The Lembi real-estate implosion (see “War of Values,” December 2009) is on the verge of claiming another casualty: little Tamalpais Bank of San Rafael, which lent $41 million to the Lembi family and has now declared virtually its entire portfolio of commercial mortgages to be in default.

The failed loans, confirmed in court documents obtained by San Francisco magazine, constitute 50 percent of the bank’s non-performing assets. The institution is operating under a cease-and-desist order by the Federal Deposit Insurance Corporation, a serious administrative action requiring the bank to revamp its lending practices, raise capital, and dispose of its troubled loans.

As reported by Danelle Morton in our December issue, Walter and Frank Lembi, the father and son behind the CitiApartments rental behemoth, used more than $1 billion in financing from international investment banks and purchased more than 170 San Francisco apartment buildings between 2003 and 2008, bringing the total number of buildings they owned to 300, which briefly made them the largest private landlords in the city. Their loans were shoveled into collateralized debt obligations, or CDOs—the same asset-backed securities behind the global financial crisis.

According to documents acquired by San Francisco, the Lembis had an aggressive business plan for removing tenants in rent-controlled units, so that they could raise rents by an average of 59 percent, reap big profits, and finance their debts.  Today, most of the Lembis’ mortgages are tanking.

The decline of commercial mortgage-backed securities and CDOs, which accounted for about half of the growth in the mortgage market during its peak, in 2006 and 2007, closed off a chief source of financing for the Lembis, but opened the door for local lenders, like Tamalpais Bank, to expand.

“It was an opportunity to grab some market share,” said Matthew Anderson of Foresight Analytics, an Oakland-based real-estate and banking research firm.  “But it wasn’t one you wanted to take advantage of.”

Tamalpais Bank made most of the Lembi loans between December 2007 and April 2008. In spring 2008, the bank’s parent company announced record earnings and assets, propelled in part by expansion of its commercial real-estate portfolio. “We had strong organic loan demand in the quarter while maintaining near pristine asset quality,” said CEO Mark Garwood in an April press release.  The bank’s directors eventually awarded him a $156,000 bonus for his performance that year.

But by this past September, the Lembis had defaulted on all except one of their loans, leaving Tamalpais Bank with a $38 million hole in its portfolio. The size of the loans was equivalent to more than 75 percent of the bank’s total capital.

“Lending that much of the bank’s capital to a single borrower is inherently reckless, imprudent, and simply unsafe and unsound,” said Richard Newsom, a retired San Francisco bank regulator. “Originating such a huge concentration of credit to one borrower in that period is beyond unsafe and unsound, because the commercial real-estate market was already starting to crack at that time.”

To shore up its balance sheet, Tamalpais recently put $37.4 million in loans on the market—almost certainly the Lembi mortgages, say analysts, though the bank wouldn’t confirm it. A month ago, Garwood told the Marin Independent Journal that the bank was in negotiations to sell the loans and hoped to conclude the transaction by the end of November.

Mark Chapman, Tamalpais Bank’s chief marketing officer, refused to comment on the Lembi loans.  “We’re just focused on the future, doing what we can for revenue growth and increasing our deposits,” he said.

UPDATE: After using a “nationwide bidding procedure,” Tamalpais Bank sold the $37.4 million in loans on November 20 for $24.1 million, according to a recent filing to the Securities and Exchange Commission. San Francisco magazine can now confirm that the loans for sale were, in fact, the Lembi mortgages.
 
They were purchased by CAPARTNERS1 LLC, which incorporated in Delaware two days before the sale.
 
Although Tamalpais made most of the loans to Lembi-affiliated companies by April 2008, two of the loans, totaling $6 million, closed in June and October of 2008.