State’s Biggest Thrifts Among the Big Winners in High Court Decision

Four of California’s largest thrift institutions are the big winners under the U.S. Supreme Court’s ruling Monday in favor of Glendale Federal Bank in its a breach of contract lawsuit against the federal government.

The ruling came in a suit by Glendale Federal Bank, which is claiming $1.5 billion in damages. Three other major state thrifts have similar cases pending the outcome of GlenFed’s suit, including California Federal Bank, Coast Federal Bank and Home Savings of America.

Seven other current or former thrifts based in California, and about 100 nationally, still have suits pending, according to the Office of Thrift Supervision.

Among them is the investment group that, without the customary federal assistance, rescued Western Empire Savings & Loan in Yorba Linda. The group alleges that regulators reneged on their promises after a 1989 law changed the rules. Six months later, regulators seized the S&L; and sold its branches.

“This vindicates what our position has been all along,” said Rob Wages, an executive at Castle Harlan Inc., the New York investment firm that put the group together.

If the thrifts prevail, the big loser will be the federal government--and by extension taxpayers. Total damages could amount to $10 billion to $15 billion, analysts said.

Final judgments could take years. GlenFed’s case, however, has been put on a fast track; bank officials expect the damages portion of the trial to begin in the fall.

Richard A. Fink, the GlenFed’s executive who oversaw the case, said: “it’s a little premature” to celebrate because the thrift still has the burden of proving its damages.

The stock markets applauded the ruling by sending GlenFed shares up on Monday by $1.50 to $19.63. CalFed went up 75 cents to $19; shares of Home Savings parent, H.F. Ahmanson & Co., rose 38 cents to $27.38, and Coast Savings shares soared $2.38 to $35.13. “For shareholders who are buying into the stock today, this may be a windfall,” said James M. Marks, an analyst at Hancock Institutional Equity Services. “For those who have hung on, they just recapture past losses.”

At issue is an arcane accounting principle called “supervisory goodwill”--a concept born in the 1980s during the industry’s dark years.

It was an accounting provision used as an inducement to healthy savings and loans to acquire failing thrifts. The failing thrifts’ negative net worth was offset by an intangible asset called goodwill, which was added to the acquiring institution’s balance sheet. It was to be written off over 40 years.

“The use of supervisory goodwill was an expedient . . . a way to enable strong institutions to acquire their weaker sisters without decimating their own capital,” said Paul A. Schosberg, president of America’s Community Bankers, a Washington-based thrift industry group.

But in the 1989 savings and loan industry bailout legislation, known as the Financial Institutions Reform and Recovery Act, Congress and President Bush disallowed the use of supervisory goodwill as capital, stripping hundreds of millions of dollars from the balance sheets of thrifts.

To meet their new reserve requirements, institutions sold assets, closed offices and in many cases were forced to recapitalize or shut down. Their stocks plummeted.

GlenFed and dozens of other thrifts sued for breach of contract. GlenFed’s claim, in conjunction with the owners of two failed thrifts, was upheld Monday by the Supreme Court. The case was sent back to a lower court to determine the amount of damages.

For Western Empire, the alleged breach not only wiped out goodwill but also forced it to sell its profitable portfolio of high-yield securities, also known as junk bonds. The lawsuit filed by Castle Harlan is among those waiting on the GlenFed decision.

Asked to invest in Western Empire, John Castle and Leonard Harlan quickly realized that the Yorba Linda thrift was close to being seized by regulators. Castle and Harlan decided to negotiate with federal thrift regulators instead.

“We negotiated with federal regulators over a period of six months, from June or July until December, 1988,” Wages said. “They were very heavily involved in negotiating all aspects of the deal.”

Federal regulators agreed, he said, that goodwill would be treated as good capital and that the S&L; could buy high-yield securities and mortgaged-backed securities.

The key was the investment in junk bonds, Wages said.

Within five months, Castle Harlan took a thrift that had been losing $200,000 to $600,000 a month to an institution generating $100,000 to $200,000 in positive cash flow a month. It had increased its junk bond portfolio to $191.8 million, or 33.8% of its $567.8 million in assets. The thrift didn’t rely just on junk bonds. It also improved conventional mortgage lending, raising the amount of home loans it funded from $5 million a month to $12 million.

Then, in early August 1989, came the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), which eliminated goodwill and ordered thrifts to get out of the junk bond business within five years.

The market for those securities plummeted. Western Empire, pressed by regulators, had to write down the value of its portfolio, which wiped out its capital.

“There was nothing fundamentally wrong with the bonds, but market went to nothing after FIRREA,” Wages said.

Goodwill played a bigger role at other institutions.

GlenFed, which agreed to take over a failing Florida thrift in 1981, had $565 million in goodwill before the 1989 law. “The government very nearly destroyed this institution,” said spokesman Jeffrey Minsakian.

A successful recapitalization has returned the institution to financial health.

Similarly, California Federal had $485 million in goodwill capital before the law changed. CalFed had acquired six failing thrifts nationwide. The law and the state’s recession forced the thrift to recapitalize and write off more than $1 billion in assets in a restructuring that was completed only last year. The thrift is again profitable.

CalFed is also suing the federal government but has not set an amount for damages above and beyond its lost goodwill.

Home Savings was not thrown into as much financial turmoil as the other two thrifts but still lost $575 million in supervisory goodwill under the 1989 law. It had taken over about 18 failing thrifts nationwide. Home Savings also has a suit pending for unspecified damages and losses.

Coast Savings lost $300 million in goodwill. The thrift has yet to set a final damage claim figure but is pursuing its suit.

Successful awards will be gravy for the thrifts but an added burden to taxpayers who have already assumed the estimated $130-billion cost of the savings and loan bailout.

Also contributing to this report were Times staff writers Patrice Apodaca and Martha Groves.