Free Memorandum of Contentions of Fact and Law - District Court of Federal Claims - federal

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No. 93-531C (Senior Judge Loren Smith) ______________________________________________________________________________ IN THE UNITED STATES COURT OF FEDERAL CLAIMS _____________________________________________________________________________
AMBASE CORPORATION AND CARTERET BANCORP, Inc. Plaintiffs, and FEDERAL DEPOSIT INSURANCE CORPORATION, Plaintiff-Intervenor, v. UNITED STATES OF AMERICA

______________________________________________________________________________ DEFENDANT'S MEMORANDUM OF CONTENTIONS OF FACT AND LAW ON DAMAGES ______________________________________________________________________________ MICHAEL F. HERTZ Deputy Assistant Attorney General JEANNE E. DAVIDSON Director KENNETH M. DINTZER Deputy Director OF COUNSEL: TAREK SAWI Senior Trial Counsel ARLENE PIANKO GRONER ELIZABETH M. HOSFORD F. JEFFERSON HUGHES DELISA SANCHEZ AMANDA TANTUM

DAVID A. LEVITT Trial Attorney Commercial Litigation Branch Civil Division Department of Justice 1100 L Street, N.W. Washington, D.C. 20005 Tel: (202) 307-0309 Fax: (202) 514-7969

Date: January 22, 2008

Attorneys for Defendant

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TABLE OF CONTENTS TABLE OF AUTHORITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iv DEFENDANT'S MEMORANDUM OF CONTENTIONS OF FACT AND LAW ON DAMAGES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 INTRODUCTION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 THE ISSUES OF FACT AND LAW REGARDING DAMAGES TO BE RESOLVED BY THE COURT.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 A. B. ISSUES OF FACT.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 ISSUES OF LAW.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

THE FACTS DEFENDANT EXPECTS TO PROVE AT TRIAL... . . . . . . . . . . . . . . . . . . . . . . 10 A. B. FACTS RELATED TO THE 1982 TRANSACTIONS.. . . . . . . . . . . . . . . . . . . . 10 FACTS RELATING TO CARTERET'S PERFORMANCE BETWEEN 1981 AND 1986.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 FACTS RELATING TO THE 1986 SUPERVISORY ACQUISITIONS.. . . . . . 16 FACTS RELATING TO AMBASE'S ACQUISITION OF CARTERET.. . . . . . 17 AMBASE ABUSED ITS OWNERSHIP POSITION BY SIPHONING CAPITAL FROM CARTERET.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 DESPITE SIPHONING CARTERET'S CAPITAL FOR ITSELF, AMBASE WAS UNABLE TO IMPROVE ITS OWN DETERIORATING FINANCIAL CONDITION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 CARTERET'S FINANCIAL CONDITION WORSENED DURING THIS PERIOD AS WELL FOR REASONS TOTALLY UNRELATED TO THE BREACH. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 THE BREACH HAD LITTLE OR NO IMPACT ON CARTERET'S FINANCIAL PERFORMANCE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

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i

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I.

BECAUSE OF ITS POOR FINANCIAL PERFORMANCE AND CONDITIONS PRIOR TO AND AFTER THE BREACH, CARTERET WOULD HAVE FAILED IRRESPECTIVE OF THE BREACH. . . . . . . . . . . . . 31 BECAUSE OF THE POOR CONDITION OF CARTERET'S BALANCE SHEET AND OPERATIONS, EVEN WITH REGULATORY FORBEARANCE, CARTERET WAS UNABLE TO RAISE CAPITAL. . . . . . 34 EVEN COUNTING GOODWILL AS REGULATORY CAPITAL, CARTERET COULD NOT HAVE RAISED OUTSIDE CAPITAL TO ENSURE SURVIVAL.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 CARTERET COULD NOT HAVE RAISED SUFFICIENT CAPITAL BY SELLING ASSETS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 CARTERET DID NOT OVER-RESERVE ON ITS COMMERCIAL REAL ESTATE AND CORPORATE LOAN PORTFOLIOS. . . . . . . . . . . . . . . 42 THE RTC DID NOT RECOVER LESS ON ASSET DISPOSITIONS THAN CARTERET WOULD HAVE IN A BUT FOR WORLD.. . . . . . . . . . . 51 CARTERET WOULD NOT HAVE SOLD ITS ASSETS IN BETTER MARKETS THAN. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 AMBASE FAILS TO ACKNOWLEDGE THE BREACH'S POSITIVE EFFECTS.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 AMBASE AND CARTERET WASTED CARTERET'S CAPITAL BY ENTERING INTO UNSOUND EMPLOYMENT CONTRACTS AND ENGAGING IN UNSOUND EMPLOYMENT PRACTICES. . . . . . . . . . . . . . . 55

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DEFENDANT'S CONTENTIONS OF LAW. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 A. B. INTRODUCTORY LEGAL PRINCIPLES.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 BECAUSE CARTERET WOULD HAVE FAILED IN THE ABSENCE OF THE BREACH, AMBASE IS NOT ENTITLED TO DAMAGES STEMMING FROM CARTERET'S FAILURE. . . . . . . . . . . . . . . . . . . . . . . . . . 63 THE ALLEGED DAMAGES WERE NOT AND COULD NOT HAVE BEEN FORESEEABLE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 UNEXPECTED FUTURE CASH FLOWS AND MARKET ii

C.

D.

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APPRECIATION REFLECT INTERVENING CAUSES AND ARE NOT ATTRIBUTABLE TO THE BREACH. . . . . . . . . . . . . . . . . . . . . . . . 76 E. PROFESSOR CALOMIRIS'S MODELS FAIL TO QUANTIFY DAMAGES TO A REASONABLE CERTAINTY.. . . . . . . . . . . . . . . . . . . . . . . 78 1. AMBASE'S ESTIMATE OF UNEXPECTED CASH FLOWS CANNOT BE SUPPORTED.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78 AMBASE'S CLAIM TO PREJUDGMENT INTEREST IS INVALID.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87 AMBASE'S CLAIM FOR LOST DIVIDENDS INVOLVES DOUBLE COUNTING. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 CARTERETS' MAXIMUM DAMAGE IS MEASURED BY ITS MARKET VALUE AT THE TIME OF BREACH NET OF SELF IMPOSED LOSSES BETWEEN THE TIME OF BREACH AND THE SEIZURE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 AMBASE'S WOUNDED-BANK DAMAGES CLAIMS ARE INVALID. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 A. B. FACTUAL BACKGROUND. . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 CARTERET CANNOT RECOVER AMBASE'S COST. . . . . . . 92

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RESPONSE TO AMBASE'S CONTENTIONS OF FACT AND LAW.. . . . . . . . . . . . . . . . . . . 95 A. B. AMBASE'S CONTENTIONS RELATING TO DAMAGES. . . . . . . . . . . . . . . . 95 CONTENTIONS RELATING TO THE RECEIVERSHIP DEFICIT.. . . . . . . . 103

