Collapse of a loan powerhouse

Ocean Tower was supposed to be a luxury condo high-rise with stunning views of the Gulf of Mexico and Laguna Madre.

But before anyone could call it home, the 30-story tower, developed by a company that had never built one before, started sinking. Doomed by a fatal construction flaw in the foundation, Ocean Tower was going back into the sugary sand of South Padre Island in Texas.

Gravity and more than 1,000 pounds of dynamite brought down "the Leaning Tower of Padre" last fall in about 9 seconds.

In all, about 30 community banks from Arizona to Wisconsin took a hit on the fiasco. They had invested in the condo tower on a far-off sand bar largely on the marketing of the Marshall organization, a Minneapolis-based group of related financial companies that financed the $74.5 million project and sold them all pieces of the loan.

Ocean Tower was one of scores of loans worth about $5 billion that Marshall entities originated between 2005 and 2007 as it financed resort, hotel, housing and condo projects coast to coast.

A loan machine in a niche industry that was largely invisible, it was the largest syndicator of commercial real estate loans to community banks in the Upper Midwest during the boom.

With a South Dakota bank called BankFirst at its center, Marshall entities sliced and diced the loans, selling pieces to small banks in places like Baraboo, Wis., and South Trevezant, Tenn.

Marshall collected the fees, offloading much of the risk -- a process known as loan syndication.

Lots of banks syndicate loans, which is a long-standing practice. But in the small universe of lenders devoted to originating commercial real estate loans to sell to community banks, only a limited number operated on the scale of the Marshall organization.

A complicated lending hybrid -- part regulated bank (BankFirst), part unregulated investment company (Marshall Group and other entities), the organization dealt with as many as 1,000 banks around the country, including about 100 in Minnesota before regulators shut down BankFirst last summer and the Marshall organization closed shop.

The reverberations of its aggressive expansion are still being felt. In addition to the failure of its own banks -- BankFirst and Marshall Bank -- Marshall loans helped wipe out at least six other small banks across the country so far, including another one in Minnesota, according to bankers and federal regulators.

One veteran banker close to the situation likened Marshall to a contagious cancer. "It might take three years to kill you. It's cancer, but you got the cancer from Marshall Group."

Not all of the Marshall organization's loans went bad, of course. And few failed as spectacularly as Ocean Tower. Still, by the time bank regulators closed BankFirst last summer, a whopping 50 percent of that bank's commercial real estate loans were delinquent or in default, according to Oakland-based Foresight Analytics. The industry average for such portfolios at U.S. banks: 6 percent.

Marshall's driving force, Chairman Dennis Mathisen, staunchly defends the organization as a victim of the country's real estate collapse, nothing more.

But interviews with bankers who worked with the organization, former employees, a growing cache of court documents and the reviews of bank regulators themselves show that the organization's problems went much deeper. BankFirst, for instance, had a "large volume" of poorly underwritten loans in an 18-month period that started shortly after Mathisen bought the bank, regulators concluded.

Court records show that some loans were done with little or no due diligence on the borrower, an accusation regulators made too. One particularly prolific loan originator said in a deposition that he never verified the most basic information about a borrower's financial wherewithal.

One of the bankers who bought into the loans said he feels "duped." A California banker who bought banks with Marshall loans called the underwriting "shameful" and blamed participating banks for failing at any due diligence of their own.

'Dennis the Menace'

BankFirst had several lives since it was founded in 1928 as Bank of Toronto in South Dakota. But it was lawyer-turned-financier Denny Mathisen who gave rise to BankFirst the loan syndicating machine.

Mathisen, born and raised in south Minneapolis, lives in Colorado, Arizona and Nevada. But he still keeps an art-filled office in the Hopkins headquarters of Jacobs Trading, the company owned by his longtime friend Irwin Jacobs. He is short and nimble, an avid art collector who, at 70, still bikes the long Ride the Rockies cycling tour every year. Only his flinty blue-gray eyes hint at the lawyer and strategist who, some say, ruled with an iron fist.

Mathisen, whose father emigrated from Norway at the age of 24 and ran a small painting business, grew up in a working-class family. After finishing law school at the University of Minnesota, he worked for years as a securities lawyer at Lindquist & Vennum in Minneapolis. He left for an illustrious career with corporate raider Irwin Jacobs, becoming his strategist and partner in a string of investment deals.

Mathisen had been buying and selling banks since the early 1970s, some with Jacobs. He figures he's bought and sold "a couple of hundred" over the years.

In 2001, Mathisen and a group of investors bought the loan syndication unit out of the failed Miller & Schroeder Financial Inc. in Minneapolis. He renamed it the Marshall Group Inc. -- his middle name and the street where he and Jacobs once had offices. The investment bank focused on commercial real estate and commercial equipment loans that it sold off to community banks.

But Mathisen was restless, a former colleague said, earning the nickname Dennis the Menace for his penchant for micromanaging and mulling big ideas. One recalls a staff meeting where Mathisen labored over whether the M in "Marshall" should go inside or outside the mountain depicted in its logo.

