Free Published Opinion - District Court of Federal Claims - federal

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In the United States Court of Federal Claims
No. 95-517 C Filed April 13, 2007 TO BE PUBLISHED __________________________________________ ) FIRST FEDERAL SAVINGS AND LOAN ) ASSOCIATION OF ROCHESTER, ) ) ) Plaintiff, ) ) v. ) ) ) THE UNITED STATES OF AMERICA, ) ) ) Defendant. ) ) __________________________________________) Winstar, damages, FIRREA, contract breach as cause of curtailed asset growth, lost profits based upon thrift's actual historic yields and costs of funds, failure to approve merger application as breach, damages due to compelled modified conversion, offset of benefits from such conversion, prior material breach, award of damages where Government bore economic risks of ownership of mutual thrift at time of breach

David T. Case, Kirkpatrick & Lockhart Preston Gates Ellis LLP, Washington, D.C., for plaintiff. Joseph J. Brigati, Kirkpatrick & Lockhart Preston Gates Ellis LLP and Joseph P. Vitale, Kirkpatrick & Lockhart, LLP, Washington, D.C., of counsel. Jerome A. Madden, Trial Attorney, William F. Ryan, Assistant Director, Jeanne E. Davidson, Deputy Director, David M. Cohen, Director, Stuart E. Schiffer, Deputy Assistant Attorney General, United States Department of Justice, Washington, D.C., for defendant. Gregory R. Firehock, Arlene Pianko Groner, William G. Kanellis, Delisa M. Sanchez, Trial Attorneys, United States Department of Justice, Washington, D.C., of counsel.

OPINION AND ORDER GEORGE W. MILLER, Judge. This Winstar matter is before the Court following a 27-day trial on damages held in Washington, D.C. The parties filed Post-Trial Proposed Findings of Fact and Conclusions of Law and responses thereto, and the Court heard closing arguments.

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Rule 52(c) of the Rules of the Court of Federal Claims ("RCFC") governs "actions tried upon the facts," and provides that findings of fact may be "based on oral or documentary evidence . . . and due regard shall be given to the opportunity of the trial court to judge of the credibility of the witness." RCFC 52(a). The Court heard testimony from fifteen witnesses. The fact witnesses included former executives and board members of First Federal Savings & Loan Association of Rochester ("First Federal" or "the Association"), including: Thomas Borshoff, former president, chief executive officer, and chairman; Mark Chaplin, former chief financial officer; Thomas Mullin, former senior vice president and general counsel; Peter Sear, former executive vice president and board member; and Professor Jack Guttentag, Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania, and a former First Federal board member. The Government also introduced into evidence portions of the transcript of the deposition of Richard B. Coles, an officer of Canada Trust who became a director of First Federal after its acquisition by Canada Trust in May 1991. See Transcript of Proceedings, First Fed. Savings & Loan Ass'n of Rochester v. United States, No. 95-517C (Fed. Cl. Jun. 1 - Jul. 14, 2004) ("Tr.") 3881:16-3884:12; DX 1778 (Coles August 24, 2000 Dep. Tr.) at 1-64. The Court also heard testimony from federal regulators of thrift institutions, including: Angelo Vigna, a former official of the Federal Home Loan Bank of New York ("FHLB-NY") and the Office of Thrift Supervision ("OTS"), who served as acting director of the Federal Savings and Loan Insurance Corporation ("FSLIC") from November 1985 through May 1986; Michael Simone, a former supervisory agent for the FHLB-NY; Simkha Palant, a former controlled associations branch chief at the FSLIC, who testified from Estonia via videoconference; Alvin Smuzynski, a former official of the Federal Home Loan Bank Board ("FHLBB") and OTS; and David Dorgan, former senior assistant director of OTS. The Government also introduced into evidence the transcript of the deposition of Thurman Connell, director of the FSLIC in 1986. See DX 1789 (Connell August 15, 2003 Dep. Tr.) at 903. Dr. Donald Kaplan testified as an expert witness on behalf of First Federal. A consultant to financial institutions, Dr. Kaplan is the holder of a Ph.D. in finance and economics from UCLA. Tr. 2770:3-22, 2776:9-15 (Kaplan). He was qualified as an expert in finance and economics as applied to thrift institutions; thrift regulation, operation and valuation; and thrift capital-raising transactions. Tr. 2827:22-2828:8 (Kaplan). Dr. Kaplan served as chief economist and director of research for the FHLBB from 1975 to 1977. Tr. 2777:13-2789:2 (Kaplan); PX 735. Plaintiff also introduced into evidence the transcript of the deposition of William F. Wolf, the partner in charge of tax and accounting services for an accounting firm, who had been retained by the Government as an expert in taxation. Mr. Wolf earned an MBA from the University of Southern California and is a certified public accountant . Tr. 4089:22-4090:17; DX 1642 ¶ 1 & Ex. A. On behalf of the Government, Dr. Haluk Unal was qualified to testify as an expert in economics; finance; accounting; credit risk; and the process and pricing of mutual-tostock conversions of financial institutions; the relationship of economics, finance and accounting to financial institutions and, in particular, to the economic ownership of mutual thrifts. Tr. 4136:16-19 (Unal). Dr. Unal holds a Ph.D. in finance from Ohio State University and teaches in the Department of Finance of the R. H. Smith School of Business at the University of Maryland. 2

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Dr. David Rochester, CEO of a financial consulting firm that specializes in work with thrift institutions, also testified for the Government. He was qualified to testify as an expert in mutualto-stock conversions and other capital-raising activities; financial institution management, operations and regulation; valuation and financial analysis of depository financial institutions; and financial and strategic planning for financial institutions. Tr. 4373:17-24, 4400:2-7 (Rochester). Dr. Rochester holds a Ph.D. from the University of Georgia with a concentration in banking and finance and a minor in economics. Tr. 4374:16-23 (Rochester). Finally, Dr. Andrew Carron was qualified to testify on behalf of the Government as an expert in financial economics; economic damages; thrift industry structure and performance; government policy and regulation of the thrift industry; mortgage and capital markets and products; and thrift industry asset and liability management. Tr. 5192:22-5193:3, 5206:15-25 (Carron). Dr. Carron, a senior vice president of an economic consulting firm, holds two masters degrees and a Ph.D. in economics from Yale. Tr. 5184:17-5185:1 (Carron). BACKGROUND I. Facts1

The factual background of the case was set forth in detail in Judge Merow's October 14, 2003 opinion, First Federal Savings & Loan Association of Rochester v. United States, 58 Fed. Cl. 139 (2003) ("First Federal I"). That background is summarized below. In the early 1980s, the savings and loan industry experienced a severe financial crisis resulting from an increase in short-term interest rates. Thrifts were placed in the position of funding long-term, fixed-rate loans with higher priced short-term deposits. In an effort to mitigate the crisis, the FSLIC in 1981 created the Phoenix program. Under the Phoenix program, troubled thrifts were consolidated in an attempt to achieve efficiencies and create a stronger resulting institution. The consolidated thrift was closely supervised, with the hope that it could be stabilized until interest rates moderated, earnings could be generated, and a more long-term solution, such as recapitalizing or selling the institution, could be arranged. Tr. 375:15-17 (Vigna); see First Federal I, 58 Fed. Cl. at 141 ("[A] new institution would arise from the funeral pyre like the mythical Phoenix."); see also LaSalle Talman Bank v. United States, 317 F.3d 1363, 1366-67 (Fed. Cir. 2003). First Federal became the first participant in the Phoenix program. It was consolidated with four other thrifts. Because it had the strongest balance sheet and was deemed by FSLIC to have the strongest management of the four, First Federal was selected to be the surviving institution.