CONCLUSION .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

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TABLE OF AUTHORITIES CASES Admiral Fin. v. United States, 57 Fed. Cl. 418 (Fed. Cl. 2003), aff'd, 278 F.3d 1336 (Fed. Cir. 2004)................................................................................................. 3, 64, 69 Alfa Laval Seperation v. United States, 175 F.3d 1365 (Fed. Cir. 1999). ................................. 105 Am. Fed. Bank , FSB v. United States, 68 Fed. Cl. 346 (2005) . ................................................ 62 Am. Fed. Bank , FSB v. United States, 72 Fed. Cl. 586 (2006), reconsideration denied, 74 Fed. Cl. 208 (2006). ............................................................................................. 73, 78 Am. Fed'n of Gov't Employees v. United States, 258 F.3d 1294 (Fed. Cir. 2001).................. 105 Ambase Corporation v. United States, 58 Fed. Cl. 32 (2003). ........................................ 2, 64, 107 Ambase Corporation v. United States, 61 Fed. Cl. 794 (2004). ........................................ 104, 106 American Capital Corp. v. FDIC, 66 Fed. Cl. 315 (2005), aff'd in part, rev'd in part, and remanded, 472 F.3d 859 (Fed. Cl. 2006). ..................................................................... 93, 102 Bailey v. United States, 341 F.3d 1342 (Fed. Cir. 2003)................................................... 106, 107 Barron Bancshares, Inc. v. United States, 53 Fed. Cl. 310 (2002)......................................... 68, 74 Bluebonnet Savings Bank v. United States, 67 Fed. Cl. 231 (2005), aff'd, 466 F.3d 1349 (Fed.Cir. 2006)....................................................................................................................... 63, 83 Cal. Fed. Bank v. United States, 54 Fed. Cl. 704 (2002), aff'd, 395 F.3d 1263 (Fed. Cir. 2005)..................................................................................................................... passim Caroline Hunt Trust Estate v. United States, 470 F.3d 1044 (Fed. Cir. 2006) . ......................... 102 Carteret Savings Bank v. Office of Thrift Supervision, 762 F. Supp. 1159 (D.N.J.1991), rev'd, 963 F.2d 567 (3rd Cir. 1992). .................................................................................. 3, 64, 65 Castle v. United States, 301 F.3d 1328 (Fed. Cir. 2002) cert denied, 539 U.S. 925 (2003)........ 93 Chain Belt Co. v. United States, 115 F. Supp. 701 (Ct.Cl. 1953). .......................................... 60, 76 Cienega Gardens v. United States, 503 F.3d 1266 (Fed. Cl. 2007). ...................................... 71, 90

iv

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Citizens Fin. Servs., FSB v. United States, 64 Fed. Cl. 498 (2005), aff'd 170 Fed. App. 129, 2006 WL 618792 (Fed. Cir. March 9, 2006) (affirmed pursuant to Fed. Cir. R. 36). ......... 62 Commercial Fed. Bank v. United States, 59 Fed. Cl. 338 (Fed. Cl. 2004).................................. 82 Corbin v. Federal Reserve Bank of New York, 475 F. Supp. 1060 (S.D.N.Y. 1979), aff'd 629 F.2d 233 (2nd Cir. 1989). ........................................................................................... 109 Daubert v. Merrell Dow Pharms., Inc., 509 U.S. 579 (1992). ..................................................... 83 Energy Capital Corp. v. United States, 302 F.3d 1314 (Fed. Cir. 2002). ............................. passim FDIC v. Citizens State Bank of Niangua, 130 F.2d 102 (8th Cir. 1942). .................................. 108 Fifth Third Bank of W. Ohio v. United States, 55 Fed. Cl. 223 (2003), aff'd in part and rev'd in part, 402 F.3d 1221 (Fed.Cir. 2005).................................................................. passim First Fed. Lincoln Bank v. United States, 73 Fed. Cl. 633 (2006)............................................... 62 G.L. Christian & Associates v. United States, 160 Ct. Cl. 1, cert denied 375 U.S. 954 (1963). . 76 Gladstone Realtors v. Village of Bellwood, 441 U.S. 91 (1979)............................................... 106 Glendale Fed. Bank, FSB v. United States, 43 Fed. Cl. 390 (1999) aff'd in part and vacated in part, 239 F.3d 1374 (Fed. Cir. 2001). ............................................................ 62, 72 Glendale Fed. Bank, FSB v. United States, 54 Fed. Cl. 8 (2002), aff'd, 378 F.3d 1308 (Fed.Cir. 2004)........................................................................................................ 62, 63, 79 Globe Sav. Bank, F.S.B. v. United States, 65 Fed. Cl. 330 (2005), aff'd in part, and remanded, 189 Fed. Appp. 964 (Fed. Cir. 2006). ................................................................. 82 Golden Pac. Bancorp v. FDIC, 2002 WL 31875395 (S.D.N.Y. 2002), aff'd, 375 F.3d 196 (2nd Cir. 2004)..................................................................................................... 108 Granite Management Corp. v. United States, 58 Fed. Cl. 766 (2003) aff'd in part and remand in part 416 F.3d 1373 (Fed. Cir. 2005)............................................................. 92, 103 Granite Management Corp. v. United States, 74 Fed. Cl. 155 (2006) aff'd -- F.3d -- (Fed. Cir. Jan 08, 2008) (NO. 2007-5054). .......................................................... 95, 108 Hansen Bancorp, Inc. v. United States, 67 Fed. Cl. 411 (2005). ........................................... 89, 91 v

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In re Hartsdale Associates, 452 F. Supp. 67 (S.D.N.Y. 1978)................................................... 109 J.D. Hedin Construction Co. v. United States, 197 Ct. Cl. 782 (1972). ...................................... 76 Home Sav. Of Am., FSB v. United States, 399 F.3d 1341 (2005). ............................................. 99 Hughes Communications Galaxy, Inc. v. United States, 271 F.3d 1060 (Fed. Cir. 2001). . 94, 101 Kidder Peabody & Co., Inc. v. IAG Int'l Acceptance Group, 28 F. Supp. 2d 126 (S.D.N.Y. 1998), aff'd 205 F.3d 1323 (2nd Cir. 1999). ......................................................... 63, 84 Kumho Tire, Co. , Ltd. v. Carmichael, 526 U.S. 137 (1999)....................................................... 83 LaSalle Talman Bank, F.S.B. v. United States, 64 Fed. Cl. 90 (2005), aff'd, 462 F.3d 1331 (Fed. Cir. 2006).................................................................................... passim Landmark Land Co. v. United States, 256 F.3d 1365 (Fed. Cir. 2003). ............................... passim Lewis Jorge Constr. Mgmt., Inc. v. Pomona Unified Sch. Dist., 34 Cal. 4th 960, 22 Cal. Rptr. 3d 340, 102 P.3d 257 (2004)............................................................................................... 77 Estate of Lillian Berg, v. United States, 687 F.2d 377 (Ct.Cl. 1982). .................................. passim Long Island Sav. v. United States, 60 Fed. Cl. 80 (2004), rev'd on other grounds, 503 F.3d 1234 (Fed. Cir. 2007)............................................................................ 88 Longshore v. United States, 77 F.3d 440 (Fed. Cir. 1996). ....................................................... 105 Maher v. United States, 314 F.3d 600 (Fed. Cir. 2002)............................................................. 104 McAllister v. RTC, 201 F.3d 570 (5th Cir. 2000). .................................................................... 104 Micro Chemical, Inc. v. Lextron, Inc, 317 F.3d 1387 (2003). ..................................................... 83 Mid Jersey National Bank v. Fidelity-Mortgage Investors, 518 F.2d 640 (3rd Cir. 1975)........ 109 Myerle v. United States, 33 Ct. Cl. 1 (1897). .................................................................. 60, 77, 93 Nat'l Controls Corp. v. Nat'l Semiconductor Corp., 833 F.2d 491 (3rd Cir. 1987). ................... 77 Neely v. United States, 285 F.2d 438 (Ct.Cl. 1961). ................................................................... 59 Northern Helex Co. v. United States, 207 Ct. Cl. 862 (1975) cert denied, 429 U.S. 866 (1976). 76 O'Melveny & Myers v. United States, 512 U.S. 79 (1994)........................................................ 104 vi

