Finance Factors is heavily invested in Mainland real estate that has declined sharply with the nation's slumping economy.

Court documents in a now settled lawsuit by shareholders of the company's parent Finance Enterprises Ltd. also show the firm issued loans to company directors and their relatives in what one board member described as a "culture of illegality and self-dealing."

Local attorney James Wright, an outside director of parent Finance Enterprises Ltd., said in a Nov. 19 deposition that nearly 20 percent of the company's loan portfolio — or about $100 million — is tied up in syndicated loans backed by Mainland real estate.

More than $5 million of those loans were acquired from Central Pacific Bank, whose Mainland loans were hard-hit by defaults from California homebuilders and the subprime lending crisis. Central Pacific took a $44.2 million loss on its Mainland loans in the second quarter 2008 after it sold those loans for 37 cents on the dollar, according to the deposition.

Wright, who had last seen Finance Factors' financials in September, also said he was concerned that the company may not have adequate reserves to cover the recent decline in real estate values on the Mainland.

"It's possible in the intervening time that they may have cleaned this up," Wright said in his deposition. "But I didn't see any enthusiasm for that, because it was going to be a really big number and the company would show a tremendous hit ..."

Steve Teruya, Finance Factors' president, told The Advertiser Friday the financial instituion is "scaling back" its Mainland operations in the wake of the economic downturn and has increased its reserves by $2.5 million to about $10 million since September.

But he added that all of the Mainland loans are performing and that loans purchased from Central Pacific were for commercial properties, such as warehouses, apartments and office buildings, which have been more stable than the Mainland residential market. Central Pacific's problem loans largely went to Southern California homebuilders.

A recent examination by the FDIC of Finance Factor's operations found no problems with the reserves, he said.

Wright's testimony was key in a state Circuit Court lawsuit pitting dissident shareholders, including Marvin Fong, son of the late U.S. Sen. Hiram Fong, against the Finance Enterprises majority shareholders, who are led by CEO Russell Lau.

The lawsuit was scheduled to go to trial on Nov. 20 but was settled the day after Wright testified about the company's reserves. Terms of the settlement were not disclosed.

In their lawsuit, Fong and several other shareholders alleged that Lau and Patrick Chun, who is the chief executive officer of the company's Finance Realty unit, withheld vital corporate information, failed to pay dividends and undermined attempts by minority shareholders to sell their stock to outside investors.

Prior to settling the suit, the company called the lawsuit "inflammatory and exaggerated allegations of corporate intrigue."

"Plaintiffs are second-generation shareholders who inherited their stock in Finance Enterprises from their parents," the company said in a court filing prior to the settlement. "Plaintiffs have short-lived, cash-now objectives and this entire lawsuit is a calculated attempt by plaintiffs to redeem their shares at an inflated price."

LOCAL HISTORY

Established in 1952, Finance Factors is a closely held company that made commercial and real estate loans to working-class people. It was founded by six prominent Chinese-American business leaders, including former Senator Fong; Clifford Yee; Mun On Chun, father of Finance Realty's Patrick Chun; and CEO Russell Lau's father, Daniel Lau.

The company has $704 million in assets and $498.5 million in deposits.

Finance Factors is insured by the FDIC for up to $250,000 per customer.

Finance Factors' investments on the Mainland are part of a diversification plan drawn up in response to the late 1990s statewide recession, according to Teruya. During the recession, the company was hard-hit by the downturn in local real estate values, he said.

Wright, who declined comment for this article, said in his deposition he was concerned that the company's reserves weren't adequate now that the Mainland real estate markets have soured.

He said he also was concerned that Finance Factors might be carrying its Mainland loans at inflated prices.

He said that Finance Factor's management valued the Mainland loans at 70 percent to 80 percent of their original amounts, which far exceeds the value that Central Pacific placed on its troubled loans: 37 cents on the dollar.

"I was much more concerned that the asset quality was much worse than had been represented," Wright said. "If the property has declined in value by 45 percent, you're exposed as a lender and you need to make appropriate reserves to reflect those changes."

Tom Tarter, a California-based banking expert and a former CEO of the Bank of Los Angeles, said that based on public data reported by Finance Factors to the FDIC, it appears that the company's reserves are low.

Even when real estate values were booming, Finance Factors' loan loss reserves should have been higher, Tarter said.

"This raises the question if there's adequate risk management," he said.

Bert Ely, an Alexandria, Va.-based banking consultant, said inadequate reserves can mean that a financial institution may be overstating the amount of capital it has available to cover depositors. If defaults on the Mainland loans exceed $10 million, a bank has to increase its reserves by that amount. The money for the increased reserves, in turn, comes out of the bank's equity capital, which backs a bank's deposits.

"Under-reserving for the loans could be a big problem," Ely said.

