WSB Financial Group in Bremerton, Wash., gave more detail about the allegations of mortgage fraud that sent its stock plummeting 60% last week.
David K. Johnson, the $476 million-asset company's chief executive officer, said on a conference call Monday that it is reviewing $90 million of loans originated by "one or two" former lenders at its Westsound Bank.
So far it has looked at 26 of the 146 loans and identified six that are "impaired," Mr. Johnson said. Regulators likely will require additional reserves as a result and impose sanctions, he said.
"But I am confident that we'll be able to deal with the sanctions," Mr. Johnson said. "In the process, I think we will become a better bank by improving our mortgage lending procedures and by more closely monitoring our lenders."
Regulators are also looking into the loans, after examiners detected problems in the spring, he said. But neither the bank nor any current employee is under investigation for fraud, he added. "The investigation is looking at one or two former employees and at third parties."
WSB's stock, which fell 60% in two days last week, rose 11.8% Tuesday, to $5.89.
The company said in a Securities and Exchange Commission filing Oct. 24 that the Federal Deposit Insurance Corp. and the Washington Department of Financial Institutions were examining its mortgage lending practices and construction loan portfolio for possible fraud and misconduct. WSB said that regulators would likely issue a cease-and-desist order, impose monetary penalties, or order an additional increase in its loan-loss reserves.
The night before, the company reported that its third-quarter net income rose 18%, to $1.3 million. Its allowance for loan losses rose 34% from a year earlier, to $5 million.
But it cautioned that those were preliminary results and might change after regulators determine whether the company should increase its reserves.
The final results are due Nov. 14, and WSB said its loan review should be complete by then.
James Bradshaw, an analyst at D.A. Davidson & Co. in Portland, Ore., said Tuesday that he was pleased that only six of the loans already reviewed were impaired. However, he said that was not enough of a sample to know whether the other 120 loans would be of similar caliber.
"If the expected losses are around $3.5 million, that may not have as much of an impact as the market has been fearing, and WSB can then start to show positive operating results fairly quickly," Mr. Bradshaw said. "But we're probably six months away from knowing definitively about this, when we see in April 2008 how many of these one-year term loans have been paid off."
On the call Monday, Mr. Johnson said the lenders in question originated construction loans for upscale homes. He said the borrowers subsequently took out mortgages with Countrywide Financial Corp. in Calabasas, Calif., using stated-income documentation only. All the borrowers of the construction loans said they intended to live in the homes, but the FDIC is investigating allegations that some of them had instead immediately sold the homes or were intending to sell.
The problem was compounded by Countrywide's decision last spring that it would no longer make mortgages on the homes that Westsound's borrowers built, effectively drying up WSB's "exit strategy" for those construction loans, Mr. Johnson said.
In April, Westsound stopped making construction loans for borrowers intending to subsequently take out mortgages using only stated-income documentation, he said.
Meanwhile, WSB might also be facing class-action lawsuits by shareholders. On Friday, the Rosen Law Firm in New York and Hagens Berman Sobol Shapiro in Seattle said they were investigating whether WSB misled investors by not disclosing the fraud investigation earlier or by falsely portraying its lending operations in its 2006 prospectus.
