The Alleged ‘Comprehensive Betrayal of Trust’ That Rocked Zions Bank and Spooked Wall Street

Zions Bancorporation lost $1 billion in valuation in one day Thursday after it revealed $60 million worth of loans it had made were unlikely to be repaid.

What led to this moment was a confused, tangled web of loans that of Zion were surreptitiously subjugated by the borrowers until the collateral was effectively eliminated.

Shares of regional banks fell on Thursday as fears piled up over the health of their lending business. The 13% plunge in Zions shares ultimately sparked concerns about possible broader credit problems for the regional banking sector, sending the entire US stock market down on Thursday with the Dow Jones Industrial Average ended 300 points lower.

Zions’ subsidiary, California Bank & Trust, is suing Andrew Stupin and Gerald Marcil, previously relatively unknown managers of several funds using the “Cantor Group” name, along with their associate Deba Shiam.

The lawsuit, filed in Los Angeles County on Wednesday, alleges “a massive betrayal of trust by sophisticated financial borrowers who abused CB&T’s trust, manipulated credit structures for their own enrichment and systematically eliminated the collateral protections that were supposed to secure the bank’s loans.”

Zions and an attorney representing the defendants did not respond to CNBC’s multiple requests for comment. The relationship in question stems from about $60 million in financing that Zions’ CB&T made in 2016 and 2017 to two related investment firms, Cantor Group II and Cantor Group IV.

The credit facilities were to be used by the funds to purchase distressed residential and commercial mortgage loans.

The Zions said they have a signed agreement that guarantees them a priority interest, meaning the bank’s claim on the collateral is higher than other creditors’ claims in the event of a default.

However, the deeds that were supposed to secure the loans ended up being subordinated without CB&T’s knowledge, Zions said in the lawsuit.

Those underlying properties were transferred to other entities or were in foreclosure, meaning the collateral was “irretrievably lost,” Zions argued.

And the new senior lenders that replaced CB&T were the same Cantor fund managers or those affiliated with the group, according to the lawsuit. “In effect, CB&T’s losses became defendants’ profits,” Zions said in the lawsuit. “Operating through a network of related companies, the borrowers and guarantors orchestrated a scheme that enriched itself while stripping CB&T of its collateral while keeping the bank in the dark for years as to the true status of its securities interests…”

The way Zions found out about it was after a related Cantor fund managed by the same management was sued for fraud by Western Alliance.

That prompted CB&T to launch its own investigation. Zions subsequently issued an 8-K on Wednesday, saying that “based on currently available information” it decided to take a $60 million provision for the outstanding loans and write off $50 million, which will be reflected in third-quarter earnings when the company reports Monday.

Western Alliance said in a separate 8-K after Zions’s that it had launched its own lawsuit against Cantor, alleging fraud by the borrower for “failing to make collateral loans in the first place, among other claims.” However, Western Alliance said it believed existing collateral covered the liability and reaffirmed its guidance. Western Alliance reported earnings on Tuesday.