For the second time in a year, a Memphis financial firm has earned national attention if not a national rating for its prowess in the once wildly popular mortgage-backed securities industry. First it was Morgan Keegan, which settled with the Securities Exchange Commission for $200 million. Now First Horizon has been named a world-class miscreant by the federal housing regulator known to none-and-all as the Federal Housing Finance Agency (FHFA).
Eat your hearts out, Nashville and St. Louis. In a front-page story in the Wall Street Journal Saturday, Memphis-based First Horizon is among the chosen in lawsuits against "17 of the world's biggest financial institutions." Also on the elite list are Bank of America (assets of $2.5 trillion), Citigroup ($1.9 trillion in assets), Goldman Sachs, and J.P. Morgan Chase & Co. First Horizon is the plucky underdog in the group, with just $25 billion in assets.
Why anyone would take a bank's asset valuation seriously these days is one for Ripleys. Investors apparently don't. First Horizon's stock value peaked at $40 a share in 2007 and has fallen to about $6 a share. And if you don't understand banking and collateralized debt obligations, don't worry. Regulators and Fannie Mae and Freddie Mac apparently don't either, or at least the lawsuit says they didn't figure it out for years until it was too late.
The charge: First Horizon and its subsidiaries were on an expansion kick in 2005-2007 and packaged mortgages into sellable securities without divulging the crummy credit quality of some of them. Not unlike the rap against Morgan Keegan and its so-called Kelsoe funds.
"Defendants falsely represented that the underlying mortgage loans complied with certain underwriting guidelines and standards, including representations that significantly overstated the ability of the borrowers to repay their mortgage loans," says the FHNA lawsuit.
"The Registration Statement contained statements about the characteristics and credit quality of the mortgage loans underlying the Securitizations, the creditworthiness of the borrowers of those underlying mortgage loans, and the origination and underwriting practices used to make and approve the loans. Such statements were material to a reasonable investor’s decision to invest in mortgage-backed securities by purchasing the Certificates. Unbeknownst to
Fannie Mae and Freddie Mac, these statements were materially false."
Named in the lawsuit are Gerald 'Jerry' Baker, CEO of First Horizon from 2007-2008 when he retired after a quarter in which the company lost $19 million, and Charles Burkett, who retired in June 2011 as president of banking at First Tennessee.
First Horizon, once known as First Tennessee, has had a succession of leaders since Ron Terry was CEO from 1973-1995. They include Ralph Horn, 1994-2002; Ken Glass, 2003-2007, Baker from 2007-2008; and Bryan Jordan, 2008-present. It is the last home grown "Big Three" Memphis bank since Union Planters and National Bank of Commerce were acquired by other companies.
The 77-page lawsuit is dense but includes some interesting details suitable for Labor Day weekend reading.
First Horizon's subsidiaries including First Horizon Home Loan and First Horizon Asset Securities "profited substantially from this vertically integrated approach to mortgage-backed securitization." The securities were issued in 2005 and 2006 "in an effort to increase revenue and profits in a rapidly expanding market. In 2005, First Horizon securitized $892 million in mortgage loans and in 2006 that figure nearly doubled to $1.74 billion. This meant higher fees, salaries, commissions, and bonuses for all involved, at least until the housing market crashed along with First Horizon's stock price in 2007.
"Defendants had enormous financial incentives to complete as many offerings as quickly as possible, without regard to ensuring the accuracy or completeness of the Registration Statement or conducting adequate and reasonable due diligence," the lawsuit says. It seeks $883 million from First Horizon.
In a section that raises questions about who is learning from whom, the lawsuit quotes from David Faber's book "And Then The Roof Caved In: How Wall Street's Greed and Stupidity Brought Capitalism to Its Knees." It describes the frenzy to create and sell "collateralized debt obligations" at financial firms such as Merrill Lynch. Morgan Keegan and First Horizon created such products.
"As Merrill headed into 2007, it had . . . a mission to get even bigger in the one area that had been so instrumental to all its success: mortgages. It wanted to originate more mortgages, buy more mortgages, package more mortgages into securities, and package more of those securities into [collateralized debt obligations]. And of course, it wanted to sell those securities and CDOs as fast as it possibly could, because that’s where the money was . . . In its quest to increase its market share, Merrill Lynch faced fierce competition from an increasing number of market players. The push to securitize large volumes of mortgage loans contributed to the absence of controls needed to ensure that the loans conformed."
One trick that First Horizon allegedly used was overstating the number of owner-occupied homes in its loan portfolio. Such homes have a better chance of repayment than second homes or vacation home.
A significant number of the loans failed two or more of these tests, indicating that the owner-occupancy statistics provided to provided to investors, like Fannie Mae and Freddie Mac, were materially false and misleading," the lawsuit says.
The lawsuit says that some First Horizon employees were aware of the "rampant underwriting failures" and filed a lawsuit against the firm based on their investment of employee retirement plans in First Horizon's stock.
The employees alleged that First Horizon's national expansion strategy consisted primarily of opening offices around the country, without regard to credit review or accounting. The flaws in First Horizon’s processes were so serious that the company failed to attain compliance with applicable regulatory guidance during 2006 into 2007. The lawsuit says First Horizon’s compensation practices and staffing favored short-term product growth over proper risk management.
As of Saturday afternoon First Horizon had not responded to the lawsuit with an official statement.