Centennial Savings, Guerneville, Northern California

(The material here is taken from Pizzo's book, Inside Job, unless otherwise indicated.)

In December of 1980, the board of Centennial voted to elect Erwin (Erv) Hansen to the job of President. Hansen was considered a conservative banker, though one who preferred not the traditional bankers clothing but sports coat and cowboy boots. A new president such as Erv, it was felt by the board, could take the thrift into the newly created deregulatory waters of S&L banking. And in these new waters, a different style of lending started almost immediately; local lending on houses was out, exotic investing in almost anything else was in.

In July of 1982, Centennial loaned a Dutch investor, Nicholas Sandmann, (a Hansen acquaintance) $5.4 million to redevelop an old 1000 acre ranch near Santa Rosa. Under the new (de) regulations, such a loan significantly improved the financial health of the struggling thrift at least in an accounting sense. Just for making the loan, thrifts could now under RAP accounting rules book 2 percent of the loan (2 and a half percent if the loan was for real estate construction) as income and show this as such in its accounts. Two percent fees had been permitted in 1979 expressly for the purpose of increasing S&L's reported earnings at a time when their spreads were being squeezed by the rising rate of interest. (Lowy, page 81) This income is of course merely an accounting (paper) profit.

Thrifts quickly learnt they could book other fees also, like loan origination fees. They learnt too that that could even add these fees to the amount of the loan. The larger the loan, the more income that could be 'booked'. And if the thrift could somehow inflate the valuation of the real estate upon which the loan was based, an even larger loan could be justified hence more income to book in turn allowing even better bonuses for thrift owners at years end.

Soon, some thrifts were even adding the interest payable on the loan, to the loan itself. For example, if a borrower wanted, say, a $5 million loan, the thrift would loan him,or her, $5.4 million, and account for the difference by putting it to a reserve out of which the next several years worth of interest might be made as and when it was due, usually monthly. Which meant of course that the loan would always appear 'current' on the books and not in arrears, regardless of the true state of the project or the whereabouts of the borrower. "This bookkeeping anomaly," said Pizzo (note 4, endnotes, page 335) "resulted in the most desperate thrifts making the most, the largest, and the riskiest loans in an attempt to make the S&L's financial statements look better or to give the borrowers a couple of years getaway time." Centennial's Santa Rosa ranch deal ultimately ended in default and allegations of fraud. The thrift though continued to book all the income due on all the loans it was making, and moved further down the road on its growth quest.

In August of 1982, Hansen bought into the construction industry with the purchase of Piombo Corporation for $13 million, making its owner, Sid Shah, an executive at Centennial. California State had just passed its Nolan bill, allowing a state thrift the ability to invest 100 percent of its assets in speculative ventures like Piombo if it so chose. "Deregulation would prove a real boon to Centennial," said Hansen, putting the thrift "into the financial fast lane".

To pay for Piombo, Centennial placed advertisements in the Wall Street Journal guaranteeing any depositor that Centennial would pay interest on their money insured certificates of deposit as they were called at a rate slightly higher than the then prevailing rate of 10.4 percent. Deposits flowed in, allowing Centennial to grow faster and larger than might otherwise have been the case had it been forced to rely on just local depositors as in the past.

To see what this might look like in practice, it is worth examining a typical, though hypothetical, thrift balance sheet, which might in the beginning have looked something like the following:

Assets
Cash - 10,000
Mortgages - 100,000
Property/equip - 5,000
Total 115,000

Liabilities
Deposits (owed to depositors) - 109,000
Owed to other banks - 2,000
Total - 111,000
Net worth - 4,000
Total liabilities & net worth - 115,000

It is soon clear that attracting more deposits means more money is available to lend, means more fees as income, means more profit.

It might also be pointed out, the thrift in this example will not become insolvent just because a few depositors for any reason decide to withdraw some or all of their money. Say, for example, next week, $15,000 in deposits are withdrawn. Provided this thrift has $5000 of mortgages it can sell for exactly what it says they are worth, there is no problem. The entries so made would reflect a new balance sheet as follows:

Assets
Cash - nil
Mortgages - 95,000
Property/equip - 5,000
Total - 100,000


Liabilities
Deposits (owed to depositors) - 94,000
Owed to other banks - 2,000
Total - 96,000
Net worth - 4,000
Total liabilities & net worth - 100,000

Despite the withdrawals, the thrift's net worth has not changed. As a percentage of total assets, the thrifts net worth has actually improved: was 4,000 / 115,000, is now 4,000 / 100,000.

