Real Estate Loans Too Often Went Into Delinquency : The Lending Practices Behind FCA’s Losses

On a hillside above the San Diego Freeway in southern Orange County is a housing tract with the elegant name of Capistrano Royale. It is, according to a promotion sign along the freeway, a “prestigious development of luxury estates.”

A closer look tells the true story.

Near the entrance of Capistrano Royale is a cul-de-sac of empty model homes that’s fenced off and padlocked shut. Scores of partially developed lots stand empty. A recreation area, with swimming pool and lighted tennis court, is strewn with garbage. A security guard stands watch over nearly two dozen other empty homes farther up the hill.

Capistrano Royale happens to be one of the many blemishes in the loan portfolio of Financial Corp. of America and helps explain why Irvine-based FCA is expecting the largest annual loss in the history of the savings and loan industry.

FCA is expected to announce that loss

today, and it will be in line with the $500 million to $700 million that the firm predicted two weeks ago, a FCA spokesman said. By contrast, the savings and loan holding company, the nation’s largest, earned $173 million in 1983, also an industry record.

The expected loss has put a spotlight squarely on FCA’s lending policies, which for years have been controversial among competitors, regulators and industry analysts. FCA is expected to commence a fact-finding probe to determine if fraud has played any part in the losses.

The company now estimates that its problem properties number between 2,500 and 2,600. So thick is the computer printout listing these loans that “it makes the Yellow Pages look like a pocket diary,” says one financier in Orange County who buys foreclosed properties from financial institutions.

FCA has also had its problems with deposits. A $6.84-billion deposit run last summer led to the ouster of Charles W. Knapp as chairman and chief executive and the appointment of William J. Popejoy to take his place. About $300 million more flowed out after Popejoy announced the most recent loss estimate. Total deposits now stand at about $20 billion, still tops in the country.

The losses are expected to stem primarily from a sharp increase in the reserve for loan losses, which stood at $90.5 million at the end of the third quarter. Additions to this reserve cut directly into operating profits.

Those sympathetic to Knapp say that Popejoy and his new team of auditors and real estate appraisers are trying to shift as much blame as possible on the former management.

“It’s customary in situations like this to dump on the old management,” says Ernest Leff, a savings and loan attorney in Beverly Hills.

Another former FCA executive who admires both Knapp and Popejoy put it this way: “If (the old management) was still in there, there might be some additions to reserves, but nowhere near” what Popejoy will be adding.

A full analysis of the problems is made more difficult by the fact that Knapp says that pending stockholder litigation against him has prevented him from telling his side of the story in public, while Popejoy says he’s not going to comment in detail until he knows exactly what went wrong.

Overly Bullish Appraisals

What is known from Popejoy is that overly bullish appraisals and the end of sharply rising land values have made the real estate collateral on many problem properties insufficient to cover the full value of the loan. Therefore, FCA has written down the loans to market value, resulting in the need for substantial additions to the reserve fund.

What emerges from other sources is the portrait of a fast-growing financial institution whose lending practices in recent years too often led to delinquency.

One now-discontinued lending program known as the “buy-sell” plan, for example, has sparked a rash of lawsuits by angry builders who charge that their loans went sour because of lender neglect.

Another program, jokingly known as “cash-for-trash,” was set up to sell problem properties, but it helped to reinforce a growing perception by outsiders that FCA was a careless lender.

FCA acted through its thrift subsidiary, which was known as State Savings & Loan Assn. in the early 1980s. The name was changed to American Savings & Loan Assn. in 1983 when FCA merged with Mark Taper’s First Charter Financial Corp.

A key to understanding FCA’s lending policies was Knapp’s openly stated tolerance of loan delinquencies and foreclosures in the range of 5% to 6%--about three times the industry average.

If the loans went into foreclosure, Knapp figured, they could be repackaged and sold to other developers. Thus was born “cash-for-trash,” whereby FCA would lend money on new projects only if borrowers also agreed to acquire some of the problem loans.