Certain of the Court's findings of fact are set out in this section. The remainder of the Court's findings of fact and rulings on questions of mixed fact and law are set out in the Discussion section at pages 8-68, infra. 3

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In 1984, the FSLIC put First Federal out for bid as a means of resolving the Association's status as a Phoenix institution. The only bid that the FSLIC received, however, was a recapitalization proposal that the Association itself submitted. The proposal recommended that the Government infuse First Federal with capital, forgive the Association's existing debt, and allow management to operate First Federal as a normal, healthy thrift. In exchange, First Federal's management would build the institution to a position where it could convert from a mutual to a stock institution2 that would have sufficient capital to operate without FSLIC assistance. The FSLIC would also receive warrants to purchase stock in First Federal after it converted to stock form. The FSLIC accepted First Federal's bid and, on August 8, 1986, executed a Financing Agreement ("Financing Agreement") incorporating First Federal's proposals. The Financing Agreement provided for an initial payment by the FSLIC of $200 million, as well as the cancellation of $158 million in debt in the form of income capital certificates and net worth certificates payable to the FSLIC. See First Federal I, 58 Fed. Cl. at 142, 148.3 In addition,

Mutual associations were permitted to convert to stock form by standard or modified conversions. See 12 C.F.R. §§ 563b.3, 563b.34 (1986). In a standard conversion, a mutual association is converted by issuing and selling stock in the public markets. See 12 C.F.R. § 563b.3(c). As part of such a standard conversion, "each eligible account holder shall receive . . . subscription rights to purchase capital stock" in the institution. Id. § 563b.3(c)(2). In a modified conversion, "the [FHLBB] will permit . . . deviance from the substantive and procedural requirements . . . for standard conversions." 12 C.F.R. § 563b.35 (1986). Associations were candidates for a modified conversion when it was determined that "(i) [s]evere financial difficulties exist which threaten the stability of the insured institution, and (ii) the conversion to stock form is likely to improve the financial condition of the institution." 12 C.F.R. § 563b.36(a)(2) (1986). "Under the Phoenix program, FSLIC provided financial assistance to First Federal by the purchase of Income Capital and Net Worth Certificates . . . to fund regulatory accounting practice (RAP) purchase accounting losses." First Federal I, 58 Fed. Cl. at 142. 4
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Section 6.10 of the Financing Agreement specified that First Federal could operate with levels of capital lower than those required by the then current regulations.4 After the Financing Agreement was executed, First Federal's management prepared the Association for conversion to stock form by increasing asset growth, net worth, and earnings through "organic growth," i.e., by originating adjustable-rate mortgages, and by purchasing wholesale assets, such as mortgage-backed securities. Management also sought to build First Federal's asset base by acquiring other financial institutions. Therefore, when the Federal Deposit Insurance Corporation ("FDIC") sought to sell Monroe Savings Bank ("Monroe"), a troubled, federally chartered, FDIC-insured, mutual savings bank that did business in First Federal's geographic area, the Association submitted applications to the FDIC and the FSLIC to acquire Monroe. On August 9, 1989, the Financial Institutions Reform, Recovery, and Enforcement Act ("FIRREA") became effective. Pub. L. No. 101-73, 103 Stat. 183 (1989). Under FIRREA, thrifts were required to maintain certain levels of core capital reserves, tangible capital, and riskbased capital. 12 U.S.C. § 1464(t)(1)(A) (Supp. I 1989). FIRREA transferred the authority for regulating thrifts from the FHLBB to the OTS. See Fifth Third Bank of W. Ohio v. United States, 402 F.3d 1221, 1224 (Fed. Cir. 2005). FIRREA also transferred thrift insurance activities from the FSLIC to the FDIC, and created the RTC to liquidate failed thrifts. Id. In November 1989,

4

Section 6.10 stated:

The amount of net worth required under 12 C.F.R. § 563.13 (1986) or any successor regulation shall not be required of First Federal. Instead, First Federal will be required to have a net worth/total liabilities ratio, computed in accordance with generally accepted accounting standards, greater than or equal to the following: Years After Initial Closing 1-5 6-7 8-10 Minimum Net Worth/ Total Liabilities 1.09 1.41 3.56

However, if the net worth ratio should at any time fall materially below the required percentages then First Federal shall be in breach of this Agreement. In addition to any other remedies available, FSLIC shall have all the rights granted it under 12 C.F.R. § 563.13 (1986) or any successor regulation. PX 17 (Financing Agreement § 6.10) at WOF0202005. 5

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OTS issued Regulatory Release 89-61, "New Minimum Capital Requirements," which informed First Federal that it would fail FIRREA's capital requirements when they became effective on December 7, 1989.5 See First Federal I, 58 Fed. Cl. at 143. OTS also issued Thrift Bulletin 36 ("TB-36"), "Guidelines for FIRREA Capital Plans, Exemptions and Exceptions." PX 281. TB36 provided that a thrift failing FIRREA capital compliance could apply "for a limited capital exception, an exemption from a supervisory sanction or restriction, or a limited growth exception." Id. at FR001243. Thrifts applying for an exemption or exception were required to submit a Capital Plan demonstrating that they could meet FIRREA's capital requirements by December 31, 1994. Id. at FR001244. TB-36 also specified that a thrift that failed to meet applicable capital standards could only increase its assets "to an amount not to exceed the amount of net interest credited to its deposit liabilities." Id. In November 1989, Mr. Vigna of FHLB-NY informed First Federal's management that the Association's application to acquire Monroe would not be approved. Tr. 342:24-344:6, 1805:9-19 (Borshoff). In December 1989, OTS again informed First Federal that it did not satisfy the new capital requirements of FIRREA, and that it would be required to submit a Capital Plan in accordance with TB-36. See First Federal I, 58 Fed. Cl. at 143. OTS also indicated that failure to meet the benchmarks in the Capital Plan would subject the Association to "appropriate enforcement action." Id. On January 5, 1990, First Federal submitted its Capital Plan ("Strategic Business Plan") to OTS. First Federal I, 58 Fed. Cl. at 143; PX 333. Later that month, OTS issued Thrift Bulletin 38-2 informing all thrifts that capital and accounting forbearances that had previously been granted by the Government were eliminated by FIRREA, and that OTS would determine capital adequacy without regard to any such forbearances. First Federal I, 58 Fed. Cl. at 143. OTS conditionally approved First Federal's Strategic Business Plan on May 22, 1990. PX 248. With some additional changes, a revised Conditional Approval of the Capital Plan was signed by OTS and First Federal on October 23, 1990. First Federal I, 58 Fed. Cl. at 144. In May 1991, First Federal engaged in a modified conversion from mutual to stock form and was acquired by Canada Trust, a Canadian bank that was interested in gaining a foothold in the American financial services market. In exchange for 99 percent of First Federal's stock, Canada Trust provided First Federal with capital sufficient to satisfy FIRREA's capital requirements following certain portfolio restructuring transactions undertaken by First Federal. As part of the Canada Trust transaction, First Federal repurchased the warrant rights it had granted to the FSLIC incident to the Financing Agreement. Later, in 1997, Canada Trust sold

