On July 2, 2010, the FDIC filed a lawsuit against former officers and directors of IndyMac's Homebuilder Division -- the branch of the failed mortgage lender responsible for funding construction loans. The 309-page complaint alleges that, among other things, the four named defendants disregarded the division's lending regulations, approving loans to builders regardless of whether they were creditworthy or had provided significant collateral. In addition, the suit alleges that they ignored the declining housing market, instead pushing for growth, even in areas that were already in decline.
Of particular note is the Division's alleged practice of allowing developers to rely on so-called "market equity" to collateralize developments. Although internal policy required that developers owned the subject property for more than two years, this policy was frequently ignored. Since this equity was based on recent increases in property values, and not on long-term growth, it was a particularly risky investment. The Division also frequently waived other policies designed to protect the equity-backed investments, including provisions that would have protected IndyMac from becoming over-invested in larger developments.
The complaint further alleges that the Division ignored many red-flag warning signs that generally point to bad loans. Some examples include: (1) loans with no or minimal borrower equity; (2) loans based on speculative, undeveloped property where the only method of repayment was sale of land or homes; (3) land with inflated value based on recent "land flips;" and (4) loans to borrowers with no development plans. The Division also developed a credit risk matrix that was flawed enough to allow a critically-flawed loan to be granted, so long as the other scores on the matrix were high.
The complaint also alleges that the compensation package for account officers encouraged risk taking and the sale of tenuous loans. Officers frequently received a front-end payout of 50% of the loan's anticipated commission, regardless of actual performance over the long-term. Officers were also paid an additional 1% for loans producing ROEs of 24% or more, loans that were typically high-risk with lower credit scores.
Overall, the suit does a good job of outlining how the named officers and directors of the Home Builder Division ignored their duties to IndyMac and likely accelerated the collapse of one of America's sub-prime sweethearts.
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