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Old Stone Corp. v. United States, 450 F.3d 1360 (2006). ............................................... 61, 72, 73 Plaintiffs in All Winstar-Related Cases at the Court v. United States, 44 Fed. Cl. 3 (1999). ... 104 Ramsey v. United States, 101 F. Supp. 353 (1951). .............................................................. 60, 76 In Re Receivership Of First Nat'l Bank in Humboldt, 523 N.W.2d 591 (Iowa 1994). .............. 108 Reynolds v. United States, 158 F. Supp. 719 (1958). .................................................................. 74 S. Nat'l Corp. v. United States, 57 Fed. Cl. 24 (2003)................................................................. 60 Sinclair Refining Co. v. Jenkins Petroleum Process Co., 289 U.S. 689 (1933). ......................... 73 Slattery v. United States, 69 Fed. Cl. 573 (2006). ................................................................... 2, 70 Southwest Inv. Co. Inc. v. United States, 63 Fed. Cl. 182 (2004), aff'd, 158 Fed. App. 283 (Fed Cir. 2006). ................................................................................... 3, 64, 69 Suess v. United States, 52 Fed. Cl. 221 (2002)..................................................................... 71, 81 Three Crown Limited Partnership v. Salomon Brothers, Inc., 906 F. Supp. 876 (S.D.N.Y. 1995). ............................................................................................................. 63, 83 Tyger Const. Co. v. Pensacola Const. Co., 29 F.3d 137 (4th Cir. 1994). .................................... 84 Wells Fargo Bank, N.A. v. United States, 88 F.3d 1012 (Fed. Cir. 1996), cert denied, 520 U.S. 1116 (1997)............................................................................................................ passim Willems Indus., Inc. v. United States, 295 F.2d 822 (Ct. Cl. 1961). ........................................... 62 STATUTES 12 C.F.R. § 561.16(c)(d)(2)(1989)............................................................................................... 46 12 C.F.R. §561.16c(d)(1)(1989). ................................................................................................. 46 12 C.F.R. §561.16c(d)(2) (1989). ................................................................................................ 45 12 C.F.R. §563.160(d)(2)(1992). ................................................................................................. 45 12 C.F.R. §561.16c(d)(3)(1989). ................................................................................................. 46 12 C.F.R.§563.160(d)(1)(1992). .................................................................................................. 46 vii

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12 C.F.R. §563.160(d)(2)(1992). ................................................................................................. 46 12 C.F.R. §563.160(d)(3)(1992). ................................................................................................. 46 12 U.S.C. § 1821(d)(11). ................................................................................................... 106, 107 Crime Control Act of 1990, 12 U.S.C. § 1828(k)(4). .................................................................. 56 Financial Institutions Reform, Recovery, and Enforcement Act ("FIRREA"), Pub. L. No. 101-73, 103 Stat. 183 (1999). ........................................................................................................ 2 MISCELLANEOUS Corbin on Contracts, § 1012 at 88 (1964).................................................................................... 61 1 Dobbs Law of Remedies, § 3.8(2) (2d ed. 1993). .................................................................... 76 J. Murray, Contracts, § 237 (1974). ....................................................................................... 74, 89 Restatement of Contracts, § 329 (1932) . ..................................................................................... 76 Restatement (Second) of Contracts, § 351(l), § 351, 352 . .............................................. 60, 61, 62

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS AMBASE CORPORATION AND CARTERET BANCORP, INC., Plaintiffs, and FEDERAL DEPOSIT INSURANCE CORPORATION, Plaintiff-Intervenor, v. THE UNITED STATES Defendant. ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) )

No. 93-531C Senior Judge Loren Smith

DEFENDANT'S MEMORANDUM OF CONTENTIONS OF FACT AND LAW ON DAMAGES Pursuant to Appendix A of the Rules of this Court and this Court's Scheduling Order dated April 13, 2007, the defendant, United States, submits its contentions of fact and law on damages. INTRODUCTION The Court should reject Ambase Corporation and Carteret Bancorp, Inc.'s (collectively "Ambase") damage claims as counterfactual, hypothetical, and unsupported by law or evidence. Ambase, joined by the plaintiff-intervenor Federal Deposit Insurance Corporation ("FDIC"), argue that Carteret Federal Savings Bank ("Carteret") would have survived in the absence of the breach and would have grown in market value from $251 million at the time of the breach to between $596 million and $4.7 billion in 2006 as a result of the "golden era of banking growth and profitability." PX 2702 at ¶¶ 24, 34, 36, 37 and 43; DX 5038, Table I. They claim that

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Carteret should be compensated for this "golden era of banking growth and profitability." According to Ambase's expert economist, Professor Charles W. Calomiris, "but for" Carteret's damages, resulting from the breaching provisions of the Financial Institutions Reform, Recovery, and Enforcement Act ("FIRREA"), Pub.L. No. 101-73, 103 Stat. 183 (1999), are between $785.7 million and $4.905 billion (without gross up for taxes). DX 5038, ¶ 34. As we demonstrate, Carteret's book value of equity at the time the regulators approved the acquisitions of Barton Savings & Loan Association of Newark, New Jersey ("Barton") and First Federal Savings and Loan Association of Delray Beach, Florida ("Delray") was $36.4 million. DX 19 at 0390. These two acquisitions are at the heart of Ambase's case.1 Thus, the assumption of Ambase's damage calculation is that the regulators could have foreseen in 1982 and 1986 that, if goodwill were disallowed as regulatory capital, Carteret would suffer a loss of from $785.5 million to $4.9 billion even though Carteret's book value of equity was only $36.4 million and the amount of goodwill booked in the transactions was only approximately $268 million. As we demonstrate, regulators did not reasonably foresee and could not have reasonably foreseen this amount of damages when they approved the transactions and, therefore, these damages are not recoverable for the breach. See, e.g., Landmark Land Co. v. United States, 256 F.3d 1365, 1378 (Fed. Cir. 2003) ("both the magnitude and type of damages [must be] foreseeable"); Slattery v. United States, 69 Fed. Cl. 573, 582 (2006) (same), appeal docketed,

Carteret booked approximately $46 million in goodwill in the Barton transaction and approximately $168 million in goodwill in the Delray transaction; it only booked approximately $21.7 million in the 1986 acquisitions of First Federal Savings and Loan Association of Montgomery County, Blacksburg, Virginia ("First Federal") and Mountain Security Savings Bank of Wytheville, Virginia ("Mountain Security"). See Ambase Corp. v. United States, 58 Fed. Cl. 32, 34-37 (2003) ("Ambase I"). 2