This time he wanted to roll Miller & Schroeder's loan syndication business into a common, regulated community bank, opening a door to the vast market of small banks that only felt comfortable buying into loans originated by a like-minded regulated bank. The banks, many in rural areas with a paucity of loan options, were hungry for deals.

In 2003, under Mathisen's leadership, Marshall snapped up a small Minnesota bank for its charter, easier to buy than get from scratch, and renamed it Marshall Bank. In early 2005, Marshall bought BankFirst in Sioux Falls, S.D., a much larger bank with a large portfolio of subprime credit cards, and then sold off the cards, giving the organization $500 million to invest.

'This is crazy'

Mathisen's two-headed lender quickly entered its golden era. Mathisen said he viewed it all as one organization, and while part of BankFirst remained in South Dakota, most employees eventually moved into the haloed Capella Tower in Minneapolis, one of the city's tallest buildings.

Mathisen helped decorate the company's three floors with about 300 oil paintings from a Las Vegas art dealer.

Inside, the organization was scrambling like mad to keep up with its rapid growth. In less than two years, BankFirst's loan volume increased more than tenfold -- from $36.6 million in March 2005 to $431.8 million by the end of 2006.

"Chaos," said one employee.

But it made money, for a time. On average, BankFirst held on to just 10 percent of the loans it originated, meaning it held little of the risk. Other Marshall entities that originated loans over the years held no stake at all. But the organization retained loan servicing rights, collecting fees for handling all the payments.

Critics accuse the Marshall organization of reckless lending. Whether a loan failed didn't affect the organization's upfront fees or commissions to the team that originated the loans or the team that sold them to participating banks -- a point regulators made when they reviewed BankFirst's failure.

Former Marshall organization insiders, participating banks and borrowers such as developers disagree about whether the group was just aggressive and sloppy or had crossed the line into negligence or fraud. One former senior-level employee, who insists he saw no evidence of fraud, said the bank simply suffered the moral hazard that afflicted Wall Street: If lenders insulate themselves from risk by parceling it out to other banks, they'll take more chances.

The Savoy deal

The Savoy was one of the poorly underwritten loans that regulators found. A 1930s-era Art Deco hotel in Miami's South Beach, the Savoy has changed hands multiple times. In 2005, a group of investors called the Savoy Hotel Partners (SHP), led by London businessman Abraham Werjuka, bought it and a parking lot next to it for $28 million intending to sell it to another developer.

A Florida broker convinced SHP to develop it themselves as a hotel-condo complex, and introduced Werjuka to BankFirst. In 2006 BankFirst refinanced SHP's mortgage with a one-year, $39.5 million loan. The bank, which was responsible for creating the prospectus with the borrower's financial information and for marketing the loan, sold parts to more than 35 banks, including eight in Minnesota.

Werjuka defaulted and BankFirst foreclosed in court. But SHP countersued with a racketeering complaint, accusing BankFirst of hoodwinking participating banks with a fraudulent prospectus that, among other things, inflated the property's value and Werjuka's financial strength, even while highlighting him as a selling point.

"It was a big scam," said Michael Bowe, a lawyer for SHP at Kasowitz, Benson, Torres & Friedman in New York.

Former BankFirst executives deny any wrongdoing. The FDIC, as receiver for BankFirst, is fighting the case.

Mathisen dismissed the lawsuit as a meritless delay tactic driven by a new partner in SHP, Manhattan real estate investor Eric Hadar. Hadar has a history of making "strident, very inflammatory claims in a variety of lawsuits in which he is involved," he said. He called the Savoy a "high quality credit" when the loan was made.

In depositions, Werjuka said he repeatedly told BankFirst he could not provide British tax statements and suggested nixing the deal. But he said BankFirst's loan originator, Ron Sweet, told him that didn't matter.

The prospectus puts Werjuka's net worth at $43 million -- $5 million in liquidity and nine properties overseas. But Werjuka said in a deposition the assets attributed to him are actually a compilation of properties he was involved with "directly and indirectly" via trusts, other companies and other people.

Sweet repeated in depositions that he never verified any of Werjuka's financial information, although he was responsible for due diligence on the deals. Asked whether he ever verified financial information with borrowers themselves on any of his loans, Sweet said, "Not that I can recall."

Sweet, who was paid a percentage of the dollar value of loans he originated, did not return multiple phone calls for this story.

The level of due diligence on the Savoy loan was typical of BankFirst loans, according to both Sweet and his supervisor, Rick Burnton, in court documents. What mattered, they said, was that Werjuka had about $13 million of cash equity in the Savoy.

The prospectus also lists the as-is value of the Savoy Hotel and parking lot as of January 2006 as $54 million, with a prospective value after development at $143 million. Just five months earlier, in August 2005, the properties had been appraised by the same appraiser at $52 million and $138 million, according to documents SHP obtained by subpoena from Miami-based AppraisalFirst Inc.

