Beleaguered Banc of California (Nasdaq: BANC) has hit another rough patch.
On March 15, the Santa Ana-based bank reported a $13.7 million theft that will most likely wipe out first-quarter profit.
“It’s a large amount in our industry,” said Kelvin Dickenson, who’s spent more than two decades in the sector and is a member of the advisory board of the Association of Certified Financial Crimes Specialists.
“It’s certainly not a routine fraud. For all I know, the bank’s officials could have checked every box and this was an incredibly skilled fraudster,” said Dickenson, managing director, global head of compliance and data solutions at Opus Global Inc., a New York-based provider of software products to banks for risk management that hasn’t done business with Banc of California.
The fraud was the talk of the Orange County banking circle over the past week. Executives found it surprising that such a large theft could occur in a highly regulated industry known for numerous due-diligence requirements, especially since the 2008 industry crisis. They wondered how the bank could have been hoodwinked, who the suspect or suspects are, and whether there was collusion by an insider. They pondered what it means for new Chief Executive Doug Bowers, who’s been replacing a host of top executives.
It was only last month that Bowers laid out a road map that indicated the bank’s restructuring was taking longer than expected. On the trading day following the theft disclosure, shares fell 3.3% to $20.35 on volume of 2 million, about twice the daily trading average of the past three months.
Bank executives declined to be interviewed about the theft, instead releasing a statement.
This Big
Just how big was the theft?
If it had been a robbery, the $13.7 million would almost make the top 10 in U.S. history. No. 10 came in 1983 at a Wells Fargo branch, costing it $16.9 million in 2016 adjusted dollars. Ironically, the biggest occurred in OC in 1972, when a gang stole an inflation-adjusted $172 million from Laguna Niguel’s United National Bank, according to the World Atlas website. The robbers were eventually caught.
The breach was the latest in a series of problems for Banc of California over the past 18 months.
Previous chief executive, Steve Sugarman, resigned a year ago on the day the bank announced the Securities and Exchange Commission was investigating how it handled allegations by an anonymous blogger. A proxy fight ensued, and now six of the nine directors on the board are new.
Bowers joined last May, having served as chief executive of Square 1 Bank until it was bought in 2015.
The chief financial officer position remained vacant for a year until John Bogler was hired in September. The bank hired Kris Gagnon as chief credit officer on Feb. 7.
Junk Collateral
The fraud began on Feb. 1 when Banc of California issued a $15 million line of credit to a borrower that the bank won’t identify.
“The line of credit was granted by the bank after the borrower appeared to have satisfied a pre-condition that the line of credit be fully cash collateralized and secured by a bank account at a third party financial institution pledged to the bank,” it said in a March 15 filing with the SEC.
The bank further indicated in the SEC document that it checked to make sure the collateral account was valid.
“As part of the Bank’s credit review and portfolio management process, the line of credit and disbursements were reviewed subsequent to closing and compliance with the borrower’s covenants was monitored.”
The fact that a third party held the collateral raised eyebrows among bankers after the theft was made public.
“It’s a red flag,” said Dickenson, who based his information on the filing, not insider information. “I’d want to know why the borrower wasn’t seeking a loan from the bank where he has a relationship.”
On March 9, Banc of California said it received information that caused it to believe “the existence of the pledged bank account had been misrepresented by the borrower and that the account had previously been closed.”
By the time it closed the line of credit that same day, the $13.7 million had already been drawn. The bank, which said unnamed authorities are investigating, said it believes the fraud was an isolated incident involving a single borrower.
Known Customer?
The transaction raised questions about how well Banc of California followed a regulation known in the industry as “know your customer.” The rule, part of the Patriot Act, was implemented after the 9/11 terrorist attacks as a way to protect the industry from abuse by money launderers and terrorists. Among the requirements are verification of the customer’s legal name, address, taxpayer identification number and date of birth.
Bankers often apply additional due-diligence methods, such as verifying income with the Internal Revenue Service, and reviewing three years of financial statements and cash-flow forecasts.
Loans of the size stolen from the bank are typically approved by loan committees instead of by individual bankers. Banc of California’s annual report said that “all material credit exposures” are reviewed by a variety of committees, which reach as high as the joint enterprise risk committee of the board of directors.
“The perpetrator of this fraud is either a particularly skilled fraudster who could create the impression of a business sizable enough to receive a $15 million credit line, or it was a legitimate business that has fallen on hard enough times that caused the proprietorship to develop moral flexibility,” Dickenson said.
Q1 Profit Hit
The theft will wipe out 24% of Banc of California’s net income this year, according to Keefe, Bruyette & Woods analyst Jacquelynne Bohlen, who reduced her 2018 estimate from $46.2 million to $35.3 million. Bohlen predicted a first-quarter loss of $2.2 million, or 4 cents a share, instead of her originally projected profit of $7.6 million, or 15 cents a share.
She nevertheless reassured investors that the theft was isolated.
“We don’t believe this is a systemic issue,” Bohlen wrote in a note to investors. “Occasionally, fraudulent loans happen, and they are often not an indication of any systemic credit problems embedded in a loan portfolio.”
Since the loans were made under current management, she said she anticipates no further announcements.
“We believe CEO Doug Bowers works continuously to create a relatively boring—which we mean in the best possible way—commercial bank that provides growth and transparency to its investors.”
When asked for further details on the theft, a Banc of California spokesperson released a statement saying it has “disciplined, rigorous risk-management systems.
“Unfortunately, as we disclosed, we believe a loan we extended in good faith was made based on fraudulent information,” the statement said.
“We have sufficient safeguards in place to ensure this loan will have minimal consequences for investors and no effect on our ability to service our clients.”