After FIRREA transferred to the OTS the authority to regulate savings associations, OTS reissued the regulations in 12 C.F.R. chapter V, as revised pursuant to FIRREA, setting forth the new regulatory structure for the thrift industry. Most of the reissued regulations became effective on November 30, 1989. However, 12 C.F.R. §§ 567.1, 567.2, 567.5, 567.6, and 567.8 through 567.11 became effective December 7, 1989. Sections 545.131, 545.132, and 545.141(d) became effective December 15, 1989, and § 571.19 did not become effective until January 1, 1990. 54 Fed. Reg. 49,411 (Nov. 30, 1989). 6

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First Federal to another financial services institution, HSBC, which merged First Federal into Marine Midland Bank, one of its subsidiaries. II. Procedural History

Judge Merow resolved nearly all of the liability issues in his October 14, 2003 opinion, holding the Government liable for breaching the Financing Agreement. First Federal I, 58 Fed. Cl. at 160. In a subsequent opinion, Judge Merow granted the Government's motion to dismiss First Federal's illegal exaction claim. First Federal Savings & Loan Ass'n of Rochester v. United States, 59 Fed. Cl. 667, 668 (2004) ("First Federal II"). At trial, the parties presented evidence on the following issues of liability and damages: Issue 1: Whether the Government's breach of the Financing Agreement caused First Federal to curtail growth of profitable assets and suffer lost profits in the amount of $26.061 million from 1990 until it was acquired by HSBC in 1997. Whether OTS's failure to approve First Federal's application to merge with Monroe Savings Bank constituted a breach of the Financing Agreement because it was based upon First Federal's failure to satisfy the capital requirements of FIRREA. Whether First Federal suffered damages of $56.137 million as a result of OTS's failure to approve the Monroe merger application.6 Whether, if the Monroe merger had not gone forward, First Federal would have, but for the breach, replaced the assets that it would otherwise have acquired through the Monroe merger with similar assets and liabilities acquired in the market. Whether First Federal suffered lost profits in the amount of $28.514 million between 1990 and 1997 as a result of its inability to replace the Monroe assets.

Issue 2:

Issue 3:

Issue 4:

Issue 5:

First Federal's claimed damages attributable to the failure to approve the Monroe merger application included: $30.388 million in profits that First Federal would have earned on Monroe's assets between 1990 and 1997, less an insurance premium of $3.232 million that First Federal would have had to pay to the Savings Association Insurance Fund ("SAIF"), plus Monroe's deposit franchise premium of $28.981 million. Tr. 2831:24-2832:3, 3160:8-3167:16 (Kaplan); PX 8000 (Kaplan Demonstrative Book) at 71. 7

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Issue 6:

Whether First Federal suffered damages of $23.883 million as a result of its merger with Canada Trust in May 1991.7 Whether First Federal committed a prior material breach of the 1986 Financing Agreement that excused the Government's later breach. To what extent any damages sustained by First Federal should be offset by the benefits First Federal derived from the Canada Trust transaction. DISCUSSION

Issue 7:

Issue 8:

I.

The Government's Breach of the Financing Agreement Caused First Federal to Curtail Growth of Profitable Assets and to Lose Profits of $26.061 Million That It Would Have Earned Between 1990 and 1997 But For the Breach

As more fully discussed below, FIRREA caused the Association to forego asset growth of approximately $400 million in 1989, which resulted in lost profits of approximately $26 million in the period from 1990 until 1997 when First Federal was acquired by HSBC. The Government argues that a recessionary economy, not FIRREA, caused First Federal to fall short of its growth target ($700 million) in 1989. The Government also argues that it was not foreseeable that First Federal would achieve asset growth of the magnitude that it claims it would have in order to maximize the amount it would realize in a standard conversion. Finally, the Government argues that First Federal did not establish the amount of profits it lost on the so-called "foregone assets" with reasonable certainty. A. In Order to Recover Expectancy Damages First Federal Must Satisfy the Requirements of Causation, Foreseeability and Reasonable Certainty

"There is nothing extraordinary about the contracts in [Winstar] cases . . . . When the Government enters into such contracts, `its rights and duties therein are governed generally by the law applicable to contracts between private individuals.'" Winstar Corp. v. United States, 64 F.3d 1531, 1551 (Fed. Cir. 1995) (quoting Lynch v. United States, 292 U.S. 571, 579 (1934)). Thus, the fact that the breach in this case was committed by the Government does not alter the remedies to which First Federal is entitled. First Federal I, 58 Fed. Cl. at 160 (quoting RESTATEMENT (SECOND ) OF CONTRACTS § 346, cmt. a (1981) ("`Every breach of contract gives
7

First Federal's claimed damages attributable to the Canada Trust transaction included: (a) the $3 million cost of repurchasing warrant rights from the FDIC; (b) $1.983 million in costs and fees, including attorneys' fees of $880,000, New York State transfer fees of $403,000, and a $700,000 payment to management resulting from the change in control; (c) $11.5 million due to income lost by reason of the need to restructure First Federal's balance sheet in order to comply with FIRREA's risk-based capital standards; and (d) $7.4 million in lost tax benefits. PX 8000 at 83; Tr. 3601:13-3607:14 (Kaplan). 8

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the injured party a right to damages against the party in breach' unless `the parties . . . by agreement vary the rules'")), aff'd in part, vacated in part, and remanded, 189 F. App'x. 964 (Fed. Cir. 2006). In California Federal Bank v. United States, the Federal Circuit clarified the burden that plaintiffs must bear in establishing a claim for damages due to breach of contract. "Contract remedies are designed to make the nonbreaching party whole. One way to achieve that end is to give the nonbreaching party `expectancy damages,' i.e., the benefits the nonbreaching party expected to receive in the absence of a breach." Cal. Fed. Bank, 395 F.3d 1263, 1267 (Fed. Cir. 2005) (citing Glendale Fed. Bank, F.S.B. v. United States, 239 F.3d 1374, 1379 (Fed. Cir. 2001) (citing RESTATEMENT (SECOND ) OF CONTRACTS § 344(a)). "Expectancy damages ordinarily serve as the basis for an award of contractual damages." Globe Sav. Bank, F.S.B. v. United States, 65 Fed. Cl. 330, 345 (2005) (citing LaSalle Talman, 317 F.3d at 1371; RESTATEMENT (SECOND ) OF CONTRACTS § 344 cmt. a; 24 SAMUEL WILLISTON & RICHARD A. LORD , A TREATISE ON THE LAW OF CONTRACTS § 64:2, at 30 (4th ed. 2002)). The Federal Circuit has explained that "[i]n order to be entitled to expectancy damages, which include lost profits, the plaintiff must satisfy three requirements." Cal. Fed. Bank, 395 F.3d at 1267. First, plaintiff must demonstrate that the loss was foreseeable. Id. (citing La Van v. United States, 382 F.3d 1340, 1351 (Fed. Cir. 2004); Energy Capital Corp. v. United States, 302 F.3d 1314, 1325 (Fed. Cir. 2002); RESTATEMENT (SECOND ) OF CONTRACTS § 351(1)). Second, plaintiff must establish that the breach caused its failure to earn the allegedly lost profits. Id. (citing Rumsfeld v. Applied Cos., 325 F.3d 1328, 1339 (Fed. Cir. 2003)); Citizens Fed. Bank v. United States, 474 F.3d 1314, 1318 (Fed. Cir. 2007). "Third, the measure of damages must be reasonably certain, although if `a reasonable probability of damage can be clearly established, uncertainty as to the amount will not preclude recovery.'" Cal. Fed. Bank, 395 F.3d at 1267 (citing Glendale Fed. Bank, F.S.B. v. United States, 378 F.3d 1308, 1313 (Fed. Cir. 2004) (quoting Locke v. United States, 151 Ct. Cl. 262, 267, 283 F.2d 521, 524 (1960))). B. Causation

