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.
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.