Minnesota lender's collapse blamed on fraud

Some of the stalled housing developments blighting communities across Minnesota failed not from hard economic times, but because of widespread fraud by a large, unregulated lender that collapsed in 2008, a Canadian bank has alleged in a $100 million lawsuit.

The Bank of Montreal charged in a suit filed Tuesday that former executives at Lakeland Construction Finance, once one of Minnesota's largest residential construction lenders, made loans for housing projects without visiting the sites or conducting appraisals.

Eagan-based Lakeland then moved the bad loans off its books by selling them to a separate entity financed by the Bank of Montreal, while intentionally misrepresenting the riskiness of its lending portfolio and its loose underwriting standards, according to the suit filed in U.S. District Court in Minneapolis.

The suit adds fuel to a widely held view among developers and city administrators across Minnesota that Lakeland's collapse resulted from its business practices -- not the faltering housing market.

The bank seeks to recover its losses from former Lakeland executives and Lakeland's main investor, Avalon Capital Group, a La Jolla, Calif., firm headed by Ted Waitt, co-founder of computer maker Gateway.

Avalon has been accused of obtaining $67.5 million from Lakeland just before the firm defaulted on loans. Lakeland is now under the control of a court-appointed receiver.

Avalon officials did not return repeated telephone calls Wednesday. Former Lakeland officials could not be reached or did not return calls.

At least 26 cities and townships are still struggling to repair messes created at Lakeland-financed projects that were abandoned when the firm defaulted on more than $400 million in loans.

In Wyoming, dirt roads lead to two partially built and recently vandalized houses. A sofa and mattress lay in an empty field that was supposed to be home to 80 upscale houses.

In Cannon Falls, a Lakeland-financed developer left partially completed roads sagging on clay soil, creating mogul-like bumps. The subdivision, Sandstone Ridge, has just one house instead of the 100 initially planned.

And in Dassel, a 50-foot-high pile of dirt sits on the edge of Summit Hills, a Lakeland-financed housing subdivision. Residents near the pile fear the spring thaw will send mud pouring into their driveways and clog the city's sewer system -- as it did a year ago.

The Bank of Montreal, one of Canada's largest banks, alleged that many of these projects would not have been started were it not for Lakeland's reckless lending practices. "Deals that would typically take weeks or months for a bank to approve would be arranged by Lakeland in a matter of days," the lawsuit said. In some cases, Lakeland lent to developers who failed to obtain appraisals or who never obtained appropriate zoning for their projects.

The suit alleged that Lakeland's former chief operating officer, Robert Machacek, strong-armed developers to consolidate maturing loans that were on the brink of default. Machacek would repackage loans with fresh maturities, creating the appearance they were new loans, the suit alleged.

Instead of writing off bad loans for a loss, Lakeland would "offload" them to a separate entity, LCF Funding, backed with money from the Bank of Montreal, the suit said. Lakeland serviced and administered the loans, which enabled it to "mask the bogus loans in the loan portfolio," the suit said.

In 2005, the Bank of Montreal became concerned about Lakeland after learning that Machacek had a criminal record. In 2000, he had pleaded guilty to two charges of mail fraud in connection with the embezzlement of $355,000 from Builders Development & Finance of Wayzata, where he was the chief financial officer. He was sentenced to a year in prison.

Waitt, of Avalon Capital, later vouched for Machacek's character in a telephone call to a Bank of Montreal representative, according to the lawsuit. Waitt indicated that, "notwithstanding Machacek's prior criminal history, he was extremely supportive of Machacek and very comfortable with his role of heading up Lakeland's loan origination and underwriting operations," the lawsuit said. Waitt is not a defendant in the suit.

Liquidating the company

Lakeland still had $213 million in loans and $226 million in real estate on its books as of November, according to a receiver's report filed with the court. The 26 communities hurt by Lakeland projects filed claims totaling $10 million, according to the report. The total claims against Lakeland are $554 million, the report said.

Andres Carbacho-Burgos, an economist at Moody's Economy.com, said the sale of loans to special entities was common during the real estate boom as a way for lenders to generate extra cash. But this practice, known as "securitization," also invited abuse because it gave lenders an incentive to make riskier loans knowing they could unload them to another party.

"When you're holding risky loans, the first thing you think of doing -- to fool the credit rating agencies or anyone else looking at your balance sheet -- is to move your risky loans to a separate company," Carbacho-Burgos said.

An endless stream of litigation has slowed down the process of selling Lakeland's assets, with competing lenders making claims on certain properties.

Last summer, the receiver filed suit against Avalon, alleging that Lakeland made a fraudulent transfer of $67.5 million to Avalon in late 2007 -- just months before defaulting on bank loans. That suit said the transfer was fraudulent because it was made to an insider and Lakeland was insolvent. The receiver is now trying to recover the $67.5 million for creditors. Avalon disputed the lawsuit, but a judge refused to throw it out.