1

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Nos. 07-5063, -5064, -5089 (Fed. Cir. 2007). Further, Professor Calomiris's damage calculation assumes that Carteret would have survived in the absence of the breach. This is contrary to the evidence. As of October 25, 1991, even though the Office of Thrift Supervision ("OTS") was required to count Carteret's goodwill as regulatory capital as a result of an injunction issued by the U.S. District Court for New Jersey in February 1991, see Carteret Sav. Bank v. Office of Thrift Supervision, 762 F. Supp. 1159 (D.N.J. 1991), rev'd, 763 F.2d 567 (3d Cir. 1992), Carteret failed its post-FIRREA regulatory capital requirements. PX 4867a at 3. Because of massive real estate writedowns stemming from poor underwriting and slow economic growth, Carteret was insolvent and OTS recommended a transfer to the Resolution Trust Corporation ("RTC"). Id. Because Carteret's management changed, OTS allowed the thrift time to recapitalize but, despite letters of intent by three sophisticated investment banking firms, Carteret failed to complete the transactions. DX 8124. Only after these failures, in December 1992, did OTS order a transfer to the RTC. At that time, Carteret failed its regulatory capital requirements by $133.2 million (tangible capital), $157 million (core capital), and $235.4 million (risk-based capital). Even counting goodwill as regulatory capital, Carteret failed all three regulatory capital requirements at the time of transfer. Because the failure would have occurred even if goodwill had counted towards regulatory capital, the effects of the failure cannot be attributed to the breach. See, e.g., Southwest Inv. Co. v. United States, 63 Fed. Cl. 182 (2004), aff'd, 158 Fed. Appx. 283 (Fed. Cir. 2005) (damages could not be awarded because the thrift was insolvent irrespective of the breach); Admiral Fin. v. United States, 57 Fed. Cl. 418, 432 (2003), aff'd, 278 F.3d 1336 (Fed. Cir. 2006) (same). 3

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Even if Carteret would have survived in the absence of the breach and regulators could have reasonably foreseen the "golden era of banking," moreover, Ambase has failed to quantify the alleged damage stemming from the breach. Ambase argues that "but for" Carteret's market value in 2006 can be reasonably quantified by applying the Gordon Growth Model, a mathematical formula to project future earnings where the cost of capital is known. According to Ambase, based upon a capital cost of 12.34 percent, "but for" Carteret would have earned $20.5 million in 1989 and would have grown at a 4.2 percent annual rate between 1989 and 2006. PX 2702 at ¶ 35-36 and pages 26-28 (Tables 5-6). This yields a "but for" book value of $442.9 million in December 2006. Id. at Table 13, page 41. By adjusting "but for" Carteret's estimated book value to market value based upon the rate of increase in book to market ratios from 1989 to 2006 of alleged "peer institutions," Ambase calculates "but for" Carteret's market value in 2006. Thus, Ambase's damage claim is based upon an estimated book value of "but for" Carteret derived from the application of the Gordon Growth Model to Carteret's estimated market value as of the time of the breach. Rather than basing damages on the loss of Carteret's estimated market value at the time of the breach, Ambase projects what that market value allegedly would have been seventeen years in the future (i.e., in 2006). This futuristic application of economic theory is contrary to well-settled legal precedents, which establish that the market value at the time of the breach is the measure of damage, not a projection of what that market value might have been at some future time. E.g., Estate of Lillian Berg, v. United States, 687 F.2d 377, 379-83 (Ct. Cl. 1982); Energy Capital Corp. v. United States, 302 F.3d 1314, 1330-34 (Fed. Cir. 2002). Further Professor Calomiris's calculation effectively compounds a return on Carteret's estimated 1989 market value to estimate the "but for" thrift's market value as of 2006. 4

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As Professor Saunders observes, "Professor Calomiris's whole approach is trying to engineer additional losses that have the transparent flavor of `prejudgment interest' add-ons." DX 5038 at ¶ 38. Ambase's method of calculating damages is contrary to precedent and invalid. Moreover, even if Ambase were entitled to estimate "but for" Carteret's alleged market value as of 2006, the assumptions behind Professor Calomiris's estimates are unsupported. For example, Professor Calomiris assumes that "but for" Carteret's earnings in 1990 and 1991 would have been $21.4 million and $22.3 million respectively. PX 2702 at 28, Table 6. This, however, is counterfactual. As Professor Calomiris concedes, Carteret's actual earnings in those years were negative $131.84 million and negative $160.25 million, respectively. PX 2702 at 26 n.59. Further, the model estimates Carteret's 1989 earnings at approximately $20 million, whereas actual earnings, which ignored a $77 million OTS-mandated write-down, were only $7.6 million. PX 4867a at 11. Thus, the record does not support the model's estimate of earnings for "but for" Carteret. Id. at 26. Professor Calomiris also concedes that his estimate of "but for" Carteret's earnings in these years is "aggressive." He acknowledges that, even in the absence of the breach, Carteret would have incurred massive losses in its commercial real estate and corporate loan portfolios. Id. Although he argues that "but for" Carteret would not have been as aggressive in writing down its commercial real estate portfolio if it did not have to raise outside capital to meet minimum regulatory capital requirements, this is contradicted by the fully supported report of David M. Kennedy, one of the Government's expert witnesses (DX 7000). As Mr. Kennedy has pointed out, all of the write-downs in the commercial real estate and corporate loan portfolios were required by the appraisals and other indications of value in Carteret's loan and investment 5

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portfolios. Further, Professor Calomiris's contention that the "but for" thrift would have survived is inconsistent with Professor Calomiris's estimate of Carteret's regulatory capital position in the "but for" world. In short, there is no evidentiary basis for Professor Calomiris's estimate of the "but for" thrift's capacity to avoid transfer to the RTC in the absence of the breach. Professor Calomiris's methodology for calculating "but for" Carteret's 2006 market value also suffers from other legal infirmities. The estimated cash flow of the "but for" thrift is based entirely upon an arithmetic calculation relating to alleged historical earnings of the actual thrift and the "but for" thrift's estimated cost of capital. Professor Calomiris does not provide balance sheets or profit and loss statements for the "but for" thrift and fails to identify the assets and liabilities of the "but for" thrift. Under relevant case law, however, a damage calculation which simply assumes the existence of "but for" cash flows is invalid. As this Court noted in Fifth Third Bank of Western Ohio v. United States, 55 Fed. Cl. 223, 240-41 (2003), such a model is speculative as a matter of law because it "fails to account for any real-world events other than the profitability of the [actual thrift] . . ." Even if the validity of Professor Calomiris's model were not dependent upon an analysis of the assets and liabilities of the "but for" thrift, moreover, the model would be unreliable because other internal assumptions contradict the record. For example, according to Professor Anthony Saunders, the Government's expert economist, the regression analysis that leads Professor Calomiris to estimate the "but for" thrift's cost of capital to be 12.4 percent fails to include the proper specification for the actual thrift's net equity, which was negative during the time the cost of capital was estimated. DX 5038 at ¶¶ 163-173. This error tends to dramatically 6