The Court of Appeals for the Federal Circuit recently stated that, in determining the proper standard of causation in an action for breach of contract, its precedents "may appear superficially somewhat inconsistent in applying the [less-stringent] `substantial factor' and [more-stringent] `but for' theories. We discern a common thread among them, however: the selection of an appropriate causation standard depends upon the facts of the particular case and lies largely within the trial court's discretion." Citizens Fed. Bank, 474 F.3d at 1318. Although the Federal Circuit has sustained the use by the Court of Federal Claims of the "but-for" test in a number of cases, such approval does not "announc[e] any broad rule that the `but-for' theory of causation must always, or even generally, be used in determining damages in Winstar-related cases or prohibiting the trial court from using the `substantial factor' test in appropriate cases." Id. at 1319.

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Although not required to meet the more-stringent but-for standard, First Federal has established that it would have earned the profits it seeks to recover but for the Government's breach. Cal. Fed. Bank, 395 F.3d at 1267 (citing Rumsfeld, 325 F.3d at 1340). First Federal need not establish that the breach of the Financing Agreement was "the sole factor or sole cause" of its lost profits. Id. at 1268. The existence of other factors operating in confluence with the breach will not preclude First Federal's recovery on a but-for theory. Id. (citing E. ALLAN FARNSWORTH , CONTRACTS § 12.1 at 150-51 (3d ed. 2004)). However, the causal connection between the breach and the loss of profits must be "definitely established" so that "the nonbreaching party will not be awarded more than it would have received if the contract had been performed." Id. 1. Historically, First Federal Had Achieved Its Goal of Increasing Its Assets In Order to Maximize Earnings Growth and Net Worth

Even as a Phoenix institution, First Federal had sought to grow its assets. The Association's assets grew from $4.023 billion in 1982 to $4.656 billion in 1985. PX 2000 (F. Fed. Asset Growth); Tr. 1086:1-3, 1088:2-6 (Chaplin). Mr. Vigna, who in early 1986 was the acting director of the FSLIC, recognized that First Federal sought continued profitable growth. In an analysis of First Federal's proposed recapitalization plan, Mr. Vigna acknowledged that "in 1986, [First Federal] will allow expansion of its core businesses to be of greatest importance by seeking a balance between longterm growth and near-term profitability." PX 562 at FLT0030037; see Tr. 393:16-395:21 (Vigna). Mr. Vigna also noted that First Federal planned to "[u]ndertake ambitious asset and liability origination goals" by increasing mortgage originations by 72 percent, commercial lending by 143 percent, consumer lending by 22 percent, construction lending by 392 percent, retail deposits by 6.5 percent, and loan servicing volume by 14 percent. PX 562 at FLT0030038; Tr. 396:1-397:4 (Vigna). First Federal also had a goal of generating off-balance-sheet assets. PX 562 at FLT0030037. Later, Thurman Connell, who succeeded Mr. Vigna as acting director of the FSLIC, recommended that the FLHBB approve First Federal's proposed recapitalization plan. PX 14 at WOT7240060. Mr. Connell wrote that First Federal had been "extremely profitable with respect to its new business," highlighting the fact that the Association had booked $1 billion of new business in 1985. Id. at WOT7240052-53. Mr. Connell also endorsed the abilities of First Federal's management team: There is much `new blood' within the organization, and as a result, management has analyzed and initiated many new ideas so that it may compete successfully in the financial services industry. [The FSLIC] staff has found [First Federal's] management to be most competent; furthermore, staff is confident in management's ability to carry out its future strategies successfully while not subjecting the Association to undue interest rate and credit risk.

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Id. at WOT7240053. Those future strategies centered upon profitable asset growth. PX 562 at FLT0030037; see PX 518 at WOF02083. In 1988, First Federal expanded its loan origination network in order to achieve increased growth. PX 68 (1988 Business Plan) at FR353882-83. By the end of 1988, First Federal had achieved asset growth of $640 million in that year. PX 2000; Tr. 1546:1-1547:4 (Chaplin). The Association was prepared to continue growing in 1989. The 1989 Budget provided for growth in the Association's assets of approximately $700 million, from total assets of $5.4 billion at the end of 1988 to $6.1 billion in 1989. PX 62 (1989 Budget) at FR355134; Tr. 1199:18-1200:6 (Chaplin). Mr. Chaplin testified convincingly that the growth plans reflected in the 1989 budget, though ambitious, were "absolutely" feasible and realistic. Tr. 1196:5-1197:3 (Chaplin); see also PX 645 at FR370148. From the time it executed the Financing Agreement, First Federal sought to maximize earnings growth and net worth. Tr. 2878:1-2879:6 (Kaplan). By doing so, First Federal expected to increase the amount it would receive in a standard conversion, and also position itself to meet regulatory capital requirements when the Financing Agreement came to an end. Tr. 2880:42881:7 (Kaplan). First Federal planned to achieve these objectives by increasing asset growth by 10 to 12 percent per year. Tr. 2879:10-22 (Kaplan).8 There are other ways to increase earnings, such as reducing overhead and increasing the interest rate spread, but asset growth is at the "top of the list" of the ways a thrift institution increases earnings. Tr. 2864:6-2865:17 (Kaplan). In order to achieve its goals, First Federal developed a strategic plan that included a 10year mission statement and several "corporate maxims." Tr. 144:17-145:19 (Borshoff). The second corporate maxim stated: "The accumulation of capital through earnings growth and other sources will be the central focus that will give the Association the means to achieve all other aspects of the Mission Statement." PX 67 (1987 Bus. Plan) at FR354880; Tr. 151:14-25 (Borshoff). The Government argues that First Federal, in fact, subordinated asset growth to the goal of increasing its net worth ratio. Tr. 4476:19-4479:17 (Sear), Tr. 5234:5-5235:5 (Carron); DX 464 at FR083048-49; DX 513 at FR439339-40. Mr. Borshoff, the former president, chief executive officer, and chairman of First Federal, conceded that "[i]n general" First Federal would not add assets if the effect would be to reduce the Association's net worth ratio. Tr. 711:15715:6 (Borshoff).

