WICHITA, Kan. – JP Morgan Chase rebutted claims in an NCUA lawsuit it misled four failed corporate credit unions into buying $1.5 billion of risky mortgage-backed securities, and pointed the finger—as NCUA’s own internal reviews have—at the management of the failed corporate and NCUA’s own examiners.
“Despite warnings from the offering documents, the news media and even the (NCUA) Board itself, the Credit Unions made the informed decision to plunge the majority of their assets into residential mortgage-backed securities at the height of the housing bubble,” the Wall Street bank said Friday in documents asking a federal court to dismiss an NCUA suit seeking damages for the failed investments. “That investment strategy-which even the (NCUA) Board has condemned as “aggressive”, “excessive” and “unreasonable”—backfired when the housing bubble burst. The Credit Unions lost their “unreasonable” wager and subsequently collapsed.”
JP Morgan Securities, a unit of the banking giant, is one of three Wall Street firms, along with RBS Securities and Goldman Sachs, being sued by NCUA over the failure of an estimated $50 billion of MBS bought by five corporate credit unions—U.S. Central FCU, WesCorp FCU, Members United Corporate FCU, Southwest Corporate FCU and Constitution Corporate FCU.
In its suit against JP Morgan, NCUA alleges violations of federal and state securities laws and misrepresentations by Morgan in the sale of $1.5 billion of MBS to four of the five failed corporates. The suit is filed in U.S. District Court in Kansas, which has jurisdiction over Lenexa, Kan.-based U.S. Central.
The failure of the five corporates will cost the credit union movement as much as $20 billion to resolve.
In its defense, RBS said the corporate were sophisticated investors and able to understand the risks of the complicated MBS it sold them. Goldman Sachs has yet to respond to its suit.
Morgan claims the multitude of risks of the residential MBS it sold the corporate were clearly spelled out in offering documents and that the corporate were blinded by their greed for increased profits the risky MBS promised, a claim corroborated by comprehensive material loss reviews conducted by NCUA’s own Inspector General. “Ignoring its own assessment of what actually happened, the (NCUA) Board now seeks to blame defendants for the Credit Unions’ losses,” says Morgan.
In fact, JP Morgan notes that NCUA claims in a separate civil suit that gross negligence by management and directors of WesCorp in allowing the one-time $34 billion to load up on risky MBS was the cause of the WesCorp failure.
In its suit, NCUA claims JP Morgan should have known the MBS, based on loans originated by 11 of the biggest subprime lenders, were doomed to fail. Among the originators of the loans were American Home, Ameriquest, Countrywide, Greenpoint, IndyMac, New Century, NovaStar, Option One, and JP Morgan’s own mortgage subsidiaries, Chase Home Finance, Chase Home Mortgage and JP Morgan Chase Bank.
But Morgan says its offering documents disclosed the very risks that NCUA alleges were concealed. For example, NCUA claims that the offering documents were misleading because some underlying loans in the MBS did not comply with the applicable underwriting guidelines. But the offering documents disclosed that there would be noncompliant loans in the pools and provided an express mechanism by which such loans could be repurchased or replaced.
NCUA also alleges that certain credit enhancement features proved to be ineffective. But, says Morgan, the offering documents disclosed that certain credit enhancements might prove to be ineffective. “Indeed, every allegedly omitted risk was the subject of extensive disclosures in the offering documents,” asserts the Wall Street bank.
In fact, says Morgan, “the Credit Unions were major players in the mortgage industry; they oversaw and provided financial services to a network of credit unions that originated the same types of mortgage products, using the same type of reduced documentation programs that are the subject of the (NCUA) Board’s allegations. “
Morgan notes that the failed corporates “themselves purchased tens of millions of dollars worth of actual mortgage loans originated by member credit unions.” It refers to activities by WesCorp, Members United and U.S. Central, through its Charlie Mac secondary market conduit, buying low-document subprime mortgages originated by credit unions. “In connection with those activities, the Credit Unions received several direct warnings from (NCUA) concerning the risks associated with the type of loans backing their RMBS investments,” says Morgan.
It notes a May 16, 2005, warning from NCUA and other federal regulators on credit risk management guidelines for home equity loans that cautioned of “risk factors that . . . have attracted scrutiny, including . . . limited or no documentation of a borrower’s assets, employment and income” and “eased underwriting standards”. The warning stressed the need to “closely monitor the quality of loans (from third-party lenders) . . . include(ing) post-purchase underwriting reviews” Still, notes Morgan, the corporate, with the approval of NCUA, continued to load up on subprime MBS, well into the crash of the mortgage market in 2007-2008.
“Indeed, until it decided to sue the JP Morgan Defendants, the (NCUA) Board itself publicly attributed the poor performance of the Credit Unions’ RMBS portfolio to market factors,” says the Wall Street bank. “For example, in an Internet video presentation entitled “Corporate Credit Unions; How Did We Get Here”, the NCUA explained that the global economic crisis caused the decline in value of the Credit Unions’ RMBS: “To understand what happened to cause the losses associated with the private-label mortgage-backed securities that were held by corporate credit unions we need to now take look at the overall global economic crisis that emerged in 2007 and 2008.”
“Thus,” says Morgan, “even according to the (NCUA Board), economic conditions—not any undisclosed flaws in the mortgage origination or securitization process—caused the disruptions that the Board points to as “evidence” of abandoned underwriting guidelines.”
NCUA does not comment on pending litigation.
