Like a Meteor, S&L; Came and Went Before Anyone Knew It Crashed
Even in an era when savings and loans were failing at a fast clip, regulators were amazed at how quickly Seapointe Savings & Loan of Carlsbad was forced to close.
The S&L; opened for business in a Carlsbad shopping center April 17, 1985, and, in little over a year, lost more than $24 million. On May 30, 1986, the Federal Home Loan Bank Board found Seapointe to be insolvent, its assets and capital dissipated by what federal regulators have described as a risky and fraudulent commodities and futures trading strategy set in motion by Strategic Investment Services, a Riverside-based financial adviser.
“You blinked and (Seapointe) was gone,” said William Davis, assistant commissioner with the state Department of Savings and Loans. “Everything happened so quickly that regulators were just behind (on detecting) . . . the problems.”
Seapointe’s brief existence also caught many S&L; executives in San Diego County by surprise. “Seapointe was like a meteor,” according to one S&L; industry observer. “Nobody really knew it was there and all of a sudden it simply exploded.”
In reports to state regulators, Seapointe’s executives described a fairly traditional S&L; that was growing in accordance with its conservative business plan. State regulators never conducted an in-depth review of Seapointe because the institution simply wasn’t around long enough, Davis said.
“It looked pretty clean, right up until” the last report before the staggering losses occurred, Davis said.
The reports that regulators were reviewing, however, masked the unusual and risky commodities- and futures-trading strategy that the financial adviser had devised to protect Seapointe from swings in interest rates. That strategy, when coupled with other unusual practices, led the S&L; to suffer a stunning string of losses in early 1986.
According to regulators, once Seapointe’s losses appeared, there was very little that could be done--largely because the S&L;’s complex options- and futures-trading strategy generated a $15.9-million loss on a single day in early February, 1986. That loss grew to $18 million in just four days, according to a recently amended lawsuit filed by the Federal Savings and Loan Insurance Corp.
State regulators first considered a merger or an outright sale of Seapointe’s remaining assets. But the losses had drained Seapointe’s capital and regulators eventually sold the S&L;’s insured deposits to Monterey Savings Bank of Monterey Park for $42,000.
According to a lawsuit amended earlier this month by the Federal Savings and Loan Insurance Corp., there were several reasons for the S&L;’s unexpected failure:
- Unlike most failed S&Ls;, Seapointe was not destroyed by bad loans. In fact, Seapointe had yet to make its first loan--or even hire a loan officer--when federal regulators seized the institution. It instead used the deposits and its equity to purchase government securities, hoping to realize a profit on its interest-rate spread.
Although that no-loan strategy was unusual, “it was not unique” during the mid-1980s, according to Davis.
- Within two months of opening, Seapointe had attracted $31.8 million in deposits--of which all but $6.3 million were Jumbo CDs. Although Jumbo CDs-certificates of deposit with a minimum worth of $100,000--help institutions build deposits quickly, they typically carry higher-than-average interest rates, which makes it harder for institutions to turn a profit. Jumbo CDs are also viewed as an unstable source of capital for S&Ls; because fickle depositors often withdraw and redeposit their funds elsewhere if they can receive a better interest rate.
In contrast, Seapointe’s business plan called for Jumbo CDs to account for just 15% of total deposits throughout the first three years. The conservative plan also called for Seapointe’s total deposits to grow slowly to $12 million during the first year, $27 million in the second year and $47 million by end of the third year.
According to the FSLIC suit, Seapointe’s collapse was caused by the complex trading strategy that Strategic Investment devised to protect Seapointe from interest-rate swings. Although S&Ls; traditionally use trading schemes as hedges against rate swings, the FSLIC suit alleges that Seapointe’s trading strategy was actually a speculative--and, consequently--illegal program.
Seapointe “risked and lost the entire net worth of the association, plus its Jumbo CD deposits, to conduct a speculative trading strategy built on the ultimately erroneous assumption that interest rates would rise,” according to the suit.
“At the time, (Seapointe was) the only institution that I knew of that was dealing so aggressively in these types of securities,” Davis said.
Seapointe “hired what they felt was an expert to transact their business and they relied totally upon their judgment,” recalled Davis. “Then, whammo . . . they were out of business.”
Seapointe’s use and alleged abuse of futures and options trading ran contrary to the staid plan that regulators approved during the early 1980s, when Seapointe was struggling to find enough capital to open its doors.
Planned to Be Traditional
According to that plan, Seapointe would be a “traditional” S&L; that would use locally generated retail deposits to finance home mortgages in the Carlsbad area.