What Knapp apparently didn’t foresee, however, was that the abnormally large volume of problem loans eventually sparked widespread concern among regulators and financial analysts who disliked or distrusted the unconventional lending methods. One analyst, Jonathan Gray, of Sanford C. Bernstein & Co. in New York, called FCA a “garbage lender.”

Ploy to Post Quick Profits

A second lending linchpin was the buy-sell program, popularized in 1980 and 1981 when most financial institutions bowed out of the building market because mortgage and construction-lending rates were too high. Many builders now charge, however, that the plan was simply a ploy by FCA to post quick profits.

As the buy-sell agreements worked in practice, some builder lawsuits charge, FCA would acquire a piece of property from a developer, then simply sell it back at a much higher price. In return, the developer got a loan for his project, while FCA posted an immediate profit on the resale.

FCA became “the only game in town,” in the words of one West Coast building executive, earning a niche by making loans that other lenders wouldn’t touch. FCA’s net income soared 66% to $21.5 million in 1981--a year when the rest of the savings and loans industry lost a total of $4.6 billion.

State Savings received hefty up-front fees for large construction loans made across the Western United States.

However, the Securities and Exchange Commission is now investigating the manner in which those loans were accounted for. FCA documents on file with the SEC suggest that the probe could result in a significant restatement of 1980 and 1981 earnings.

Many buy-sell projects got into trouble after construction-loan interest rates soared above 20% and stayed there longer than the worst pessimist had imagined. Builders couldn’t complete the projects because they were decimated by rising interest costs.

But the builders charge that State Savings came to regard the buy-sell loans, in the words of one lawsuit, “as a nuisance” once the profit was booked. The voucher system set up to disburse the loans was allegedly so fouled up that builders say they had to wait months for payments that should have taken days.

What’s more, State Savings earned the builders’ wrath because it was quick to initiate foreclosure proceedings once a project started having problems. That was counter to the normal lending tradition of initiating foreclosure only as a last resort.

“They have gotten away with so much and ruined so many people’s lives that it’s just a shame,” adds Sacramento builder William Simas. “They promised us the moon but didn’t deliver.”

(Popejoy said in a recent interview that a number of the buy-sell lawsuits have been settled out of court but added that “we don’t plan to roll over just to settle a suit.”)

Another problem at FCA apparently was its internal organization.

Even some of Knapp’s admirers say he was a laissez-faire administrator who had neither the interest nor disposition to run a company as fast-growing, far-flung and decentralized as FCA. The company had major lending centers throughout California that operated with great autonomy. “People had signatory powers who weren’t using prudent lending practices,” one former loan officer says. “That was the biggest problem.”

FCA was growing so fast that even the best manager would have had trouble running it, another ex-Knapp lieutenant said, adding that the “end result is the company got out of control.” FCA’s assets, the principal measure of its loan volume, grew to $32 billion by the time that Knapp was forced out last summer from $1.04 billion at the end of 1979. While a large part of the growth came from the acquisition of First Charter, FCA also proved an eager lender.

Sued to Recover $81 Million

FCA’s penchant for fast growth also earned it a reputation for being willing to buy loans from other lenders no matter what the underwriting or documentation. FCA bought the mortgages in return for a fee. In one notable case last fall, FCA sued to recover $81 million in condominium loans that it acquired in 1982 and 1983 through the now-defunct San Marino Savings & Loan Assn.

In the case of Capistrano Royale, the lenders took back the project after the developer, Goeden Co., sought bankruptcy protection in January, 1984.

According to lending records obtained by The Times, State Savings lent more than $13 million to develop 82 luxury homes with price tags as high as $506,000. So far, none of the lots have any homes.

Another financial institution, Bank of America, has lent money to build 27 homes, only five of which are occupied. Loans to build the seven empty models came from Security Federal Savings & Loan Assn. of Garden Grove.

FCA officials, for their part, view Capistrano Royale as merely one of thousands of problem properties in need of attention. Said a company spokesman: “We don’t even know what the physical condition of those lots is right now.”