Asset growth helped First Federal spread its operating costs over a larger base, thereby decreasing operating ratios and permitting the Association to be more profitable. Tr. 1192:191193:1, 1195:11-20 (Chaplin); PX 645 (October 21, 1988 Memorandum Re: 1989 Budget) at FR370147. Asset growth can be a successful strategy for increasing earnings. Assuming equivalent asset quality, interest rate risk, and comparable operating characteristics, an institution with more assets will have higher earnings. Tr. 712:13-24, 713:10-25 (Borshoff). 11

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However, Mr. Chaplin, First Federal's former chief financial officer, stated that First Federal's primary objective was to grow earnings through asset growth. Tr. 2337:3-5 (Chaplin). First Federal established that while strengthening net worth ratios was an important objective of the Association, management was not fixated on any specific net worth ratio. Mr. Chaplin explained that: Our primary objective was to grow earnings, and the earnings were being grown through growth. That was our primary objective. Certainly, we had a duty and a secondary goal of increasing capital. However . . . we looked at the longer-term economic benefits that were coming from individual activity and weren't fixated on an individual number at a point in time. So to make this as clear as I possibly can, we were trying to increase ­ to build a value that investors would pay the most for when we converted the institution, and they wouldn't pay for an existing net worth ratio at a point in time. They would pay for our earnings and future prospects of earnings growth, and that was really our key focus. Tr. 2337:3-16 (Chaplin). The Government points out that in early 1989, First Federal recognized that funding its budgeted asset growth would be more costly than planned. PX 134B at FR344581; Tr. 4510:54512:24 (Sear). Although retail deposits tended to be the least costly source of funds, the Government maintains that due to increased pressure in the retail markets, First Federal suffered unanticipated deposit runoff and was forced to rely upon typically more expensive sources of funds such as Federal Home Loan Bank advances and brokered deposits. See DX 558 at FR09970-71; DX 562 at 1; DX 571 at FR098180-82; DX 575 at FR098193-94; DX 513 at FR439486; DX 2046 at 46; Tr. 4518:2-4522:3, 4524:1-4528:18 (Sear); Tr. 5573:3-5574:19, 5582:11-5584:17 (Carron). The Government contends that First Federal, rather than paying any price to fund additional growth, instead slowed things down and reduced the level of competitiveness in its pricing structure to maximize profitability. See Tr. 4519:2-4520:24 (Sear); see PX 676 at FR199514. The Government argues that First Federal had difficulty in managing its liability costs and that the difficulty was exacerbated by problems in maintaining sufficient liquidity. DX 571 at FR098181; DX 575 at FR098191-94; Tr. 4527:12-4528:18 (Sear). In late 1988, First Federal's Asset and Liability Management Committee had adopted a comprehensive liquidity management policy. The policy was adopted in order to ensure that the Association had adequate amounts of cash on hand in order to "react to the market and to take [advantage of] opportunities within the market." Tr. 4505:12-4506:10 (Sear); DX 496 at 5-6. The Government points out that during a March 8, 1989 meeting, the Asset/Liability Management Committee recognized that "the Association faces the choice of increasing its liquidity with relatively high cost sources of funds, or reducing its investment in new assets." DX 575 at FR098194; Tr. 4527:12-4528:18 (Sear). There is no evidence, however, that the Association actually reduced its growth in March 1989. Nor does the evidence support the notion that First Federal's asset growth was hampered 12

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by any shortage of liquidity. Tr. 5671:15-5673:19, 5675:21-24 (Chaplin). The Association's asset origination and acquisition activity also belie that notion. By April 30, 1989, in fact, First Federal's assets had grown by more than $250 million. Compare PX 47D (April 1989 Financials) at FR193063, with PX 45L (Dec. 1988 Financials) at FR192952. At the rate of growth First Federal achieved through April 1989, the Association was on track to grow its balance sheet by more than $700 million by the end of 1989. 2. FIRREA Caused First Federal to Curtail Asset Growth

In May 1989, however, the Association became concerned that it would have to comply with proposed FIRREA capitalization regulations and it wanted to be able to do so. See Tr. 214:5-215:4 (Borshoff). As a result, First Federal decided to curtail growth. Id. As Mr. Borshoff explained: [T]his is the era of FIRREA, and this is the period in which we are first being advised that . . . we are going to have to meet the regulations that are going to come through on new capital standards. And in that concern, we made the conscious decision to slow the growth of the balance sheet down and put emphasis on a higher capital ratio than we otherwise would have continuing our growth. Id. In light of the upcoming capital restrictions of FIRREA, and looking toward the business planning process for 1990, First Federal reduced its growth projections. By the end of July 1989, despite changing market conditions and management's decision to slow growth, First Federal still managed to achieve $349 million in asset growth, nearly half of the $700 million projected in its 1989 Budget. PX 47F at FR193175; Tr. 1207:9-12 (Chaplin). When FIRREA became effective on August 9, 1989, First Federal decided to stop additional balance sheet growth until the implications of the legislation became clearer. Tr. 220:20-222:14 (Borshoff). "We determined that the safest and most prudent course of action was to attempt to not grow the institution and . . . reduce our growth pattern. Growing under our historic plan was not a wise thing to do in the face of FIRREA and what we were being told." Tr. 224:3-7 (Borshoff). According to Mr. Chaplin, there was clear concern over FIRREA and "definitely in the third quarter [the Association] had hit the brakes." Tr. 1605:14-1606:10 (Chaplin). Dr. Kaplan concurred, testifying that "based on all of the analyses that I've done and after hearing the testimony of both Mr. Borshoff and Mr. Chaplin, my conclusion is that the FIRREA legislation, as conveyed to the [A]ssociation by the regulators, caused them to completely shut down their growth in the summer of 1989." Tr. 2954:8-18 (Kaplan). First Federal's balance sheet shrank by approximately $60 million during August 1989. PX 47H (Aug. 1989 Financials) at FR193204. As of October 1989, First Federal still accepted all loan applications that it received, but the Association continued to curtail growth by reducing its loan origination network and by adjusting its pricing mechanisms, such as raising interest 13

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rates offered on mortgages, or adjusting underwriting criteria to limit mortgage volume. Tr. 1617:2-14, 1618:12-20, 2434:24-2436:7 (Chaplin). By the end of 1989, First Federal had $5.64 billion in assets. PX 47L (Dec. 1989 Financials) at FR193313. The Association grew by only $277.6 million during 1989, id.; Tr. 1258:3-19 (Chaplin), falling short of its budgeted growth by approximately $430 million. 3. But For the Breach, First Federal Would Have Added Approximately $400 Million in Additional Profitable Assets ("the Foregone Assets") to its Balance Sheet by the End of 1989

Dr. Kaplan concluded that but for the breach, First Federal would have added approximately $430 million in additional assets in 1989. Tr. 3145:4-3146:4 (Kaplan). For purposes of his calculation of damages, Dr. Kaplan rounded that figure down to $400 million. Tr. 3148:19-3149:1 (Kaplan). First Federal showed that, but for the breach, it would have continued its growth by acquiring adjustable-rate mortgages and mortgage-backed securities. Dr. Kaplan explained that the Association had a whole loan adjustable-rate mortgage9 portfolio of approximately $2.7 billion as of year-end 1989. This represented approximately half of the Association's assets. Tr. 2979:20-2981:3 (Kaplan); PX 8000 at 38; PX 687 at FR216554. Dr. Kaplan also estimated that several hundred million dollars worth of First Federal's $900 million in mortgage-backed securities were made up of adjustable-rate mortgages. Tr. 2982:12-2983:1 (Kaplan). Second, First Federal showed that the national mortgage market could have accommodated First Federal's planned growth. As Dr. Kaplan testified, on a national basis, mortgage-backed securities comprised of adjustable-rate mortgages issued in 1989 were approximately $40 billion, and adjustable-rate mortgage whole loans originated in 1989 were approximately $120 billion. Tr. 2985:6-17, 5891:13-5893:2 (Kaplan). Mr. Chaplin testified that although self-originated loans were more profitable for First Federal, its earnings on purchased loans and mortgage-backed securities were still substantial. Tr. 2432:19-2434:12 (Chaplin). Mr. Chaplin also testified that, beginning in late 1989, there were bank branches available to be acquired. Those branches represented further opportunities to acquire assets. Had OTS not required First Federal to limit asset growth, the Association would have attempted to pursue those opportunities. Tr. 2321:15-2323:2, 2324:24-2325:2, 2327:8-20, 2401:7-2402:14 (Chaplin). The opportunities to acquire branches expanded because the RTC was beginning to liquidate savings associations. Tr. 1261:24-1262:9, 2322:22-2323:2 (Chaplin). That made it possible to acquire deposit franchises for almost no cost. Id. Mr. Chaplin testified that the Association had not analyzed any specific opportunities to acquire assets in late 1989 or 1990. Tr. 2400:18-19. In late 1989, First Federal did not analyze any growth opportunities because "we were concerned
9

