LOS ANGELES The Justice Department’s suit against Standard & Poor’s targets several failed credit union deals among the more than two dozen collateralized mortgage obligations, or CDOs, the Wall Street agency allegedly rated falsely, causing two of the biggest credit union failures ever, WesCorp FCU and Eastern Financial Florida CU, the only two credit unions authorized to buy CDOs.
Two of the deals cited in the new suit cost investors, including Eastern Financial, almost their entire investments after they failed within months of their 2007 issuance, according to the suit.
Eastern Financial, the one-time $2.4 billion Miami credit union, failed in 2009 after it lost virtually all of its $150 million investments in CDOs, making it the biggest natural person credit union failure ever. Space Coast CU, which acquired the remnants of the failure is suing several Wall Street banks over the sale of the CDOs. The Space Coast CU suits cite some of the same deals cited in the new Justice Department suit.
CDOs are mortgage-backed securities constructed of other mortgage-backed securities.
The S&P suit also cites CDOs purchased by WesCorp, which at one time held more than $600 million of CDOs, that eventually defaulted at a rate of more than 95%, helping cause the collapse of the one-time $34 billion corporate credit union. In one case, a $550 million CDO named Sorin CDO VI, Ltd, WesCorp purchased a $100 million tranche that S&P had rated AAA, and eventually lost $90 million of its investment when the securities went sour.
In another 2007 deal, a $1.78 billion CDO named Cairn Mezzanine ABS CDO III Ltd, WesCorp also bought a $100 million tranche and eventually lost $90 million of its investment, according to the suit.
WesCorp eventually lost more than $500 million on its CDO deals, prompting NCUA takeover in March 2009.
Other buyers of the CDOs cited in the Justice Department suit were Citibank, M&T Bank, Bank of America and First Midwest Bank, but the majority of the deals cited in the suit involved either WesCorp or Eastern Financial.
In its suit, the Justice Department alleges that S&P falsely represented that its ratings were objective, independent, and uninfluenced by S&P’s relationships with investment banks when, in actuality, S&P’s desire for increased revenue and market share led it to favor the interests of these banks over investors, thereby giving unwarranted ratings to certain securities.
The suit cites an instant message exchange between two members of S&P’s CDO committee who questioned the legitimacy of the ratings, with one stating, “it could be structured by cows and we would rate it.”
Contrary to these representations, from 2004 to 2007, the government alleges, S&P was so concerned with the possibility of losing market share and profits that it limited, adjusted and delayed updates to the ratings criteria and analytical models it used to assess the credit risks posed by RMBS and CDOs. According to the complaint, S&P weakened those criteria and models from what S&P’s own analysts believed was necessary to make them more accurate. The complaint also alleges that, from at least March to October 2007, and because of this same desire to increase market share and profits, S&P issued inflated ratings on hundreds of billions of dollars’ worth of CDOs. At the time, according to the allegations in the complaint, S&P knew that the quality of non-prime RMBS was severely impaired, and that the ratings on those mortgage bonds would not hold. The government alleges that S&P failed to account for this impairment in the CDO ratings it was assigning on a daily basis. As a result, nearly every CDO rated by S&P during this time period failed, causing investors to lose billions of dollars.
