Contrarian Pundit

The Wall Street Journal this week told the backstory of Marin’s Casa Madrona Hotel and Spa’s bankruptcy, the news of which anguished my wife and I last fall as we planned our wedding’s rehearsal dinner there and also tried to find accommodations for our invitees. As it turns out, the full tale of the Sausalito landmark involves a defunct community bank in Georgia, a Florida real estate developer, failed hotel-condo conversions … and curious parallels to Tamalpais Bank.

Earlier this decade, Coral Gables commercial-real-estate developer Guy Mitchell sought to expand his portfolio of properties and turned to Integrity Bank of Alpharetta, Georgia (Motto of bank: “In God We Trust”) for financing. Their relationship began with shopping centers in Georgia and moved on to hotels.

Integrity didn’t require Mitchell to put any of his own money into his projects. According to the WSJ,

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.

In 2005, Mitchell bought Casa Madrona for $12 million but received a $29.5 million loan from Integrity for his plan to convert the hotel into condominiums. There was just one thing: he didn’t have the support of Sausalito. Yes, the bank extended Mitchell a huge loan to convert a city landmark with a 125-year-old rich history (beatnik poets, Hollywood stars) into condos without knowing whether the city endorsed it. Sausalito passed a moratorium on such conversions, souring the deal.

In all, the bank extended $83 million in credit, or 127 percent of its capital, to Mitchell by 2008. This was a violation of Georgia law, which restricted banks from lending more than 25 percent of its capital to one borrower. How did Integrity skirt the law? The WSJ says,

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.

Do you understand this sentence? If you do, please explain why it is not transparently ridiculous.

At any rate, when the real estate market started tanking in 2007, several of Mitchell’s loans went into default. The bank used some of Mitchell’s other credit lines to pay them. (Hmmmm… using borrowed money to pay previous commitments … what does that remind you of?) And when Mitchell’s purchase of Miami’s Royal Palm Hotel (another condo-conversion, with his partner on the deal, Chicago hotelier Robert Falor) neared foreclosure, the bank extended an emergency loan “without a loan package or documentation,” according to the FDIC.

Why would Integrity Bank risk all its capital on one highly leveraged borrower? According to the WSJ,

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 you probably suspect, none of this ended well. Mitchell’s projects went into bankruptcy, and his defaulted loans ultimately cost the bank $44 million, which contributed to its failure in August 2008. Integrity’s collapse left the FDIC’s fund $295 million poorer. Though the bank appraised Casa Madrona at between $30 million and $80 million, it sold last month for $11.4 million. Mitchell, meanwhile, has been accused of funneling $3.8 million from the failed Royal Palm deal to offshore accounts in the Cook Islands.

WHAT DOES THIS HAVE TO DO WITH TAMALPAIS BANK?

Believe it or not, this story has striking parallels to the Lembi-Tamalpais Bank scandal:

(1) Like Mitchell, the Lembis used massive leverage to gobble up properties.

(2) Like Mitchell, the Lembis engineered hotel-condo hybrids, in which condos could be rented out as hotel units, as the “creative/innovative/entrepeneurial” underpinning for deals.

(3) Like Integrity, Tamalpais lent nearly all its capital to the Lembi Group, despite California state banking law, which similarly restricts loans to one borrower to no more than 25 percent of capital (See 1220 and 1221 of the financial code).

(4) Like Integrity, Tamalpais extended loans to the Lembis even as the real estate market was cracking.

(5) Like Integrity, Tamalpais Bank showered its underwriters and executives with raises and bonuses. For his 2008 performance, CEO Mark Garwood received a $156,000 bonus.

But maybe we shouldn’t get carried away. After all, was Mitchell, like the Lembis, being sued by the city attorney for illegal business practices while Integrity extended loans to him? Perhaps we should cut Integrity some slack.

Moral of the story: In real-estate profiteering, it’s all about location, location, location: find deals in a bubble region, get a nearby community bank to extend massive credit to you without your having to put in a dime of your own money, then move proceeds offshore.