"Whole loan" adjustable-rate mortgages are distinct from mortgage backed securities. Tr. 2980:15-18 (Kaplan). 14

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about being seized ourselves." Id. In 1990, First Federal was "struggling to comply with our own TB-36 capital plan." Tr. 2400:21-22 (Chaplin). In the course of developing that plan, First Federal was told by OTS that it could not grow. Tr. 1254:9-1256:-6, 2400:23-2401:6 (Chaplin); PX 338 at FR0040769-70. Mr. Chaplin testified that, but for the breach, First Federal would have sought to acquire certain branches of Columbia Federal, another thrift institution in the Rochester area. Tr. 2335:1-17 (Chaplin). The Association, as Mr. Chaplin reiterated, was intent on increasing earnings through growth and thereby building a value that investors would regard as attractive when the institution converted from mutual to stock form. Tr. 2335:23-2336:12, 2337:2-16 (Chaplin). The Government disputes that First Federal had either the capacity or the resources to grow by an additional $400 million in 1989. The Government argues that a flattening of the yield curve in early 1989 led customers to shift their preferences from adjustable-rate to fixedrate mortgages. Defendant's Proposed Findings of Fact ("DPFF") ¶ 129. According to the Government, the Association felt the effects of this shift as early as January 1989. "[T]he price differential between a fixed rate mortgage and an adjustable rate mortgage is so narrow that the consumer's preference is shifting towards the fixed rate product." PX 103A at FR342210-11; see Tr. 4514:13-4515:21 (Sear), 5023, 5025-26 (Guttentag). At the same time, the Government contends, First Federal decided to "increas[e] the mix of fixed rate loan production to be sold in the secondary market, and increas[e] adjustable-rate loan prices" in its "efforts to decrease its near term funding needs to reduce the level of high-cost funds acquired." PX 134B at FR344581; Tr. 4510:5-4512:24 (Sear). Mr. Sear, who was called as a witness by the Government, testified that the effect of this strategy was that (1) growth in fixed-rate products would only stay on the balance sheet for one or two months; (2) increased prices for adjustablerate mortgages would reduce the volume of adjustable-rate mortgages First Federal could generate; and (3) it would be difficult to achieve budgeted asset growth through loan production. Tr. 4515:11-4517:10 (Sear); PX 103A at FR342211. Dr. Carron testified that there was also scarcity in the wholesale market for alternative sources of assets, particularly mortgage-backed securities comprised of adjustable-rate mortgages. Tr. 5323:14-5324:4 (Carron). Many institutions preferred to hold onto their adjustable-rate mortgages and sell fixed-rate loans in the secondary market so as to avoid excessive interest rate risk. Tr. 5322:13-20 (Carron).10 Dr. Carron acknowledged that these securities were available, but because they were scarce, they were not available at "a level that would earn you a decent rate of return." Tr. 5321:1-20 (Carron). However, as noted earlier, Mr. Chaplin testified that although self-originated loans were more profitable for First Federal, its earnings on purchased loans and mortgage-backed securities were still substantial. Tr. 2432:192434:12 (Chaplin). Mr. Chaplin was on the witness stand for five and one-half days. The Court found him to be very knowledgeable and completely honest and straightforward. His testimony was clear, precise and credible. In the face of a searching cross-examination, Mr. Chaplain
10

Indeed, First Federal followed a similar strategy. Tr. 5023:1-5, 5025:15-5026:4 (Guttentag). 15

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maintained an even and professional demeanor, conscientiously seeking to explain complex matters in plain English for the benefit of counsel and the Court. Thus, the Court credits Mr. Chaplin's testimony regarding the asset growth that First Federal would have achieved but for the breach. First Federal established through the testimony of Mr. Chaplin and Dr. Kaplan that the Association was focused on growth throughout 1989, and it had the capability and resources available to achieve that growth, even in the midst of shifting economic currents. For example, Dr. Kaplan noted that as of mid-May 1989 First Federal was "looking at a forecast of nearly a billion dollars of growth [for the years 1989 and 1990]." Tr. 3150:4-5 (Kaplan); PX 676 at FR199514. Dr. Kaplan added: "And it just seems to me that the $400 million of forgone assets that we're talking about in this context, in these time frames, is a very, very conservative amount to be incorporating into a damages calculation. I have absolutely no doubt that this . . . would have been achieved." Tr. 3150:5-10 (Kaplan); see Tr. 1259:11-1264:8; 2431:10-2434:12 (Chaplin). The Government next points out that First Federal, like the rest of the thrift industry, began suffering increasing delinquency rates and levels of non-performing assets during the second half of 1989. Tr. 4536:8-23 (Sear), 5326:7-22 (Carron); DX 2046 at 35. The Government contends that the increase in non-earning assets reduced the overall return that First Federal could earn on its assets, and, if assets had to be written off at a loss, directly reduced the Association's earnings and net worth. See Tr. 4535:8-4537:1 (Sear), 5036:6-24 (Guttentag), 5326:7-22 (Carron), 1872:1-1873:15 (Chaplin); see also PX 134AA at FR233241; PX 103K at FR233251. Dr. Carron testified that the appropriate response to that situation was for First Federal to be more cautious about lending and to maintain a larger capacity to add to loan loss reserves. Tr. 5326:14-22 (Carron). The Government points out that First Federal booked higher loan loss provisions than expected in 1989. Tr. 5326:23-5327:5 (Carron); DX 2046 at 19. Mr. Chaplin, however, provided credible testimony that the Association's analysis of loan delinquencies in early 1990 showed that they were attributable to earlier underwriting deficiencies that were corrected at that time. Tr. 2421:6-2424:5 (Chaplin). Also, Dr. Carron acknowledged that First Federal's loan delinquency rate was substantially below industry averages and that he did not know whether the Association's loan losses increased during the period. Tr. 5538:12-5539:23 (Carron). The Government argues that because the period from 1990 to 1991 was a very difficult time for the thrift industry, it is unlikely that First Federal would have had profitable opportunities to grow its balance sheet significantly if there had been no breach. Tr. 5397:17-24 (Carron). The Government notes that the deterioration in economic conditions and the customer shift to fixed-rate mortgages that began in 1989 continued into 1990. DX 979 at FR477759. As a result, the Government contends, First Federal's shift to production of fixed-rate mortgages over adjustable-rate mortgages became more pronounced in 1990, during which 59 percent of production was fixed rate and sold into the secondary market. Tr. 5324:1-4 (Carron); PX 9 at 16

