Editor: David Reiss
Brooklyn Law School

January 31, 2013

FDIC Lawsuit against Bank Directors

By David Reiss

The FDIC has filed a lawsuit (hat tip LaCroix by way of April Charney) against the officers and directors of a small bank in New Mexico alleging negligence, gross negligence and breaches of fiduciary duties.  The FDIC alleges that the

Defendants, as officers and directors of Charter Bank of Santa Fe, New Mexico (“Charter Bank” or “the Bank”), committed $50 million – 72 percent of the Bank’s core capital of $69 million – to open and operate a highly risky and speculative subprime lending operation in Denver, Colorado in late 2006, when they knew or should have known that there was no secondary market for subprime loans. The Bank funded loans that no reasonable financial institution would have made at any time, much less in 2007 and 2008 when the risks of such lending were well recognized. The Defendants negligently permitted and presided over, and failed to suspend, limit or stop the production of a portfolio of approximately $50 million in risky, subprime residential loans intended for sale into a secondary market that at the time was recognized to be increasingly unstable, unpredictable, and illiquid due to concerns about the credit quality of subprime loans. (1)

While the allegations, if true, would prove that the bank engaged in predatory lending, the complaint is revealing about the behavior of the bank’s regulators too:

Federal regulators repeatedly warned the Director Defendants that the Bank was over-leveraged and needed to raise more capital. The Director Defendants responded that they could operate the Bank with less capital and more borrowed money because they had placed most of their loans in the real estate acquisition, development, and construction loan business. The Director Defendants asserted that, because these loans were shorter in duration, the Bank had less risk – an analysis that failed to anticipate any real downside risk in the real estate development business. (6)

One wonders if the regulators should have done more than “repeatedly warn”  these defendants in the run up to its failure.

The complaint also has some revealing allegations about how far lenders went to skirt the Home Ownership and Equity Protection Act’s regulation of high cost loans by limiting “loans to interest rates of no more than 11.5 to 12 percent. Given the minimum FICO score and maximum debt-to-income ratios for SLG loans based solely on stated income, these artificially capped interest rates were simply insufficient to cover the very high risk of default.” (10)  Clearly, incentives ran amok at this closely held bank.


| Permalink