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Sonoma Valley Bank continued to provide loan extensions to one of its largest borrowers and his business partners long after other lenders had begun to foreclose on his Sonoma County real estate projects.

By providing developer Bijan Madjlessi and his partners more time to repay, the community bank postponed foreclosing on the Sonoma County real estate used as collateral and avoided reporting any losses that would have resulted — a process that ultimately showed the deals had lost more than $22 million.

The extent of the bank's loan problems remained out of the public record until bank regulators, conducting a routine audit, forced executives in February 2010 to restate their earnings and recognize $26.6 million in troubled loans — a 300 percent increase over the $6.6 million the bank had originally reported.

Regulators shut down the bank six months later.

The federal government is estimated to have lost at least $20 million due to the closure. The bank's approximately 1,000 shareholders, whose stock was worth about $15 million the night before the bank publicly restated its loan losses, saw the value of their shares tumble 35 percent in one day. Today, their stock is worthless.

"Extend and pretend"

Beginning in 2008 and continuing until the final weeks before regulators closed Sonoma Valley Bank, Madjlessi and his business partners were given extensions to repay the millions of dollars their companies had borrowed despite defaulting on the loans, according to public records.

This practice of renewing loans that had defaulted was all-too common at troubled banks, according to one local banker, who said people in the industry called it "delay and pray." Another banker called it "extend and pretend." Both spoke on condition of anonymity, citing the ongoing investigation.

"It's not a prudent strategy. They are pushing the envelope forward," the banker said. "You may be buying time, but you've kind of dug yourself a deeper hole."

When a $9.2 million loan to Madjlessi for his condo project in Santa Rosa became due in April 2008, Sonoma Valley Bank provided him a short-term modification, according to court records.

A few months later, Madjlessi defaulted on the loan and did not pay interest for seven months, according to court records.

In December of that year, the bank again provided him an extension and wrapped the unpaid interest into a new loan — essentially ballooning the former $9.2 million loan into a $9.34 million loan.

The president of one North Bay bank said the tactic was more than just unusual. "You can't capitalize interest," said the banker, who spoke on the condition of anonymity. "It's just not permissible."

The property was foreclosed on last month by Westamerica Bank, which purchased most of the assets of the failed Sonoma Valley Bank. No buyers stepped forward at a public auction to outbid Westamerica's $1.5 million offer for the condo project.

In late 2009, Brian Melland, a bank loan officer, attempted to arrange an oral agreement to extend a $10.7 million defaulted loan for Madjlessi's business partner Glenn Larsen, who wanted to avoid foreclosure on their project, a Santa Rosa self-storage facility, according to court records.

In another deal, which occurred eight days before the bank was closed by regulators, bank president Sean Cutting gave Madjlessi and his business partners an extension to avoid foreclosure on a condo-conversion project in Petaluma.

For information on the reopening, go to www.srcity.org/emergency or call 707-543-4511.

Good year for bank?

In 2008, as loan troubles started to emerge, the bank reported a $3.96 million annual profit. Its two top executives, Cutting and Mel Switzer, who was then chief executive officer, received total compensation of $1.3 million, according to public filings with the Securities and Exchange Commission.

By that point, Madjlessi's companies had already defaulted on bank loans on both his Petaluma and Santa Rosa condo projects, for which Sonoma Valley Bank had loaned more than $23 million.

The bank's 2008 annual profit was made possible by keeping down costs such as setting aside money for future loan losses, which executives that year had increased by 33 percent to $5 million.

Less than a year later, regulators audited the bank's 2009 third-quarter financial reports and forced executives to increase their reserves for loan losses to $29.3 million — an increase of more than 295 percent.

When regulators finished their monthslong audit in February 2010, the bank was required to restate that it had lost an additional $18.5 million due to bad loans.

Regulators closed the bank six months later.

"You saw how fast the FDIC closed the bank down," the banker said. "That's because they probably saw a pattern of restructuring these loans imprudently."

You can reach Staff Writer Nathan Halverson at 703-1577 or nathan.halverson@pressdemocrat.com.