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understate the cost of capital which, in turn, overstates the growth rate of earnings of the "but for" thrift. Id. Further, whereas debt and equity have differing capital characteristics, Professor Calomiris's regression analysis indiscriminately mixes values relating to equity with values relating to debt. Finally, because costs of capital vary over time, a regression analysis which focuses on 1993-1994 is irrelevant for calculating the cost of raising capital in 1989 (the time of the breach). In estimating "but for" Carteret's book value in 2006, Professor Calomiris also assumes year-by-year "but for" dividend payments of 31.7 percent of earnings based upon his estimation of "the mean annual dividend payout ratio for all publicly traded thrifts with data available in Compustat from August 1989 through December 2006." PX 2702 at 26-27. Professor Calomiris assumes there is some similarity between the average publicly-traded thrift with data available on the Compustat database and "but for" Carteret. Professor Calomiris, however, never makes an effort to support this assumption. More troublesome is the assumption that "but for" Carteret would pay a steady dividend. This assumption is inconsistent with the thrift's historical performance, which involved few if any dividend payments between 1982 and 1988 and none representing 31.7 percent of earnings. Thus, Professor Calomiris's assumption concerning dividend payments in the "but for" world is contrary to the evidence. If his assumption of a steady stream dividend payout equal to 31.7 percent of earnings is invalid, the calculation of damage is invalid as well. In short, as we will demonstrate at trial, Ambase's damages calculations are contrary to law and lack evidentiary support in the record. Accordingly, this Court should rule that Carteret has failed to prove damages as a matter of law. 7

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THE ISSUES OF FACT AND LAW REGARDING DAMAGES TO BE RESOLVED BY THE COURT. We anticipate that this Court will be required to resolve the following issues of fact and law at the trial on the plaintiffs' claims for damages:2 A. (1) Issues Of Fact Whether, in the absence of the breach, OTS would have imposed a conservatorship on Carteret. (2) Whether regulators foresaw or could have reasonably foreseen that breach-related damages would have exceeded Carteret's book value in 1982 and 1986. (3) Whether Professor Calomiris accurately estimates Carteret's market value at $251.4 million as of the time of the breach. (4) Whether, in the absence of the breach, "but for" Carteret would have been profitable and, if so, the quantum of profits it would have earned between 1989 and 2006 or 2008. (5) Whether the book value of "but for" Carteret in 2006 would have been $442.9 million. (6) Whether "but for" Carteret would have made the dividend distributions hypothesized by Professor Calomiris in his report. (7) Whether Professor Calomiris's estimates of the market values of "but for" Carteret in 2006 and 2008 are accurate to a reasonable degree of certainty.

Plaintiff-intervenor FDIC has not presented an expert witness to testify concerning Carteret's damages. Accordingly, we assume that the only damage estimates to be presented by plaintiffs at trial will be those advanced by Professor Calomiris. 8

2

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(8)

Whether "but for" Carteret would have required an infusion of outside capital to survive and, if so, how much.

(9) (10)

Whether Carteret could have raised this capital in the "but for" world. Whether "but for" Carteret's losses on commercial real estate and corporate loans would have been less in a "but for" world.

(11)

Whether the breach caused the "wounded bank" damages claimed by Professor Calomiris.

(12)

Whether the FDIC's estimate of the receiverships deficit as of December 2006 is reasonable.

B.

Issues of Law

We anticipate that this Court will be required to resolve the following issues of law related to plaintiffs' claims for damages: (13) Whether the Gordon Growth Model provides an evidentiary basis upon which to calculate "but for" Carteret's market value as of 2006 or 2008. (14) Whether, if the market at the time of the breach were unable to estimate Carteret's future growth opportunities, as Professor Calomiris alleges, such growth opportunities were reasonably foreseeable to regulators in 1982 or 1986. (15) Whether Carteret suffered damages relating to the breach when it failed FIRREA regulatory capital requirements as of the second quarter of 1991 and never regained compliance with FIRREA regulatory capital requirements. (16) Whether Carteret's damages can be measured by its estimated market value in 2006 and 2008 when these estimates exceeded by a large margin its market value 9

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at the time of the breach. (17) Whether plaintiffs have demonstrated the existence of damages caused by the breach. (18) Whether plaintiffs have demonstrated the quantum of damages caused by the breach. (19) Whether the amount of damages can exceed Professor Calomiris's estimate of the market value of Carteret's unamortized goodwill at the time of the breach. (20) Whether the real estate losses in 1990 and 1991 constitute an offset to Carteret's alleged damages. THE FACTS DEFENDANT EXPECTS TO PROVE AT TRIAL A. 1. FACTS RELATED TO THE 1982 TRANSACTIONS In 1981, Carteret was a mutual thrift chartered by the Federal Home Loan Bank

Board ("FHLBB"). With approximately $1.9 billion in liabilities and a net worth ratio of under 2.1 percent, Carteret's strategy focused on the need to raise capital and regain profitability. DX 9117. 2. As a mutual, Carteret could not raise equity capital without converting to a stock

association. DX 9117. Carteret's capital-raising strategy focused upon raising capital in the public marketplace. Carteret was advised by its investment bankers that it should consolidate its deposit base in New Jersey and expand its deposit base to Florida to attract capital. Carteret, therefore, sought opportunities to expand its deposit base to the Florida market. DX 9117. 3. As of August 31, 1982, Delray reported a net worth of approximately $1.2

million. PX 2433 at 1. Delray's Board of Directors agreed to permit FSLIC to seek financial 10

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assistance and FSLIC listed Delray as a troubled association. FSLIC received bids to acquire Deray from five out-of-state institutions, including Carteret. PX 2433 at 9-10. Carteret actively pursued Delray. Delray was particularly attractive to Carteret because the population of Florida and other sunbelt areas was expanding, many people who had lived in New Jersey had retired to Florida, and many New Jersey residents took vacations in, and had second homes in, Florida. DX 9117 at ¶ 13. Carteret's market analysis indicated that 24 percent of all residents in Palm Beach County, Florida, had originally come from either New York or New Jersey. Florida averaged twice the deposits per average depositor as New Jersey and New Jersey was losing population at a rate of about 1.5 percent per year. Carteret could engage in construction lending all year round in Florida whereas it could only do so part of the year in New Jersey. As a condition of acquiring Delray, FSLIC required Carteret to acquire Barton as well. Barton had suffered net losses since 1979 and was of little, if any, interest to other New Jersey associations. DX 9117. 4. Based upon its financial analysis of Delray, Carteret concluded that Delray's

operating difficulties were temporary and stemmed from a poor decision relating to the pricing of deposits. DX 9117 at ¶ 17. Delray, however, had "relatively few bad loans and bad assets . . . and [Carteret] thought [its] problems were manageable given time." Id. Thus, Carteret actively pursued the merger with Delray in order to qualify for a conversion. 5. In September 1982, with FSLIC cash assistance of $11.7 million for Barton and

no cash assistance for Delray, Carteret acquired Barton and Delray. Carteret booked a total of $214 million in goodwill, approximately $160 million from the Delray acquisition and approximately $40 million from the Barton acquisition. PX 2433. The goodwill resulting from 11

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the Delray and Barton acquisitions constitutes approximately 90 percent of the goodwill at issue in this litigation. B. FACTS RELATING TO CARTERET'S PERFORMANCE BETWEEN 1981 AND 1986 In 1981, Carteret expanded its asset base by approximately $230 million by

