the initial banks were reckless deviations from banking industry standards and, in my opinion, caused the counterclaimant sub-participant bank to incur substantial losses that it would not have otherwise incurred.
The expert has spent more than 35 years as a regulator, banker, and consultant.
