The alleged ‘sweeping betrayal of trust’ that rocked Zions bank and spooked Wall Street

Zions Bancorporation lost $1 billion of its valuation in a single day on Thursday after disclosing $60 million worth of loans it had made that were unlikely to be repaid.

What led to that point was a messy, tangled web of loans that Zions said were surreptitiously subordinated by the borrowers all while the collateral was effectively eliminated.

Shares of regional banks tumbled on Thursday as fears mounted around the health of their lending businesses. Zions’ 13% share plunge ended up sparking worries about possible broader issues with lending for the regional bank sector, knocking the whole U.S. stock market on Thursday with the Dow Jones Industrial average finishing lower by 300 points.

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

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

Zions and a lawyer representing the defendants didn’t respond to CNBC’s multiple requests seeking comment. The relationship in question stemmed from about $60 million in financing that Zions’ CB&T made in 2016 and 2017 to two related investment vehicles, 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.

Zions said they had an underwritten agreement guaranteeing them first-priority interest, meaning the bank’s claim on collateral was superior to other creditors’ claims in the event of a default.

However, the deeds that were supposed to to secure the loans were ultimately 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 claimed.

And the new senior lenders, who replaced CB&T, were the same managers of the Cantor funds or those affiliated with the group, according to the suit. “In effect, CB&T’s losses became Defendants’ gains,” Zions said in the lawsuit. “Acting through a web of affiliated companies, the borrowers and guarantors orchestrated a scheme that enriched themselves while stripping CB&T of its collateral, all while keeping the bank in the dark for years about the true status of its securities interests…”

The way that Zions found out about this was after a related Cantor fund, managed by the same leadership, was sued for fraud by Western Alliance.

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

Western Alliance said in a separate 8-K following the Zions one that it had initiated its own lawsuit against Cantor, alleging fraud by the borrower for “failing to provide collateral loans in the first position, among other claims.” However, Western Alliance said it believes the existing collateral covers the obligation and affirmed its guidance. Western Alliance reports earnings on Tuesday.