6.

acquiring six New Jersey institutions, including River Edge Savings and Loan Association, which was insolvent at the time of the acquisition. PX 2433 at 11. As of August 31, 1982, Carteret's net worth, which was approximately $36.4 million, was only approximately 1.5 percent of assets of approximately $2.3 billion. Id. at 12. Thus, even prior to acquiring Delray and Barton in September 1982, Carteret was extremely undercapitalized. 7. To allow thrifts to become more competitive, Congress, in 1982, expanded thrifts'

asset and investment powers through the enactment of the Depository Institutions Act, which provided thrifts with the opportunity to widen interest spreads and potentially reduce interest rate exposure arising from asset-liability mismatching. DX 8000 at n.20. Carteret responded to this new authority by adopting a "vigorous strategy aimed at giving Carteret and its customers the maximum benefits of emerging investment opportunities." Id. at n.21. 8. Carteret's primary strategy was to diversify into new product areas, such as

corporate and commercial real estate loans, and expand its geographic franchise by acquiring such institutions as Delray. Although diversifying into higher yielding products such as corporate and commercial real estate loans had the potential to improve interest rate risk and profitability, such new products also exposed Carteret to higher credit risk. DX 8000 at n.20. Under good banking practice, a thrift which diversified into high yield assets had to have

12

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sufficient tangible capital to absorb unexpected losses to be prudent. Id. Carteret, however, failed to raise tangible capital. Further, it failed to recruit competent staff to handle its expanded asset portfolio. DX 5001 at ¶ 22. 9. For example, after its 1982 acquisitions (and the assumption of $229 million of

goodwill), Carteret's assets increased by approximately $1 billion (approximately $800 million from Delray and approximately $200 million from Barton). Yet, aside from approximately $16 million contributed by FSLIC, Carteret received no additional tangible capital. Its tangible net worth at the end of 1982 was negative $212 million and the ratio of goodwill to net worth exceeded ten. DX 8000 at ¶ 30. Following the raising of approximately $58.3 million in its conversion, PX 2702 at 9, Table 2, Carteret's equity capital (or net worth) was just $22 million, or 0.67 percent of total assets. Id. 10. Despite its undercapitalized position in 1982, Carteret rapidly exploited its new

asset-making powers, converting itself from a traditional thrift into a commercial banking institution virtually overnight. In April 1983, for example, it began commercial real estate lending. Over the next 18 months, it originated approximately $500 million in commercial real estate loans. DX 5001 at ¶ 21. During this period, Carteret had approximately $194 million in corporate loans on its books. DX 8043 at 1188. The explosion in commercial lending happened too quickly to enable the institution to build the infrastructure needed to make correct credit decisions. Corporate and commercial real estate lending went from zero to approximately $500 million over a two year period. DX 5001 at ¶ 21. 11. A due diligence conducted by Peat Marwick in connection with Ambase's

acquisition of Carteret in 1988 recognized that Carteret's diversification into commercial bank 13

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like products was imprudent. As noted in the Peat Marwick report: We believe that the commercial lending and commercial real estate portfolios represent a relatively high degree of prospective risk for Carteret. The following are contributing factors: the rapid growth in these portfolios over the past four years; a credit process that has not been fully developed in the planning and monitoring segments; the high concentrations within the portfolios in categories generally considered to be of high risk by many financial institutions; [and] specific individual credits in the process of liquidation. In order to at least partially mitigate and close the gap between potential risk and capacity to manage risk and support Carteret's growth plans at a reasonable level of risk, we believe that increased investments in people and processes will be required. DX 659. 12. In August 1983, Carteret went public by selling 6.82 million shares at $9.50 per

share and raising approximately $58.4 million in net proceeds. PX 2702 at Table 2, ¶ 9. Although the conversion was successful, the market's uncertainty regarding the future was reflected in the fact that only 35 percent of the issue was acquired by existing depositors, the price-earnings ratio was less than 2 and the price-to-book ratio was only .55. DX 8000 at ¶ 35. In 1985, Carteret raised approximately $11 million by issuing new shares and, later in that year, raised $21.2 million through the sale of preferred stock. Id.; PX 2702 at Table 2. In 1986, Carteret raised $28.7 million by issuing and selling new shares. Thus, between 1982 and 1986 Carteret raised equity capital of $119.3 million. DX 8000 at ¶ 35; PX 2702 at Table 2. As a result of this capital raising, and by virtue of retaining most of its earnings, between 1982 and 1986 Carteret improved its shareholder's equity to total assets ratio from .7 percent to 4.7 percent, and its tangible net worth improved from negative $212.3 million to $21 million. DX 8000 Exh. 3, Table 1 at 2.

14

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13.

Between 1982 and 1986 Carteret's assets grew by approximately $2 billion (i.e.,

from approximately $3.3 billion to approximately $5.5 billion). DX 8000 Exh. 3, Table 1 at 1. During this period, Carteret's operating earnings remained very low or were negative. For example, for 1982, Carteret's operating earning were approximately negative $25.5 million; for 1983, approximately negative $11.6 million; for 1984, approximately negative $3.7 million; for 1985, approximately $8.2 million; and for 1986, approximately $33.2 million. DX 5038 at n.26. Thus, Carteret had negative operating earnings in three of five years between 1982 and 1986. The ratio of Carteret's operating earnings to assets in 1985 was only .16 percent and in 1986 was only .5 percent. Further, these figures include temporary non-cash operating income resulting from the mismatch between the accretion of the discount on mortgage loans and the amortization of goodwill. See DX 8000 at ¶ 29. This mismatch increased earnings between 1983 and 1987 by approximately $47 million. PX 1601 at CAM524 0836. As the discounts were fully accreted and the goodwill continued to be amortized, Carteret projected a net accretion loss of approximately $137.2 million from 1997 forward. Id. 14. Between 1982 and 1987, Carteret grew at a compound rate of 12.2 percent. DX

8000 at ¶ 31. By the end of 1987, its total assets had increased to 177 percent of what they had been at the end of 1982. Id. Although insured deposits were the lowest cost of funds for savings and loans, during this period Carteret increased its dependence on loans from the FHLBB and other institutional lenders. Id. at ¶ 33. Thus, deposits declined as a percentage of total liabilities from 82 percent in 1982 to 74 percent in 1987. Thus, Carteret's branch network, which spanned four states and the District of Columbia, was not generating sufficient deposits and Carteret had to rely upon Federal Home Loan Bank ("FHLB") loans to support its aggressive 15

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growth. Id. 15. In 1987, the year in which Carteret fully utilized capital markets, its return on

assets was .57 percent and its return on equity was 11.5 percent. Tangible net worth was $75.3 million and net interest was 2.2 percent of assets. Net income was boosted by selling loans and securities (mainly mortgage-backed securities) for a gain of $21.8 million. DX 8000 at ¶ 36. C. 16. FACTS RELATING TO THE 1986 SUPERVISORY ACQUISITIONS On June 6, 1986, Carteret acquired three troubled thrifts, namely Mountain

