Risk Management is for “Pu$$ies” – The Temple Inland Lawsuit

This is an interesting read.

Cliff notes:  Temple Inland ($TIN) is being sued by the liquidation group of GFG – Guaranty Financial Group – which was a bank that TIN spun-off at the end of 2007, and which subsequently was seized by the FDIC in August 2009.  The complaint is that TIN basically looted the bank, leaving it insolvent, before spinning it off so that when GFG blew up, it wouldn’t trigger TIN’s cross-default covenants on their own debt*, since TIN would no longer own GFG.  If you’re wondering why Temple Inland owned a bank in the first place, well, welcome to the club:  it’s symptomatic of our entire financial meltdown – that a packaging and building products company could lose a billion dollars or more on mortgage backed securities…

The gist of the complaint is:

“Temple-Inland, its affiliates, and the defendant directors, engaged in this scheme to strip GFG of its value and to avoid Temple-Inland’s capital maintenance obligation because they recognized that GFG and the Bank were headed for financial disaster. Temple-Inland caused the Bank to heavily invest in high-risk, private-label MBS collateralized by toxic residential mortgages known as Option ARMs. These MBS were dramatically overvalued on the Bank’s and Temple-Inland’s consolidated financial statements, as Temple-Inland well knew.

In fact, shortly before the spin-off of GFG and the Bank, the Bank’s Director of Quantitative Analysis warned of the potentially disastrous nature of these high-risk, private-label mortgage-backed securities and the impending catastrophic consequences of the unsafe and unsound investment strategy Temple-Inland had imposed on the Bank — the consumption of the Bank’s entire stated capital of approximately $1 billion. These concerns were dismissed in curt internal emails that called the Director of Quantitative Analysis a “pussy.””

Now this is the fun part.  Here’s how the story goes:  there’s a guy at GFG who realizes that they have crap on their books – let’s call him DoQA for short (Director of Quantitative Analysis).  He writes an email about his concerns, a copy of which is included in the complaint:

“This graph kills me – do we need to start thinking about a plan B or plan C? Should we start reserving now for potential securities write-downs, or should we start quietly selling $ 50MM – $ 75MM a month of the MTAs or maybe do a little of both? I know economically it doesn’t make sense when we have positive  spread and the loss on the bond is greater than the regulatory capital it frees up, but I’m concerned that this market’s going to snap and start trading at subprime-like prices – today’s loss of 5 points might look cheap to a 25 or 30 point hit in 2010 on a portfolio that is likely to have shrunk very little in the next 2 years.”

As the complaint notes:

“Those warnings were not heeded. To the contrary, the Director of Quantitative Analysis was called a “pussy.””

Undeterred with being called a pussy, DoQA tries again, emphasis mine:

“After looking at several of those Nomura bonds that had price drops of 20 to 50 (yes 50) points after these downgrades, I’d rather be a live pussy than a dead gambler. Right now we have an unrealized loss of $ 200MM – if we had wholesale downgrades to single A, that loss looks like it would grow to over $ lB and on top of that we’d have to recognize it. In that scenario, no amount of capital is going to fix the problem, because the problem is MBS as a percent of balance sheet. That’s all I’m saying.”

And the response?  You guessed it:

“The Treasurer of the Bank, responded a short time later with a single word, “Pussy.””

Amazing. Look – I’ve managed a lot of risk in different roles on both the sell side and the buy side of Wall Street.  I have never in my life encountered a higher up (supervisor, risk manager, internal auditor, etc) who called me a pussy for wanting to mitigate risk exposure.  This is one reason why I am usually perturbed at the image often painted of Wall Street traders as loose cannons gambling recklessly with other people’s money and not caring about the consequences – I have never met such a person.  Yet clearly, as is evidenced by these emails, such people do exist (although even in this case it wasn’t the trader who was the problem – it was the treasurer!).

TIN’s defense looks like it will be that their actions were blessed by authorities/regulators.

As TIN’s latest 10k notes (cliff notes: “Hey, we got an opinion on this – it’s all good”):

“In October 2007, we closed the sale of the timberlands, and in December 2007 we distributed 100 percent of the stock of Guaranty Financial Group and Forestar Group to our shareholders consistent with this transformation plan. Since their spin-off in December 2007, we have had no ownership in or affiliation with Guaranty Financial Group, Guaranty Bank, or Forestar Group. In connection with the spin-off, we received an opinion from a qualified advisor that Guaranty Financial Group and Guaranty Bank would be solvent and adequately capitalized after the spin-off. In addition, Guaranty Bank satisfied Office of Thrift Supervision criteria to be considered well capitalized both before and after the spin off.

In August 2009, the Office of Thrift Supervision closed Guaranty Bank and appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. Shortly thereafter, Guaranty Financial Group, filed for bankruptcy. In second quarter 2010, we received a document request from the FDIC pursuant to an Order of Investigation of the acts of the former officers and directors of Guaranty Bank in connection with its failure. We voluntarily produced documents in our possession responsive to the request.”



disclosure: long $TIN (sad face)

* here’s the section of the complaint about the cross-default covenant motivation:


“Temple-Inland had its own debt obligations which contained cross-default covenants providing that if GFG or the Bank became insolvent or failed to make payments, Temple-Inland’s own debt obligations would default with catastrophic results including bankruptcy. For that reason, Temple-Inland had a compelling incentive to provide capital support to GFG and the Bank as long as they remained subsidiaries of Temple-Inland, which in turn provided an enormous benefit to GFG and the Bank that was taken for no  consideration upon the occurrence of the spin-off. Temple-Inland, as the ultimate corporate parent of GFG, also had an obligation to maintain the capital of the Bank at adequate levels.

After fraudulently stripping GFG and the Bank of assets beyond the point of solvency and adequate capitalization, Defendants then attempted to avoid the clear and present danger of a disastrous cross-default on Temple-Inland’s own debt obligations and any potential liability for Temple-Inland’s capital maintenance obligation by spinning off the fatally crippled and doomed-to-fail GFG and its subsidiaries as separate stand-alone corporations, leaving GFG’s creditors, the FDIC, and the American taxpayers to suffer the enormous losses Defendants created.”

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