Two months earlier, in June 2005, Werjuka paid $32 million for both, court documents show.

One Wisconsin banker said in a deposition his bank wouldn't have taken part had it known BankFirst didn't get financial basics like tax returns.

BankFirst pocketed nearly $1 million in origination fees alone on the Savoy loan, according to a copy of the loan closing statement. The broker earned $500,000. Participating banks ate big losses.

Werjuka's lawyer said his client won't discuss the case.

'A live issue'

The Marshall ripple effect is still on the FDIC's radar, said an FDIC official, speaking on condition of anonymity. He said regulators have identified five failed banks in which bad BankFirst loans were a "material" percentage of the bank's capital and played a role in their demise: Bank of Wyoming in Thermopolis, Wyo.; Venture Bank in Lacey, Wash.; Mutual Bank in Harvey, Ill.; MetroPacific in Irvine, Calif., and First State Bank of Flagstaff, Ariz.

That list doesn't include tiny 1st American State Bank of Hancock, Minn., whose capital was wiped out by losses on 22 BankFirst loans it had on its books.

More than 500 banks around the country still have Marshall organization loans on their books, loans the organization held no part of. About half of the loans in that $1.5 billion portfolio are in default, a source familiar with the portfolio said.

"This is potentially a live issue out there," the FDIC official said. "I can't really put my arms around it yet."

Neither can Glenn Gray, but he bought two failed banks linked to BankFirst deals. After plowing through MetroPacific's books, the CEO of Sunwest Bank in Tustin, Calif., was ready when he traveled to Arizona to look at First State Bank's books.

"Uh-oh, here's some more Marshall loans," Gray recalled thinking. "We knew what to expect."

He called underwriting of the BankFirst loans he reviewed as "sloppy" and "shameful."

"It's the same thing that happened to the syndication of mortgage loans. There's a lack of ownership," he said.

Greg Lovell, CEO of Idaho First Bank in McCall, a town of 3,000, said his bank lost $1 million in two BankFirst deals.

"If we had that million dollars in capital still, we might not be in a consent order," said Lovell, referring to the increased scrutiny the bank is getting from regulators.

Lovell recalls getting so frustrated trying to communicate with BankFirst that he flew to Minneapolis in 2007 to talk with executives face to face. He was "stonewalled," he said. But the Marshall organization made an impression: "I was surprised at how opulent their offices were when they were having such problems."

'Internal control deficiencies'

In 2007 regulators ordered BankFirst to stop syndicating loans. Another, unregulated Marshall entity took up the baton until it, too, quit in 2008, insiders said. Last summer, regulators shut BankFirst down for good.

"At the end of the day, putting a $2 billion-per-year origination business within a $500 million community bank did not work as intended," said Scott Anderson, president of the Marshall Group, in a letter to clients dated Aug. 13, 2007.

Regulators saw it differently. BankFirst's losses stemmed from "pervasive internal control deficiencies," according to a damning 37-page report that the internal watchdog arm of the Federal Reserve Bank released in February.

The problems included such things as not managing risk, poor loan underwriting and a pay structure that rewarded excessive risk-taking. Loan originators were paid commissions based on the size of the loans, not on quality and with no repercussions if the loan went bad.

The report also blames regulators for not braking the runaway train earlier. Examiners from the Federal Reserve Bank of Minneapolis had checked BankFirst's books six times by 2007 when they finally restricted it from making more participation loans, the report noted.

Not broke 'by a long shot'

Considering that his crowning achievement just exploded, Mathisen is remarkably calm.

"It's the story of life," Mathisen said. "You can't be in business and not have ups and downs. This is a bigger down than I would have liked."

Mathisen is downsizing. He sold his three-bedroom New York condo for $2.8 million. The eight-bathroom mansion he built in the mountains near Vail is on the market for $7.9 million. He has mothballed his eight-seater Falcon jet. But he's not broke -- "not by a long shot," he said.

And he still has business plans that include financial products and more commercial real estate. He's also working to manage his rare blood disease, a form of leukemia.

Mathisen dismisses as a formality the letter the FDIC sent him and other BankFirst executives and directors in March, demanding that they help pay for the losses that the FDIC's insurance fund incurred as a result of the bank's failure. The accusations are as broad as possible to make a claim on BankFirst's insurance policy, he said. If the government pursues a legal case against him, he will defend himself.

He is adamant that the implosion of the commercial real estate market brought down BankFirst, not poor internal controls or quixotic underwriting.

The bank's loan packages were as "good or better than most," he said, adding that the bank rejected many deals. Yes, originators were paid to make the loans, he said. However, the bank's loan committee approved them and they were paid on straight salaries and had no incentive to agree to bad deals, he said.

"Ultimately, the people that made these credit decisions were the banks we sold the loans to," Mathisen said.

Jennifer Bjorhus • 612-673-4683