Security, First Federal, and Admiral Builders Savings and Loan Association, Parkville, Maryland ("Admiral"). This allowed Carteret to extend its franchise to Virginia, Maryland and the District of Columbia. At the time, First Federal and Mountain Security had negative tangible capital and Admiral had a net worth of only .5 percent of assets. As a state chartered thrift insured by the Maryland Deposit Insurance Fund, Admiral is not at issue in this litigation. DX 9117 at ¶ 26. 17. At the time of the First Federal and Mountain Security transactions, the FHLBB

had a policy which allowed a thrift that acquired a troubled out-of-state thrift to have branching rights in the state of the insolvent thrift and two contiguous states as well. Carteret desired to acquire Mountain Security and First Federal to expand its branch network to Virginia, Maryland and the District of Columbia. DX 9118 at 0270-0271. The FHLBB awarded branching rights when it approved these acquisitions. DX 351 at 0331-0333. 18. FSLIC was Mountain Security's receiver and, in that capacity, entered into an

acquisition agreement with Carteret. Carteret and First Federal agreed to merge and the agreement was approved by the FHLBB. As a result of the acquisitions of First Federal and Mountain Security, Carteret booked approximately $22 million in supervisory goodwill. DX 16

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9117 at ¶ 25. Carteret booked approximately $20.3 million of goodwill from the Mountain Security acquisition and the remainder of the goodwill from the First Federal acquisition. 19. Carteret's decision to expand its branch network to Maryland, Virginia, and the

District of Columbia was premised on its consultant's view that nationwide banking would be the wave of the future. Senior Carteret management was not actively involved in the decision to expand the branch network to these areas. Carteret was particularly interested in opening branches in the District of Columbia because management desired to impress Congressmen, lobbyists and other people in Washington, D.C., because Carteret claimed to have a partnership with them. Carteret opened de novo branches in the District of Columbia, which were expensive to own and operate. Carteret, however, was not able to realize its objective of forming an East Coast brand and it "pulled back" when it saw that it was unable to earn profits on its midAtlantic branch system. It sold these underperforming branches in 1990 to a Baltimore institution, Loyola Federal Savings and Loan. D. 20. FACTS RELATING TO AMBASE'S ACQUISITION OF CARTERET In early 1987, Ambase, which was a publicly owned insurance holding company

(then known as Home Insurance Group), began discussions concerning the acquisition of Carteret. At this time, the CEO of Ambase was Marshall Manley who, from 1966 to the mid1980's, was counsel to Southern California Savings and Loan Association ("Southern California"), a subsidiary of City Investing Company ("CIC"). CIC was a conglomerate that had owned the Home Insurance Group. Manley was hired by Home Insurance Group to improve the insurance subsidiary (Home Insurance Company or "Home"), which had performed poorly. DX 8000 at 16. At the time Manley was recruited (1985), Home was among the least productive 17

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property casualty insurers in the United States. Before joining Home, Manley had been chairman of Merchant Bank of California, which he founded and which, shortly after he left to join Home, became the target of Federal and state investigations. Manley also was affiliated with Finley, Kumble, Wagner, Heine, Underberg, Manley, Myerson & Casey, a law firm which declared bankruptcy in the late 1980s. While CEO of Home, Manley also received money from Finley, Kumble during the time Finley, Kumble did work for Home. 21. In 1986, Home lost $197 million in its insurance operations. DX 8000 at 17.

Home struggled to develop a new corporate strategy and decided to become a diversified financial services company. Manley devised a strategy to improve Home's performance by extending Home's product line into specialty areas such as lawyer malpractice insurance. Manley attempted to improve Home's profit margins by shifting financial assets into so-called "high yield" (junk) bonds. In 1987, Home acquired Gruntal Financial Corp., a retail brokerage and securities firm and announced the proposed acquisition of Carteret Bancorp. DX 8000 at 17. 22. Carteret agreed to the Home acquisition for at a premium of 47.5 percent above

the last sale price of Carteret stock before the announcement of the acquisition. The purchase price was $291.9 million in cash, 9.45 times the expected fully-diluted 1987 earnings and 92 percent of year-end book value. Prior to the announcement, Carteret was trading at $15.25 per share, 6.4 times 1987 earnings per share and 62 percent of its 1987 book value. DX 8000 at 17. 23. Two months after Home initiated its efforts to acquire Carteret, on October 19,

1987, the New York Stock Exchange ("NYSE") fell 508 points, or more that 20 percent. Soon thereafter Carteret was trading at $11 5/8 per share and Home, at $14.50 per share, was approximately $4 down from the $18.50 per share it traded at when the merger was announced. 18

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Home sought to renegotiate the deal and Carteret filed suit in Delaware to force Home to complete the merger. In January 1988, the parties agreed to a new price of $19.00 per share. Home received an option to acquire 18.5 percent of Carteret (which it exercised for $11.9 million to deter others from bidding on Carteret), and Carteret was given 30 days in which to seek a better offer. No better offer emerged. DX 8000 at 17-18. 24. By the end of 1987, Carteret was beginning to suffer substantial earnings

problems. Net income declined by 28 percent in 1987, and income before gains on securities sales declined by 68 percent, to $11.6 million. Carteret also was losing the benefit of the income spread between accretion and amortization because many of the accreted loans were maturing and the thrift reduced the period over which the goodwill would be amortized from a maximum of 40 years to a maximum of 25 years. Although these changes in Carteret's financial condition may have supported a decision by Ambase to abandon the transaction under the "material adverse changes" clauses in the acquisition contract, Ambase acquired Carteret. The transaction closed in August 1988, a year after Ambase made its initial offer. DX 8000 at 18. The FHLBB approved Ambase's change of control application upon the assumption that Ambase could be a source of capital strength to Carteret. Indeed, under the FHLBB's policy, Ambase's application could not have been approved if it did not appear financially competent to augment Carteret's regulatory capital ratios in the event the thrift suffered losses and lacked sufficient capital. Unfortunately, as future events demonstrated, Ambase's financial condition deteriorated as, or more, quickly than Carteret's and it was unable to provide the financial support Carteret required.

19

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E.

AMBASE ABUSED ITS OWNERSHIP POSITION BY SIPHONING CAPITAL FROM CARTERET While Ambase was fully aware that Carteret was undercapitalized at the time it

25.

made the acquisition, DX 8000 at 18, instead of taking immediate steps to improve Carteret's capitalization it drained capital from Carteret to advance its own business objectives. For example, immediately after the acquisition, Ambase caused Carteret to pay a $22.9 million dividend to Ambase and to redeem $11.9 million of stock Ambase had acquired before the acquisition pursuant to the exercise of an option. In 1989, Ambase caused Carteret to upstream another $13 million dividend. Ambase also caused Carteret to acquire one of Ambase's businesses, Imperial Premium Finance ("IPF") for $65 million in cash. This transaction enabled Ambase to record a $10.8 million gain and required Carteret to charge $10.8 million against regulatory capital. DX 7063 at 10. In 1990, Ambase also required Carteret to make an advance of $2.1 million to Chairman O'Brien against his accelerated retirement benefit, to enable Mr. O'Brien to repay a mortgage he held with a Home subsidiary. Further, Carteret agreed to pay Ambase a management fee of $2.5 million in 1989 and in future years. DX 8000 at 18-19. 26. Ambase also misused Carteret's capital by engaging Carteret in transactions with

