FDIC Sues Former Directors and Officers for "Reckless Gamble" on Subprime Lending

Earlier this month, the FDIC filed its 42nd D&O lawsuit since the advent of the Great Recession. This suit was filed against the former directors and two former executive officers of Charter Bank of Santa Fe, N.M. ("Charter" or the "Bank"), which was closed and placed into FDIC receivership in January 2010.  A copy of the FDIC's complaint is available here. This case represents a departure from the FDIC's typical claims about alleged over concentrations in ADC and CRE lending. It instead focuses on Charter's intentional strategy to enter into the subprime lending market in late 2006.

According to the FDIC's complaint, the defendants authorized the formation of a subprime lending group in late 2006, with plans to target subprime borrowers, primarily in Florida, California and Texas. The Bank ultimately committed 72% of the its core capital to opening and operating its subprime lending unit. By pursuing this strategic path, the FDIC alleges, the defendants ignored regulatory warnings about the significant liquidity risk of originating subprime loans for sale, as well as obvious early warning signs that the secondary market for subprime residential mortgages had already started to tighten significantly.

The FDIC's harshest criticisms relate to the defendants' decision to double-down on their subprime lending strategy even after the secondary market was in full meltdown. Within a year of entering the market, the FDIC contends, more than 69% of the Bank's subprime loans were more than 30 days delinquent, and the secondary market for resale of those loans had evaporated. Unable to sell more than $45 million of the subprime portfolio into a secondary market, the Bank was forced to transfer the loans to its investment portfolio, where most of them stopped performing altogether. By the time it was closed, the Bank had recorded losses on its subprime portfolio of at least $8 million. That is the amount of compensatory damages that the FDIC seeks on its claims for negligence, gross negligence (under FIRREA) and breach of fiduciary duty.

As noted above, this complaint represents a brief departure from the FDIC's typical focus on losses arising from over concentrations in ADC and CRE lending, and it is not likely to signal a new trend in FDIC case theory. The facts in this case, at least as alleged by the FDIC, are somewhat extreme, and it is unlikely that many other banks fell into the same strategic trap of diving headfirst into the subprime residential mortgage market after the first obvious signs of an impending slowdown.