Lincoln Exemplifies How S&Ls; Collapse, Official Says

The collapse of Lincoln Savings & Loan of Irvine may be the most costly thrift failure on record, but the pattern of high-risk investments, rosy accountant reports and efforts to wield political influence were painfully familiar to federal regulators.

While the example set by Lincoln was “the worst of the worst,” its downfall was a replay of other catastrophic S&L; failures during the last five years, according to testimony by William K. Black, regional counsel for the Office of Thrift Supervision in San Francisco.

It was as simple as “ADC,” Black told Congress on Thursday, referring to Lincoln’s heavy investments in risky “acquisition, development and construction” loans to developers and virtual abandonment of the far safer, traditional loans to single-family homeowners.

“A thrift was the perfect cash cow for a real estate developer,” said Black, who testified before the House Banking, Finance and Urban Affairs Committee, which is investigating the Lincoln failure.

In his congressional testimony, Black noted that American Continental Corp. of Phoenix, controlled by the family of Charles H. Keating Jr., was basically a home builder when it acquired Lincoln in 1984.

Lincoln was seized by federal regulators on April 14, a day after its parent company filed for bankruptcy court protection. Estimates of the cost of cleaning up the mess have ranged as high as $2 billion, which would make it the most expensive thrift failure in history.

Black, who along with other regional regulators in San Francisco tried to call attention to Lincoln’s problems two years before the government finally acted, told Congress that Lincoln was a textbook case of thrift excess.

A typical Lincoln ADC loan, Black said, required no down payment by the borrower and included funds for architect fees, developer fees and other costs on top of the price of the property and construction expenses. In addition, the borrower was not required to make principal payments for the first two to five years of the loan.

“In other words, the borrower puts zero money in and walks away with money in his pocket,” the regulator said.

At the same time, the thrift would charge the borrower millions of dollars in “points” and other fees that were added to the amount of the loan, along with enough money to cover two years’ worth of interest payments. Those charges were then recorded on the thrift’s books as income, even though no money had changed hands, Black said.

Because commercial real estate projects are frequently speculative, with no legally committed or financially capable buyer on hand, they are far riskier than home loans.

“The typical ADC project that sank thrifts was scores of millions of dollars in size,” Black testified. “Yet hundreds of such loans were made with no loan application, no credit checks, with no appraisal or feasibility study, with no down payment and no personal guarantee” of repayment.

Even under the best of circumstances, Black noted, an ADC nothing-down loan is an extraordinarily risky investment.

“When combined with poor underwriting, a serious loss is highly likely,” he said. “When fraud is involved, these ADC loans become almost total losses.”

While conservatively run institutions would not make this kind of loan, S&Ls; that did were able to charge higher-than-normal interest rates and fees.

“Lenders willing to take on these garbage loans were generally troubled thrifts or thrifts acquired by unscrupulous individuals,” Black said.

The problem was compounded by friendly accountants who were willing to disguise the true financial condition of thrifts by counting as income the fees and interest payments charged on ADC loans rather than categorizing them properly as direct investments.

In Lincoln’s case, he said, a chief accountant for the Dallas office of Arthur Young & Co. who had worked on the S&L;’s books was hired at a salary of $1 million a year by American Continental.

“It is a sad fact that most of the worst losses (experienced by the government’s deposit insurance fund) were from thrifts that received ‘clean’ audit opinions from Big 8 accounting firms prior to their failures,” Black said.

“Indeed, Lincoln is proof positive that any thrift in America could obtain a clean audit opinion despite being grossly insolvent.”

As a result, he said, such accounting methods ensured that an ADC loan would appear profitable for the first two years--until the time came for the borrower to begin repaying with real money.

“If a thrift grew rapidly and put the great bulk of its assets into ADC loans,” Black said, “it was guaranteed to report record profits, at least until the first payments to be made by the borrowers were due.”

Sham sales of dubious loans also helped these S&Ls; appear to be in good shape, the regulator noted, along with swaps of bad projects.

“I’ll trade you my dead cow for your dead horse,” became a catch phrase with some of the worst thrifts, Black noted. “By paying each other more than the book value of the projects, they could each convert a loss into a gain and declare new income.”

To fend off government regulators who tried to halt these practices, Black told Congress, owners of high-flier thrifts made campaign contributions in an effort to obtain political influence that could squelch an investigation.

In the end, the failures of Lincoln Savings and other troubled thrifts left the taxpayers, rather than the owners, holding the bag since losses were covered by federal deposit insurance.

“Federal deposit insurance is like giving the owner of a thrift access to the federal mint,” Black concluded. “Lincoln may have appropriated over $2 billion in taxpayer funds. This is truly taxation without representation.”