General Development Corporation ("GDC"), a real estate developer and a participant in the time share industry. GDC had been a subsidiary of CIC, and its Board of Directors included four members of Ambase's Board of Directors (Scharffenberger, Hatch, Payne, and Manley). Following Ambase's acquisition of Carteret, Carteret was required to purchase $66.8 million of mortgages from a subsidiary of GDC without the required appraisals. Carteret also participated in a revolving credit agreement that was classified as 100 percent doubtful by OTS and FDIC

20

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examiners. DX 8000 at n.41. The loans to GDC were in excess of permissible loans to a single borrower. Carteret's interest in the credit agreement amounted to approximately $9.5 million. DX 7000 at 79. In December 1989, the U.S. Attorney for the Southern District of Florida charged GDC and various executives with fraud based upon allegations that GDC was using inflated appraisals to sell homes at inflated prices. Id. On March 16, 1990, GDC pleaded guilty to one count of conspiracy and agreed to pay a criminal fine and make restitution to customers. Id. In April 1990, GDC declared bankruptcy in response to the indictment of the company and its two top officers. Carteret suffered a loss of approximately $5 million on its participation in the revolving credit line to GDC. DX 7000 at 83. F. DESPITE SIPHONING CARTERET'S CAPITAL FOR ITSELF, AMBASE WAS UNABLE TO IMPROVE ITS OWN DETERIORATING FINANCIAL CONDITION Despite siphoning capital from Carteret for its own corporate purposes, Ambase

27.

was unable to achieve stable earnings or provide a reservoir of capital strength for Carteret. For example, between 1986 and 1988, Ambase used substantial leverage to acquire a finance company, a retail brokerage firm (Gruntal Financial Corp.), and Carteret Bancorp. The cost of the acquisitions was approximately $530 million. DX 5001 at 71. These acquisitions increased Ambase's debt load to $2.9 billion, or 60 percent of its total capital, which was about four times the average debt load of other property and casualty insurance companies. During the time Ambase engaged these acquisitions, competition from other insurance companies had driven down premiums and margins tightened. From October 1989 through May 1990, Ambase's stock price fell from $15 per share to approximately $7 per share. Id. As a major holder of Drexel Burnham underwritten "junk bonds," Ambase was one of Drexel Burnham Lambert's largest 21

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unsecured creditors. The week of February 13, 1990, when Drexel Burnham filed for bankruptcy protection, Ambase's stock fell 4 percent. Id. at 72. 28. In order to enhance shareholder value, Ambase decided to sell Home and two

smaller insurance units (U.S. International Reinsurance Co. and Commonwealth Insurance Co.). Ambase could not sell Carteret or Gruntal because it had overpaid when it acquired them and did want to have to report a loss on the sale of either firm. DX 5001 at 72. At the time of the sale, many analysts commented that Home's reserves were materially short of legal requirements and Ambase was unlikely to realize the price it anticipated. Id. In fact, the price received ($740 million) was extremely low relative to outstanding debt and prompted a sell-off of Ambase bonds which caused their prices to plunge. Id. at 74. In August 1990, Ambase announced a second quarter loss of $106 million which largely stemmed from the devaluation of junk bonds held by its insurance subsidiaries. This loss of capital caused Ambase to fall out of compliance with the loan agreement to finance the acquisition of Carteret. Id. In the second quarter of 1990, Ambase was forced to cancel a promised extraordinary dividend and its stock price fell to approximately $2.75 per share. PX 2702 at 70. G. CARTERET'S FINANCIAL CONDITION WORSENED DURING THIS PERIOD AS WELL FOR REASONS TOTALLY UNRELATED TO THE BREACH By the end of 1987, Carteret was beginning to suffer earnings problems as its net

29.

income declined by 28 percent, and income before gains on securities sales declined by 68 percent, to $11.6 million. DX 8000 at 18. The general economy slowed down in 1988 and 1989 and moved into a recession in 1990 and 1991. Id. These events were unrelated to the breach but set the stage for Carteret's eventual demise. Carteret began to experience a severe credit crunch 22

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based primarily upon the inability of its commercial loan customers to satisfy their obligations and the loss in property values caused by the economic slowdown and recession. As late as 1992, the FDIC, in its report of examination, attributed Carteret's real estate losses in large part to "poor underwriting standards and weak credit administration practices . . ." DX 8058 at 1-2. Between December 1987 and June 1989, Carteret's criticized assets increased from $274.6 million to nearly $479 million. DX 7000 at 16. As of June 1989, Carteret's classified assets equaled 5.6 percent of its total assets; this was far in excess of the peer group average of 3.3 percent. In the 1989 report of examination, the FHLBB cautioned that "the level of criticized assets may even increase since numerous loans originated during the review period are located in regions of the country that are experiencing depressed real estate markets." Id. The examiner attributed the decline in asset quality "to the lack of adequate underwriting." DX 7063 at 20. 30. In 1988, Carteret added $14 million to loan loss reserves, and then added another

$28 million in 1989. DX 7000 at 22. Despite the $28 million increase in 1989, the FHLBB examiner identified $24.6 million in specific losses and noted that Carteret's reserves had to be increased by an additional $77.2 million. Carteret, however, never booked this additional reserve. Id. at 17. 31. According to the OTS 1990 report of examination ("ROE"), because of the "poor

quality of loan underwriting . . . [and] a declining real estate market . . . loan loss allowances are seriously inadequate . . . [and] [t]he bank's viability has deteriorated due to the corrosive effect of its asset problems on its level of capital." DX 7064 at 8. Carteret itself reported criticized assets of $616.9 million as of June 1990; this was a $138 million increase from the $478.9 million identified in the 1989 ROE. DX 7000 at 18. The examiner concluded that Carteret's internal 23

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loan review function was inadequate and that Carteret's criticized assets actually totaled nearly $862 million, which was $245 million more than Carteret had identified. Id. In view of Carteret's deteriorating commercial loan portfolio, the examiner concluded that Carteret carried insufficient general valuation allowances. The examiner ordered Carteret to increase these allowances by $77 million (to $98 million) by September 1990. Id. Carteret recorded a total loan loss provision of $122.3 million in calendar year 1990. Id. 32. Carteret's asset quality continued to deteriorate following the 1990 examination.

During the March 1991 quarter, Carteret's classified assets increased by nearly $110 million. DX 7000 at 20. Carteret's management, however, only increased its valuation reserves from $160 million to $169 million. Id. In May 1991, Richard Bianco took over as Chairman and Chief Executive Officer of Carteret. Among other management changes, he appointed Wayne Moor as Executive Vice-President in charge of Carteret's Commercial Asset Division on June 21, 1991. DX 7000 at 20. As of March and June 1991, 61.6 percent and 72.3 percent of Carteret's commercial assets, respectively, were classified. An additional $107.5 million in commercial assets were marked "special mention." As of June 1991, criticized assets totaled nearly $782.8 million or 84 percent of Carteret's total commercial asset portfolio. Id. at 21. 33. As of September 1991, the commercial real estate portfolio deteriorated even

further. An incredible 53.6 percent of Carteret's commercial assets were non-performing, while 45.2 percent of its outstanding commercial loans were either in-substance foreclosure or on nonaccrual. DX 7000 at 22. Mr. Moor's job was to determine what the aggregate reserves should be and how much of a credit loss Carteret needed to record to cover the losses inherent in its commercial asset portfolio. Id. 24

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