More important, is the use to which the thrift has put the deposits. (Of course how the value of the mortgages is accounted for is another question, at cost, at market, and in the end, what they can actually be sold for, which will affect the accounting net worth, but we will overlook this at the moment.) Anyway, back at Centennial, with the use of such deposits, and then Hansen lending them out ostensibly to make money, the accountants had managed to have Centennial's mortgages and assets valued at roughly $400 million by August 1985, from just $49 million at the beginning of 1983. Hansen and Shah came to rely more and more on such incoming deposits to fund their growth plans.

However, with Centennial paying ever slightly higher interest rates on the deposits in order to attract the money, it was expensive funding for the thrift. So ideas were needed to put the money to profitable use. Real Estate speculation solved this problem, in the short term at least. In one such loan, Shah decided a fortune could be made in land and mushrooms. Taking Hansen and another Centennial director into the operation, Centennial loaned the group $1.5 million for ownership of a large, formerly bankrupt mushroom company in Washington state; the plan being to corner 80 percent of the West Coast market. Ultimately for Centennial, a $4 million non-performing loan.

With all the new loan business, new offices were deemed necessary. Centennial bought, then refurbished a large office building in Santa Rosa for $7 million. Wrote Pizzo (page 35) in describing it: "Everything at the new office was first class: oak, brass, etched glass, box-beamed ceilings, mirrored walls, plush carpets. There was a board room big enough to jog in with a conference table long enough to skate on. Western oil paintings graced the walls and cowboy sculptures stood on cabinets and desks. A five-foot high solid crystal horse head dominated the conference room." It seemed only appropriate therefore that directors should be rewarded for their efforts in growing Centennial. In 1984, Centennial announced that Shah and Hansen would be awarded bonuses of $818,000, each, from the $2.6 million Centennial 1983 accounting (read paper) profit. There was nothing paper about the bonus though; this was in cash.

Centennial grew in 1984 also. So did the spending. This is best explained in Pizzo's own words (page 36): "Hansen, a renowned ladies' man, had made the acquaintance of a stunning young woman who fancied herself an interior decorator. He took an immediate liking to her, and the two began a relationship that would cost Centennial hundreds of thousands of dollars. When Hansen needed a decorator...he hired his young friend. Over the next few months, the two of them flew often to Los Angeles and Las Vegas, on Centennial's twin-engine Cessna, on 'buying trips'... antique desks... a gold and silver chess table with an inlaid marble top and matching gold-and-silver chessmen."

Hansen spent $90,000 decorating his own office and equipped the conference room with the finest antique tables and Persian rugs. Before long, Hansen had five cars for himself and his family, paid for with a Centennial check. The director of every Centennial subsidiary received a new Mercedes.

"It wasn't long before the spending sprees caught the attention of the public," wrote Pizzo. "Few knew quite what to make of them, but most people accepted the ostentatious life-styles...as one more piece of proof that the area was becoming a playground for the rich and famous..." By throwing money around, Hansen "rose to (a position) of considerable prestige in northern California."

A few though, thought the spending looked out of place. One of those few, Pizzo himself, as a journalist at the local Russian River News, published pieces questioning where the money was coming from for such expensive displays from a once local thrift. In reply, Hansen sought out the offices of the competing local paper, simply called 'The Paper', which as it happened was having money troubles. Financial support was offered. Hansen hoped the extra money might alter the balance between the two publications.

There was more than good press to buy too. Centennial, via its directors, was quite an active corporate citizen when it came to local political campaigns. As for the regulators, in these early days of deregulation, since on-site examinations were difficult, if not impossible, regulators relied upon supervision by mail, often requesting what was needed via Centennial's directors. If further appeasement was required, Hansen would attempt to hire them at often double their former regulator salary. (Pizzo, page 47) In the same way, Centennial ended up hiring seven of its former auditors, who had often sat in on the board meetings anyway, helping the thrift structure its real estate deals.

Poor lending practices cannot go on forever though, especially if the loans are made, as they were, without proper real estate valuations and other supporting documents, when on the payroll is a $48,000 European chef (so that meals could be prepared for thrift guests in the full gourmet kitchen at the office), a corporate jet costing $35,000 a month in fees and maintenance, a San Francisco penthouse and 25 company cars.

Federal regulators finally got around to properly auditing Centennial about two years later and, amidst great shock, fired all the officers and directors and quietly closed it down. $165 million of federally insured deposits had vanished.

Follow up references:

Lowy, Martin. High Rollers: Inside the Savings and Loan Debacle, Praeger, 1991.

Pizzo, Stephen, Inside Job: The Looting of America's Savings and Loans, McGraw Hill Publishing Company, 1989.

Copyright: Phil Anderson, 2004


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