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Red ink deepens, troubles mount for Westsound Bank

As the free-flowing red ink continues to deepen, other problems continue to mount for beleaguered Westsound Bank . Meanwhile president and CEO Dave Johnson keeps trying to spin what is seemingly daily doses of bad news, as if everything were just business as usual.

It appears that major New York City law firms — and others — are circling like buzzards to file a class action lawsuit against Westsound Financial Group, Inc. , which is the holding company that owns the bank. At least seven different law firms have jumped into the fray, and are all actively soliciting clients to fill the required class requirements to file a suit.

The firm of Hagens Berman Sobol Shapiro , which has offices in Seattle, Los Angeles, San Francisco, Phoenix, Chicago and Boston, was the first to announce its intentions about three days after it came to light that Westsound had laid of 33 people in its mortgage lending division, and that serious problems existed not only with an extraordinarily high number of bad loans, but also under the circumstances those loans were made.

Adding to Westsound’s woes is that on Nov. 13, the company filed a Notification of Late Filing on Form 12b-25 with the Securities and Exchange Commission, reporting that it will not be able to file its quarterly 10-Q report for the period ending Sept. 30, on time because it is in the process of completing a previously announced review of its loan portfolio by independent third party auditors. It also cited the return from a medical leave of absence by WSFG’s chief financial officer, Mark D. Freeman.

According to Westsound, as expected, it had been contacted on Nov. 20, by NASDAQ regarding its listing status due to the delay in filing the 10-Q. The notice was issued in accordance with standard NASDAQ procedures as a result of the delayed filing, and WSFG said it will request a hearing before a NASDAQ Listing Qualifications Panel to appeal the potential delisting. The appeal and request for a hearing automatically stays the suspension of WSFG stock and the delisting, pending the Panel’s review and determination.

“We remain well capitalized and certainly expect to file our Form 10-Q as soon as reasonably practicable. We intend to follow through on any other actions necessary to bring WSB Financial back into compliance with NASDAQ requirements,” said Johnson in a press release when the actions were announced.

Also on Nov 20, WSB announced it expected to add somewhere between $7 million and $9 million pretax dollars to its reserve for loan losses, and added that it has engaged an independent third party to review its loan portfolio. That review is expected to be completed in mid to late December. WSFG said it will file its third-quarter results after the completion of independent review. It had originally announced it would file the earnings report on Nov. 14.

It appears, according to the bank’s own figures, that the money it will add to its bad loan reserves will be about equal to two years of profits.

The bank also announced that a portion of the reserve will be written off as impairment charges under generally accepted accounting principles . However, the amount of such charges cannot be reasonably determined until the independent third party review of the loan portfolio is completed.

Things began unraveling at Westsound on Sept. 21. That’s the day WSB announced that it would eliminate 33 jobs in the mortgage division of the company, and that Executive Vice President of Sales and Lending, Brett Green, was leaving the company. Green has subsequently formed his own company and reportedly hired most of the personnel WSB laid off.

At the time, Johnson steadfastly refused to answer any questions about Green, who is a major stockholder in WSFG, or the circumstances under which he left WSB. He did say at the time however, that WSB may be referring its mortgage business to Green’s new company — a statement he repeated on WSFG’s investor’s conference call which took place shortly afterwards.

When the truth about accounting policies and compliance with applicable laws and regulations began to come out, WSB’s stock price fell from $15.30 to $12.40. After the market closed on Oct. 23, WSB belatedly revealed that auditors from both the FDIC and the Washington State Department of Financial Institutions had been delving into WSB’s books and advised the bank’s management that in the opinion of the regulators, the bank violated certain banking laws and regulations which are primarily related to the origination, administration, and monitoring of construction and mortgage loans. Due to these revelations, WSFG stock collapsed to close at $4.73 on Oct. 25.

The examiners advised Johnson they intended to recommend that the FDIC and DFI take regulatory action against the bank with respect to such lending practices and activities, which may include a Cease and Desist Order, monetary penalties, further increases in allowances for loan losses, reserves and charge offs.

At that time, WSB admitted publicly for the first time its been cooperating in an investigation by the regulators pertaining to certain past activities involving former employees and third parties, including possible fraud, misconduct and other violations with respect to the application, processing and approval of certain loans previously made.

On that same conference call, Johnson revealed that in this past spring DFI had identified at least 146 high end home construction loans made to approximately 130 borrowers and valued at $90 million — for which WSB Financial had not obtained proper income documentation. Of those, although funding had been disbursed, construction was in various stages of completion on some, while it hadn’t commenced on others. He stated that these were primarily in the south King County area, and made no mention of any problem loans locally.

Johnson also revealed that Countrywide Funding, to whom Westsound had sold many of its questionable loans, had withdrawn from continuing to do business with the bank, and would be seeking recovery of non-performing loans it had acquired from Westsound.

Johnson also stated on the call that the bank looked at 126 other loans and identified serious problems with some of those as well. As a result, the company stopped making these loans in April, but never disclosed these facts until Oct. 29.

A number of questions remain, and Johnson didn’t take, or return, several phone calls from the KPBJ so they could be answered. Among those are: Does the $7 to $9 million in reserves cover WSB’s entire loan portfolio, or just the portion of it that has been revealed thus far? If it applies to everything, why are those independent auditors still working — and what specifically are they looking for? Of those 126 other loans, how many of those are in Kitsap County and how many from out of the area? When the auditors are finished, how much more does WSB expect to have to dedicate to reserves, and where will that money come from? How much loan value does WSB have on its current watch list?

WSB’s drama hasn’t played itself all the way out yet, and whether or not more bad news is lurking in those books, and how deep the red ink could get, is something only the auditors know for sure — and like Johnson, they’re not talking. At least not yet.

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