To manage interest-rate risk, Seapointe would not “presume to outguess the marketplace” or “risk the net worth of the institution in an attempt to ‘make a killing’ for the sake of short-term earnings.”
Although Seapointe’s business plan devoted a full page to outlining its interest-rate risk strategy, regulators have maintained that there was no mention of the futures and commodity options that Strategic Investment developed.
Events leading to that failure were described earlier this month in the FSLIC lawsuit that seeks $24 million in damages from Strategic Investment and Kidder Peabody, the New York-based investment firm that conducted trades for Seapointe.
A San Diego attorney who represents Strategic Investment and Dirk Rose, its founder and president, declined to comment on the suit. A spokeswoman for Kidder Peabody has denied any wrongdoing in Seapointe’s failure.
The Seapointe suit is one of many to spring from federal investigations that try to set blame--and, if possible, recoup losses--in connection with the continuing stream of S&L; failures. Already, more than 100 lawsuits have been filed against S&Ls; and their advisers, Federal Home Loan Bank Board member Lawrence J. White said during a press conference last week in San Diego.
The FSLIC suit stemming from Seapointe’s failure is one of a growing number that hold outside professionals responsible for S&L; failures. “We’ve been suing the accountants, lawyers and others,” White said. “There will be a strong effort to bring more and more of the parties” to trial.
Hold Directors Responsible
Federal regulators also are exerting “more and more pressure on thrift directors to set (responsible) policies,” White said. “We’re not expecting them to become ‘rocket scientists,’ but we do want them to look harder at what they’re signing off on.”
Despite Seapointe’s dramatic failure, its officers and its board of directors--including Ernest Dronenburg Jr., a member of the state Board of Equalization--were not named in the lawsuit filed in the FSLIC suit.
Dronenburg has denied any knowledge of the allegedly fraudulent trading scheme that Strategic Investment developed to shield Seapointe from unexpected interest rate swings. “There was a lot of deception going on,” according to Dronenburg.
Seapointe was “the only case I can recall where not one member of management or the board” was held responsible when federal regulators went to court to seek damages in the wake of an S&L; failure, Davis said.
Seapointe’s directors were unaware that Strategic Investment had developed a risky and illegal trading strategy that left the S&L; open to “a potentially unlimited loss” in the event of an interest-rate swing, according to the FSLIC suit.
“What struck me was the total lack of sophistication of the management and directors for those types of transactions,” Davis said. “They didn’t know a damn thing about” futures and commodities trading.
Seapointe’s failure surprised the state Department of Savings and Loans, in part because regulators were beset by a dramatically changing industry.
State Regulators Swamped
At the time Seapointe was seized, regulators were responsible for 158 state-chartered S&Ls.; Savings-and-loan examiners also were processing applications from more than 100 groups that wanted to open new S&Ls.; And, during 1985 and 1986 alone, regulators took over or created conservatorships for 23 state-chartered institutions.
The state had been slowly bolstering its inspection team to meet the growing workload, but, even by 1987, there were still only 79 S&L; examiners.
“When it blew, it caught everyone unaware,” recalled David Ross, who had become Seapointe’s second president just weeks before the dramatic losses. Ross, who now works for an executive search firm in Orange County, had been hired to bolster Seapointe’s anemic retail deposits. The trading strategy “was already in motion when I got there,” Ross said.
Ross linked the losses to “very rapid movements in oil prices during the first few weeks of 1986. . . . That kicked off a very precipitous change in interest rates,” which caused Strategic Investment’s trading strategy to collapse.
Seapointe, which dismissed Strategic Investment one day after learning about the $15.9-million loss, decided to seek damages by filing suit against the financial-advice firm and Kidder Peabody. However, federal regulators took over the troubled S&L; the same day that Seapointe’s board voted to file a suit, and the lawsuit was never filed.
“The lawsuit (became) moot at that point,” Ross said. “I ended up being a caretaker for four months. That was basically my job.”
Interestingly, a capital shortfall almost kept Seapointe from ever opening for business.
Seapointe’s initial board of directors, which included mostly San Diego County residents, had trouble gathering $2 million in capital needed to gain deposit insurance from federal regulators.
As the group approached $2 million, regulators increased Seapointe’s regulatory capital minimum to $3 million and many of the original investors backed out. “Evidently, it was one thing to be just a couple of thousand dollars short and another to be $1 million short,” Ross said.
Early in October, 1984, Strategic Investment’s Rose told Seapointe’s board that he could attract investors with enough capital to meet the stricter capital requirement. Rose eventually solicited 51% to 80% of Seapointe’s capital, according to federal regulators.
But, with that new wave of investors, control of the Carlsbad-based S&L; passed to investors who were largely from outside San Diego County.
