Bank Merger Canceled; Firm Reveals Problems

Valencia Bancorp Monday canceled its proposed rescue takeover by a Peruvian bank holding company and revealed that its 1984 losses more than doubled to $5.7 million. Valencia also acknowledged a “misappropriation” of more than $6 million from its trust department.

In calling off the acquisition by Credito del Peru Holding Corp. because of an alleged breach of contract, Valencia said it seized $5.2 million left on deposit by the Peruvian company.

Valencia Bancorp, Santa Ana parent of Valencia Bank, also disclosed that it has been under orders from the Federal Deposit Insurance Corp. to raise capital to cover its huge losses. The bank said that as of March 31, its capital-to-assets ratio was 2.8%--far below the 7.5% demanded by the FDIC.

The grim combination of events led the bank’s auditor to refuse to issue an opinion about Valencia’s year-end figures or its future viability.

Although the FDIC’s order to increase its capital was issued at least nine months ago, Ken Slezak, senior vice president of Valencia, said Monday that Valencia has not received any additional orders from either the FDIC, which insures its deposits, or the state banking department, which is its primary regulator.

He said however that the FDIC has just completed a new examination at Valencia and that the state banking department completed an examination of its own about four months ago.

Regulatory sources said that in light of Valencia’s increasing financial difficulties, it is likely that both agencies are preparing new orders which would cover minimum capital requirements and could possibly direct the bank to reduce its emphasis on real estate lending. Valencia said Monday that its $5.7 million in losses last year included $2.1 million set aside to cover possible future loan losses. In addition, the losses included several million in real estate loans that the FDIC ordered written down as well as legal expenses incurred in the now-terminated acquisition negotiations.

In announcing its restated loss for 1984, Valencia also said its auditor, Peat, Marwick, Mitchell & Co., issued a disclaimer on the 1984 audit at Valencia and qualified the 1983 audit report. A qualified report means the auditor does not guarantee any of the audit findings because the auditor believes that the institution’s financial situation could change rapidly and without warning.

Auditor’s Uncertainty

Valencia said Peat Marwick took the actions because of “uncertainty as to the resolution of the trust department misappropriation” and because of “possible actions that might be taken by regulatory agencies in the absence of capital and earnings improvement.”

In its announcement Monday, the bank said it terminated the year-old agreement to be acquired “because of material breaches of contract.” The bank seized $5.2 million of deposits placed with Valencia by Credito and its bank, Banco de Credito de Peru of Lima. Industry sources said Monday that if Valencia is to prevail in what surely would be a lengthy court battle with Credito, the seized deposits would offset most of Valencia’s 1984 losses.

Valencia’s troubles have long been rumored in local banking circles, but the extent of the 14-year-old bank’s woes was not known until Monday’s announcement.

Banking industry and regulatory sources said Monday that despite its problems, it is possible for Valencia to extricate itself--but if that happens, a much different bank would emerge, they say. For Valencia to raise its capital-to-assets ratio to the level required by the FDIC would likely require the bank to raise millions of dollars of new capital, sell off a large portion of its loans and possibly rid itself of some of its six branches or other assets such as its large data processing center, which does contract work for many other area banks.

Negotiations Reported

In a written statement Monday, Valencia Chairman Ray Smith said the bank is negotiating with unidentified parties interested in purchasing some of its assets. He also said that Valencia’s “top priority” is the resolution of its trust department problem.

But the trust department problem, according to Slezak, centers on the misappropriation of and apparently illegal investment of more than $6 million in pension funds by several former Valencia employees. Smith could not be reached for comment.

Slezak said the bank uncovered the misappropriation in an internal audit early last year and called it “an isolated event.” He said Valencia is discussing the situation with the trust department clients who lost money but would not identify the clients or elaborate on the discussion.

Slezak said the money was not embezzled but rather was used to make real estate investments not permitted by the federal law governing trust department management of pension funds.