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FR000510. Another factor, however, limiting the volume of First Federal's adjustable-rate mortgage loan originations in 1990 and 1991 was curtailment of the Association's loan origination network. First Federal had reduced its loan origination capacity in reaction to FIRREA. Tr. 2003:8-16 (Chaplin) ("Q: And that reduction in capacity . . . that was a decision made by First Federal management; right? A: In the context of the impending FIRREA balance sheet growth requirements, yes."). And, again, First Federal had alternatives for achieving balance sheet growth, including purchasing adjustable-rate mortgage loans wholesale or via the Association's correspondent lending network, and by purchasing fixed- or adjustable-rate mortgage-backed securities. Tr. 2431:21-2432:18; 2461:7-16 (Chaplin). First Federal did not pursue such alternatives in 1990 because the Strategic Business Plan submitted to comply with TB-36 ultimately required First Federal to maintain zero growth. Tr. 2461:21-24 (Chaplin). The Government further points out that in the 1991 Business Plan, First Federal listed as one of the "operating environment factors" that was projected to impact the Association's financial performance "[t]he weak primary real estate market in the Metro New York Region, [which] has reduced the Association's ability to generate assets from traditional sources to a level insufficient to maintain balance sheet footings." DX 968 at FR253443-46. However, the 1991 Business Plan also referred to five more important growth-limiting factors, four of which related to FIRREA and its impact on First Federal. The most significant of the FIRREA-related factors was described as follows: FIRREA has reduced the Association's leverage capacity by mandating increased levels of capital to support existing leverage. FIRREA has also resulted in the assessment of excessive insurance premiums, and decreased Federal Home Loan Bank of New York stock dividends. Id.; Tr. 2480:15-2483:8 (Chaplin). The Government contends that poor market conditions persisted in 1991 and that First Federal attributed its inability to grow its balance sheet and its higher than average loan loss reserves to "the weak real estate environment in the Company's primary lending markets." PX 471 at WOL4441233; see PX 10 at FR000028. The evidence shows, however, that OTS prohibited First Federal from undertaking any asset growth in 1990 and 1991. Despite the fact that TB-36 allowed thrifts to grow up to the amount of net interest credited, PX 281 at FR001244, OTS required First Federal to reduce its balance sheet growth to zero before it would approve the Association's Strategic Business Plan. PX 345 at 0FR0020295; Tr. 1254:9-1255:6; 1256:3-19; 1624:19-1625:9; 1628:24-1629:7; 1632:14-1635:11 (Chaplin); 799:22-800:4; 817:411 (Borshoff). The Government disputes that First Federal was forced to cut all balance sheet growth. However, Mr. Dorgan, one of the OTS regulators reviewing First Federal's Strategic Business Plan, informed Mr. Chaplin that the Strategic Business Plan as it had been submitted on January 5, 1990 would not be approved, and that the Association was required to modify the plan to provide for zero percent growth. Tr. 1254:9-1255:6; 1256:3-19; 1633:10-1634:25 (Chaplin); see also Tr. 2670:2-2671:5 (Simone). The Government did not offer direct evidence to refute 17

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Mr. Chaplin's testimony on this issue, and the Court found Mr. Chaplin's testimony with regard to conversations he had during the process of securing approval of the Association's Strategic Business Plan to be credible. Mr. Dorgan testified that he did not believe he would have told First Federal to reduce its growth, Tr. 5102:4-5103:11, but he admitted that he did not recall First Federal's Strategic Business Plan, OTS's review of it, or any conversations that he had with First Federal about its plan. Tr. 5108:24-5110:7; 5115:5-7 (Dorgan). In light of the foregoing, the Court finds that First Federal established that but for the breach, it would have added approximately $400 million in profitable assets to its balance sheet by the end of 1989 and would have achieved its goal of $700 million in asset growth for that year. 4. But For the Breach, First Federal Would Have Earned Profits On the Foregone Assets in the Amount of $26.061 Million In the Period From 1990 to 1997

Dr. Kaplan calculated the earnings First Federal would have realized on the $400 million in foregone assets during the period of 1990 to 1997. To do so, Dr. Kaplan first determined the Association's historical average highest-cost source of funds. He then determined the category of First Federal's assets that historically yielded the lowest average return. Next, he subtracted the former cost from the latter return and used the resulting difference or "spread," 87 basis points,11 to calculate the profits First Federal would have earned on the $400 million of foregone assets. Tr. 3153:10-3156:12 (Kaplan). Dr. Kaplan's spread income was based on First Federal's actual, historic yields and costs from 1989 until the end of 1996. PX 737 (Corrected Kaplan Expert Report) at Ex. 7 (First Federal Historical Yield Cost Analysis); PX 8000 at 75; Tr. 3153:10-15, 3155:19-21; 4057:1-6 (Kaplan). Applying the 87-basis-point spread to the $400 million in foregone assets, Dr. Kaplan calculated the amount of lost profits on the foregone assets in each year from 1990 to 1997 as follows: 1990 1991 1992 1993 1994 1995 $ 3,480,000 $ 3,480,000 $ 3,480,000 $ 3,491,000 $ 3,632,000 $ 3,814,000

One basis point is the equivalent of one-hundredth of one percent, i.e., 0.01 percent. BLACK'S LAW DICTIONARY 161 (8th ed. 2004). Thus, for example, 87 basis points is the equivalent of 0.87 percent. 18

11

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1996 1997

$ 4,004,000 $ 680,000

Total $ 26,061,000 Tr. 3156:13-3158:22 (Kaplan); PX 8000 at 68. Though First Federal proffered evidence to show that, but for the breach, First Federal would have continued to grow its assets after 1989, see PX 676, Dr. Kaplan calculated lost profits in the years from 1990 to 1992 only on the $400 million in assets foregone in 1989, and he did not seek to calculate any profits that may have been lost on the foregone assets in 1989. Tr. 3149:3-12 (Kaplan). Dr. Kaplan assumed no growth of the $400 million in assets from 1990 until mid-1993. From the middle of 1993 until First Federal was acquired by HSBC in early 1997,12 Dr. Kaplan assumed an annual growth rate of five percent, though First Federal actually experienced 7.5 percent annual growth during that period. Tr. 3149:14-3150:1 (Kaplan). Dr. Kaplan explained that the annual figures set forth above do not equate exactly to the projected amount of foregone assets in each year multiplied by 87 basis points because they are year-end figures and his model calculated lost profits from the foregone assets on a quarterly basis. Tr. 3157:5-3158:22 (Kaplan). The Government criticizes Dr. Kaplan's calculation of lost profits on the grounds that: (1) it lacks sufficient foundation, (2) it is a "whole bank number" rather than an analysis of marginal income, and (3) that it does not account for overhead or credit risk. The Government maintains that even if First Federal had added $400 million in assets in 1989 as Dr. Kaplan claims, there is no basis to believe it would have earned 87 basis points on those assets between 1990 and 1997. Tr. 5376:4-5382:11 (Carron); DX 2046 at 59. However, the yield percentages and costs on which Dr. Kaplan based his spread of 87 basis points were historical averages based upon the actual results of First Federal from 1989 until the end of 1996. Tr. 3153:10-15; 3155:19-21; 4057:1-6 (Kaplan). As Messrs. Chaplin and Borshoff testified, the assets that would have been obtained but for the breach were the same types of assets that First Federal had historically acquired. Tr. 294:17-296:18, 297:10-19 (Borshoff); Tr. 1261:16-1264:8 (Chaplin). Therefore, it was reasonable for Dr. Kaplan to utilize First Federal's actual, historical rates of return and costs to determine the lost spread income. Tr. 5908:14-5910:10 (Kaplan). The Court finds that Dr. Kaplan's calculation of lost profits on the foregone assets was based upon First Federal's historical track record and was both sound and reliable. With regard to the criticism that the spread of 87 basis points was a whole bank number ­ as opposed to an analysis of marginal income ­ Dr. Kaplan stated that no database exists that