As of Sept. 30, Finance Factors had $68.6 million in total equity capital, according to the FDIC documents.

Teruya, Finance Factors' president, said the company's reserves exceed the reserves carried by its peers.

Finance Factors reserves represented about 1.4 percent of its overall assets while the average for the peer group of Mainland and local banks was about 1.2 percent, according to filings with the FDIC.

With the additional $2.5 million added after September, reserves now represent about 1.9 percent of total assets.

Previously, the company's reserves were at even higher levels, Teruya said.

But, he added, "We're not allowed to carry excessive reserves."

LOANS TO INSIDERS

The Mainland loans are just one of several controversies raised in the litigation between Finance Enterprises shareholders.

Attorneys for dissident shareholders — Terry O'Toole, Judy Pavey and John Perkin — said in court documents that they uncovered several questionable loans to company board members.

They included a $300,000 loan to a company called Vision Partners, which is owned by the family of director Dale Fong. Dale Fong is not related to Hiram and Marvin Fong.

The loan was at one time placed on Finance Factors' "watch list" for potentially troubled loans, internal company documents filed in the court case show.

A May 15, 2002, letter from Finance Factors executive Alvin Ige shows that the Vision Partners loan was made even though the company did not file tax returns for three years and did not provide Finance Factors with a financial statement for the loan.

Handwritten notes on the May 2002 letter said that the company asked the Fongs three times over a 4 1/2-month period to provide tax returns and financial statements but never received those records.

In a Sept. 15 deposition for the lawsuit, Ellen Fong said she later received a $400,000 loan from Patrick Chun's real estate company, Kress Properties Inc., to pay off the $300,000 loan to Finance Factors.

In his deposition, board member Wright said the loan not only represents "preferential treatment" to a director but it also made Dale Fong "beholden" to Patrick Chun and Finance Factors' majority shareholders.

He said the loan was part of a "culture of illegality and self-dealing."

"If somebody else had not had tax returns, that would have sent off an alarm bell. If they don't have tax returns, they may not be filing their returns. They might not be paying their taxes. They might have financial difficulties," Wright said.

"I mean, this is bizarre. We are talking about an FDIC institution. ... We are not talking about Aloha Pawn Shop."

Dale Fong and Patrick Chun could not be reached for comment.

Finance Factors declined to respond when asked about its loan to Dale Fong's family, saying "it is our practice to not comment on individual borrowers."

But Corey Park, attorney for Finance Enterprises, noted that loans to company directors are not illegal and that Finance Enterprises reported all such loans to the FDIC.

PENDING LAWSUITS

Wright was also critical of a decade-old loan by a Finance Factors affiliate to former director Sherman Hee.

Hee's wife, Stephanie Hee, is related to company co-founder Clifford Yee. The Yee family represents a 1/6 voting bloc on all Finance Enterprises shareholder votes.

Wright said he had been told by an outside attorney who represented the Yee family that Lau and Chun used Hee's loans as leverage to obtain the support from the Yee family.

The company sued the Hees over the loan last year for alleged nonpayment. Hee also sued Finance Enterprises, saying the company did not pay for past legal work, despite his efforts to resolve problems that could have cost Finance Factors millions of dollars.

Those suits are pending.

"(The attorney) made it clear that Sherman's loans were all part and parcel, as long as they didn't pursue Sherman's loans, the Yees would vote with management," Wright said in the deposition.

In a telephone interview Wednesday, Hee denied any connection between his loan and shareholder votes, saying the lawyer either misspoke or Wright misunderstood his comments. Hee said he has been tied up in litigation with Finance Factors' management for more than eight years, which "belies" the allegation that he was used as a bargaining chip for shareholder votes.

Finance Enterprises declined comment on Hee's loan.

A DEEP-SEATED FEUD

In many ways, the litigation between Finance Enterprise's dissident and controlling shareholders underscores long-running rivalries between the company's second generation.

For decades, Finance Factors and its parent company's public image was that of the old-school management style: Decisions were made by consensus, disagreements were settled quietly and proceeds from the business were divvied up evenly among the six Chinese-American founding families.

But behind the scenes, resentment between the families grew, culminating in the now-settled litigation.

Wright, in his deposition, said the feud between Marvin Fong and Patrick Chun was especially deep-seated.

For years, Fong and Chun had been partners in a local real estate venture that owned the Market City Shopping Center in Kapahulu but the two ended up suing each other over control. Fong later gained control of the shopping center.

According to Wright, Chun said that Marvin Fong and his father "cheated" his family out of the Market City venture. Chun also vowed to retaliate some day, Wright said.

"Pat said, 'Listen, Marvin Fong bent me over on Market City and I am going to bend him over here,' " Wright said.

" 'Because now I know that once you've got 50 (percent) plus one, you don't need anything else, and he is going to learn that lesson.' "