Sunday, November 27, 2016

Letter to Arizona Bankers Association Lobbyists - how about a cup of tea?

Wendy Briggs/Paul Hickman/Steven Killian
Lady &Gentlemen
As lobbyists for the Arizona Bankers Association, we’d like to introduce you to some topics with serious banking implications coming out of volunteer work I’m doing as part of Arizona HOA Legislative Reform. For some reason, I’m told by Senator Farnsworth’s office that you did not want to meet. Whilst we may not be suggesting new state legislation, we may wish to propose new Federal changes. And without question insist upon the enforcement of current banking law and prudential principles many bank tellers would understand. Absent the bankruptcy aspects, this is banking 101.
In addition, you may not be serving your constituents well. Based on what I’ve seen there is a tremendous business opportunity here for technology based financial institutions to better serve the 62 million homeowners paying $75Billion annually into their HOA’s topping up $50billion of cash. But to do it transparently.
The concerns I’ve already registered break down into five area, one historical, four current and future. Some of this involves serious bad actors in my view. Some of it not. As an experienced banker, I try not to just groan and say – oh not again. But a considerable number of highly seasoned retired banking friends, including ex regulators, have reacted with shock to what the onion peeling has thrown up. And it’s not finished yet. Consequently, I’d welcome feedback. Please also check out our blog where this will be posted at www.arizonahoa.blogspot.com The banking business also operates under he golden principle of "two eyes". Would you and/or any of your members like to prove us wrong - because I would like to be? 
Here are the issues
Historical losses.  
First National Bank of Arizona and Desert Hills Bank engaged in wholesale harvesting of deposits via the HOA Management Companies resulting in a rare instance where UNINSURED depositors with deposits far in excess of the $100,000 FDIC limit had to be bailed out. This occurred in the shadow of IndyMac in 2008 with no accountability or even awareness generally of what happened. In the case of FNBA, explosive growth in their deposits from HOA’s in the community banking division (“CAB”) blossomed to $1Billion with only $75mm invested back. Where did the $925mm go? The President of CAB had as qualifications CAI membership and running Las Vegas nightclubs and remains a figurehead with Western Alliance Bank. Click HERE
In the case of DHB, click HERE for details of their relationship with HOAMCO in Prescott, where deposits gathered by them in excess of FDIC limits were routed back to them as property loans.
HOW WAS THIS ALLOWED TO HAPPEN?
Anti-Money Laundering.
Many of the so called “HOA banks” such as Mutual of Omaha, Western Alliance Bank, and US Bank surprisingly, looking to garner deposits cheaply, have no idea who their customers, the HOA’s, actually are. They have never met them and consider the unlicensed Management Companies to be the real clients. This flies in the face of the Patriot Act anti-Money Laundering procedures which rely on two things:
controlling the point of entry of new accounts into the banking system and;
the old fashioned “know your customer” principle.
HOW DO THEY KNOW THE ULTIMATE DEPOSITOR IS NOT ISIS OR A DRUG LORD?
Our records searches so far cover we believe almost 1,000 Arizona HOA's including account opening documentation from US Bank, Mutual of Omaha, Alliance Association Bank and others. Standard practice is a Master Agreement between the bank and the Management Company with little or no mention of the underlying account holder. Click HERE  Under these arrangements, the signing authority is given exclusively to Management Company employees. And the name of the Association as the beneficiary of the funds appears nowhere. Furthermore, user names and passwords for bank accounts on a view only basis are being denied. This adds to the evidence that bank accounts are being co-mingled.  With the recent exposure of the Wells Fargo account opening scam, should we be surprised at loose banking practices at smaller banks operating in the shadows and with no relationship at all between the depositary institution and the account holder? BUT US BANK?
HOW IS THIS ALLOWED TO HAPPEN?
Risks to the Money Transfer System via The Automated Clearing House (“ACH”).
The lack of controls on vast numbers of ACH direct debit banking authorities given by HOA members - TO THE MANAGEMENT COMPANIES - not a depositary institution, poses staggering worst case risks to the ACH money transfer system. With an annual volume now at $27 trillion per annum, this system is the backbone of local and retail commerce nationally. One polluted entry into this “batch” driven system might pose catastrophic risks to a payment system at the heart of every Americans’ daily lives. These authorities to debit bank accounts, the fundamental role of a depositary institution, are being issued by HOA members to totally unlicensed Management Companies who typically have difficulty managing landscapers and who would not know a debit or credit from a pretzel. See a collection of those authorities issued to MANAGEMENT COMPANIES – NOT BANKS HERE
WHY ARE THESE MANAGEMENT COMPANIES ALLOWED TO OPERATE AS SHADOW BANKS AND/OR FIDUCIARIES?
