A group of Wall Street banks and ratings agencies told a federal court in Miami that “greed” and the need to grow earnings was responsible for the 2009 demise of Eastern Financial Florida CU, the one-time $2.4 billion credit union, not alleged fraud on their part in the sale of $100 million of risky financial derivatives known as collateralized debt obligations.
The suit comes as the National Credit Union Administration is contemplating opening up financial derivatives to more credit unions. NCUA issued a statement Friday pointing out that its proposal focuses on an interest-rate derivatives, like swaps, future or options.
In their motion to dismiss the suit, the Wall Street banks said Eastern Financial was a sophisticated investor that asserted in writing numerous times it was warned and knew of the risky nature of the CDOs, which amount to derivatives created from derivatives, in this case mortgage assets.
“Each of the twelve CDOs at issue here was offered pursuant to a separate offering circular. These offering circulars contained page after page of disclosures and disclaimers, explaining to Eastern Financial the nature and risks of the particular CDO investments, the place of each tranche within each CDO, and the credit rating expected to be assigned by the Rating Agencies of each tranche,” argue the Wall Street banks in a joint motion to dismiss the suit.
The Wall Street banks, JPMorgan Chase (as successor to Bear Stearns), Wells Fargo (as successor to Wachovia Capital Markets), Barclays Capital and UBS Securities, as well as rating agencies Standard & Poor’s and Moody’s, are all being sued by Space Coast CU, which obtained the estate of Eastern Financial after acquired the biggest failure in credit union history in June 2009. Separate claims against Merrill Lynch have been dismissed. Space Coast, now south Florida’s biggest credit union at $3.3 billion in assets, claims the Wall Street entities fraudulently packed the CDOs with poorly underwritten mortgages that were destined to fail.
The CDOs all had colorful names, like the Longshore CDO and Grand Ave. CDO III issued by Wachovia Capital, or Milbrook 2007-1 issued by Bear Stearns, or UBS’ Nautilus RMBS CDO I and Barclays’ Citius I Funding and Pampelonne CDO II.
Eastern Financial was the only noncorporate credit union authorized by regulators to invest in financial derivatives outside of a strict pilot program monitored by NCUA, and the failure of the 72-year-old credit union was largely attributed to its CDO losses, put at a staggering 99% of its total $149 million CDO investment.
But the banks insist that Eastern Financial knew all along they were engaging in risky bets when they opted to invest in the financial derivatives. They point to an investigation conducted by NCUA which found that as the credit union’s rapid expansion began to slow profits growth, the credit union giant decided in 2007 to “double down” on its CDO investments in order to increase its potential profits.
The Material Loss Review conducted by NCUA’s Office of the Inspector General concluded that Eastern Financial “knowingly invested” in CDOs in order to chase higher yields. Eastern Financial’s board “supported a high cost, aggressive growth strategy that ultimately drove down core earnings and encouraged management to search for higher returns in higher risk investments.”
Eastern Financial’s losses, which amounted to $68.9 million in 2007 and $113.5 million in 2008, eventually erased all of its capital and spelled the end of the one-time airline employees’ credit union, which had survived the 1991 demise of its chief sponsor, Eastern Airlines, to thrive for almost two decades more by serving more than 1,000 select groups.