12

See First Federal I, 58 Fed. Cl. at 154. 19

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allows one to capture marginal rates. Tr. 4060:10-18 (Kaplan). In addition, the evidence showed that in the period prior to FIRREA, First Federal's marginal income reflected a return of 200 basis points. PX 14 at WOT7240053. See also DX 968 at FR 253447 ("Marginal ARM originations generally return 100 [basis points] in interest margin in the first year . . . ."). Dr. Kaplan explained persuasively that the yields and costs he used to calculate the 87-basis-point spread were "a very fair and unbiased representation of what the company's yield and cost experience actually was." Tr. 4060:3-5. Dr. Kaplan testified, "I've excluded nothing. It covers all of the time periods. This reflects all of the events, whether it's economic conditions in the marketplace, changes in business strategy. This is an all-in calculation." Id. at 4060:5-9. With regard to the Government's argument that Dr. Kaplan did not address issues such as credit risk and overhead in deriving his spread of 87 basis points, Dr. Kaplan testified that, in determining the spread between cost and yield, he used the yield on mortgage-backed securities, historically First Federal's lowest yielding category of assets. Because the assets in mortgagebacked securities are pooled and guaranteed, Dr. Kaplan testified, credit risk has been largely eliminated. Tr. 4058:18-22 (Kaplan). Further, to determine cost, Dr. Kaplan used the cost of borrowed funds, First Federal's highest cost source of funds. Dr. Kaplan stated that his use of that source permitted him to disregard overhead: By using cost of borrowed funds, which is a wholesale source of funding, as opposed to the cost of deposits, which is a retail source . . . you don't incur the whole raft of operating expenses that are associated with managing an extensive branch network, having all of the staff and back office, the marketing. A borrowing cost basically at the end of the day means you avoid all of the operating expenses, because you either pick up the phone or call the source of the borrowed moneys. And those costs really drop out of the equation. Tr. 4059:6-16 (Kaplan). As the Court of Federal Claims held in Commercial Federal Bank, F.S.B. v. United States, another Winstar case in which Dr. Kaplan applied a similar damages methodology: It is true that competition and economic conditions can affect the profitability of a business, but that is true not only during the period of breach but also before and after. . . . To the extent that these factors did contribute to plaintiff's business plans, the court concludes that the conservative growth and profitability percentages applied by Dr. Kaplan compensate for them. 59 Fed. Cl. 338, 348 (2004), aff'd, 125 Fed. App'x 1013 (Fed. Cir. 2005). Dr. Kaplan employed the same approach to his damages analysis in this case as he did in Commercial Federal. Dr. Kaplan's approach accounted for the economic conditions that the Government argues caused an adverse effect on first Federal's ability to generate increased assets and earnings.

20

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Dr. Kaplan proved himself to be a knowledgeable, thorough, and credible witness. His demeanor through 3½ days of detailed direct examination and 2 days of vigorous (not to say hostile) cross-examination was calm, business-like, confident, and careful. As stated earlier, the Court found Dr. Kaplan's testimony regarding the amount of profits First Federal would have earned on the assets it was forced to forego as a result of the breach to be sound and reliable. As more fully set forth in subsequent sections of this opinion, the Court also found Dr. Kaplan's testimony regarding the other elements of plaintiff's claimed damages (with one minor exception) to be sound and reliable. Taking its history of successful asset growth into consideration, First Federal planned for $700 million in asset growth in 1989. PX 364 at FR172244. Through the first half of the year, the Association was well on its way to reaching that target. First Federal then slowed, and eventually stopped, its asset growth because it had become evident that Section 6.10 of the Financing Agreement would be abrogated by FIRREA's new capital standards. First Federal achieved only $270 million of asset growth by the end of the year. But for the breach, First Federal would have achieved approximately $400 million in additional asset growth by the end of 1989, and the Association would have earned profits of approximately $26.061 million on those foregone assets between 1990 and 1997. C. Foreseeability

As noted above, First Federal must also establish that its damages were foreseeable. Cal. Fed. Bank, 395 F.3d at 1267. Foreseeability "requires only reason to foresee, not actual foresight. It does not require that the defendant . . . should have promised either impliedly or expressly to pay therefor in case of breach." Anchor Sav. Bank., F.S.B. v. United States, 59 Fed. Cl. 126, 146 (2003) (quoting 11 CORBIN ON CONTRACTS § 1009 at 66 (Interim ed. 2002)) (emphasis in original). "It is erroneous, therefore, to refuse damages for an injury merely because its possibility was not in fact in contemplation of the parties at the time they made the contract." Id. The Government had reason to foresee lost profits as a probable result of its breach of Section 6.10. See Chain Belt, 127 Ct. Cl. at 59, 115 F. Supp. at 715 (quoting RESTATEMENT (FIRST ) OF CONTRACTS § 330); see also Globe Savings Bank, 65 Fed. Cl. at 348. Section 6.10 of the Financing Agreement allowed First Federal to conduct its operations in accordance with capital requirements much lower than those then applicable to healthy thrifts. Section 6.10 enabled First Federal to achieve increasing earnings and asset growth. The lower capital standards of Section 6.10 were reasonably understood to be critical to maintaining the level of First Federal's profitable assets. Therefore, it was reasonably foreseeable that breaching Section 6.10, by requiring First Federal to comply with FIRREA's stricter capital standards, would cause First Federal to curtail growth of profitable assets and thereby lose profits it would otherwise have realized.

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The Government argues that there was no evidence that the parties foresaw in 1986 that First Federal would set a goal for growth in 1989 of 13 percent. See DX 513 at FR439437 ("During 1989, the Association's total assets are budgeted to grow to $6.1 billion from $5.4 billion at the end of 1988, representing a growth rate of 13%."). That growth rate was higher than the asset growth projections that First Federal had included in the capital plan set forth as Exhibit E to the 1986 Financing Agreement. See DX 2046 at 5. However, the parties did not view the growth projections set forth in Exhibit E as limitations. Tr. 1132:18-21, 1133:1-4, 1494:3-10 (Chaplin); 3508:6-21 (Palant). Indeed, the Government had reason in 1986 to foresee that First Federal might grow significantly in excess of the rates contained in Exhibit E. The Association's primary business strategy before the recapitalization was to increase its assets. That growth strategy is reflected in First Federal's business activities even during the Phoenix years. See Section I.B.2, supra. As Mr. Vigna had reported, First Federal's 1986 Business Plan, its last as a Phoenix institution, underscored the importance of growth to the Association: "In 1986 the Association will strive to achieve similar objectives as in 1985, but will allow the expansion of its core businesses to be of paramount importance by seeking a balance between long-term growth and near-term profitability." DX 168 (1986 Bus. Plan) at FR172065; PX 562 at FLT0030037; see Tr. 393:16-395:21 (Vigna); Tr. 1109:8-1110:2 (Chaplin). Mr. Vigna was aware that even while it was a Phoenix institution, First Federal had set "ambitious asset and liability origination goals." PX 562 at FLT 0030038; Tr. 396:1-397:4 (Vigna)