Substantive Consolidation in Bankruptcy.
This core principle of bankruptcy only becomes apparent when it’s too late. Most of the so-called HOA attorneys operate in a twilight zone with the goal to dip into the pot of money and confuse transparency laws. How can they possibly assess the bankruptcy risks which is federal law anyway? This they will discover if the Arizona HOA industry ever must move from the relatively simple provisions of ARS 33, creating a cottage industry of so called “HOA Attorneys”, into the federal bankruptcy field.  Substantive consolidation in bankruptcy is not even controversial. It’s just not well known to the community of CAI attorneys who market themselves as HOA Attorneys when no such specialty exists. Corporate bankruptcy is not state law and much more complex than personal bankruptcy.
Substantive consolidation depends on tracking cash flows and the lack of arm's-length dealings. As even Enron discovered, you can’t be arm’s length if you are both writing a check to an LLC, but also the depositing officer for the recipient.  Using this “duck” principle, the mingling of cash by HOA Management Companies, with the cooperation (collusion) of certain banks means they have become the general partners of essentially general partnerships. Depending on further evidence, some banks also may suffer the same fate akin to the “lender liability” known to any banker with corporate bankruptcy experience. These principles are in common with many other fundamental dealings between economic entities.  These include, constitutional fair value dealings under state gift clauses, transfer pricing across borders, using the corporate veil to protect business owner’s personal assets from business creditors, and the whole concept of fair value arm’s length transactions between supposed independent entities. The collective faces of HOA industry participants, be they management Companies, HOA Boards, attorneys and financial institutions will go white when they face this. This will sort the Men/Women from the boys/girls. Unfortunately, this is a double-edged sword.
Failure to respect old fashioned governance procedures
There has been a complete failure in Arizona HOAs to respect extremely long standing corporate and banking procedures relying on merely “clever”, as opposed to “smart” moves. Consequently, little or none of the standard protections to insulate members and individual HOA’s from bad actors remains. One HOA bankruptcy could spill over and affect every HOA managed by the same Management Company.  It’s tantamount in a worse case to “Financial Ebola”. And the “duck” principle will be applied by any federal bankruptcy judge. If the cash looks mingled, acts mingled, smells mingled - it's all mingled - you’re all in the bankruptcy together, including municipalities and banks and other financial actors who will probably be the last to discover this.  
Co-mingling on moneys is not supposed to happen. This poses enormous risks wherein Management Companies are acting as fiduciaries but posing as agents. This presents risks as to the real availability of FDIC insurance for every deposit. See the difference HERE
FirstService is the publicly quoted parent of FirstService Residential, the country’s largest HOA Management Company. This is a company with a 20% annual revenue growth since 1998 by acquisitions. Click HERE
Unfortunately, its financial statements raise enormous flags. Click HERE  This is an HOA Management Company with few hard assets. Yet its debt of $197 million exceeds its net worth of $167 million. Three other factors are highly relevant
The goodwill on its balance sheet of $207 million exceeds the $167 million of net worth. That goodwill is the value of the customer lists and employees acquired. Its tangible net worth is therefore NEGATIVE $40 million.
The debt comprising $197 million is secured over all the company's assets including its own cash. Plus, controls over leverage.
Not only does it not pay taxes, it appears to be getting refunds
To me it evokes ENRON
So:
WHAT HAPPENS IF ONE HOA GOES BANKRUPT?
HOW WOULD YOUR MEMBERS DEAL WITH PUD RIDERS IF A MANAGEMENT COMPANY SUCH AS FIRST SERVICE FOLDED? See DeMenna PUD Rider for a typical rider.
Super liens in favor of banks’ lending to HOA's
Banks specializing in lending to HOA’s find this attractive for reasons I find irrational. First, they seem to like lending into a structure where the revenue(assessments) are part of an enforced structure. Well that’s not so smart in my view because of the “you can’t make a dead horse drink” banking theory. A voluntary arrangement is much better. Also, the ability to foreclose on a HOA members home because of a modest late payment makes no sense. They also view this as attractive under their “super lien” approach. Click HERE
WHY WOULD ANY MORTGAGE LENDER ALLOW THIS TO HAPPEN?
WHY WOULD THEY NOT SUPPORT AMENDING LEGISLATION?
Your thoughts and those of your members are appreciated
Regards
John Sellers
CC:
Senator Farnsworth
Steven Briggs, ADFI
BCC
Arizona Bankers Association Members, Staff and Sponsors
Arizona Mortgage Lenders Association
Arizona HOA Blog