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CDO With Name of St. Tropez Beach Melted With S&P’s Top Mark

A $1.6 billion collateralized debt obligation issued by Vertical Capital LLC in March 2007 with the same name as a portion of the beach at St. Tropez, France, burned out just 228 days after it was issued.

The Pampelonne CDO II, underwritten by Barclays Plc, is one of dozens of deals listed in the Justice Department’s Feb. 4 lawsuit against Standard & Poor’s that received the company’s highest AAA grade. The U.S. is accusing the world’s largest credit rater of deliberately misstating the risks of mortgage bonds to keep its share of the booming business of repackaging home loans for sale as securities.

Eastern Financial Florida Credit Union lost its investment after purchasing a portion of the Pampelonne CDO II, relying in part on S&P’s assessment of the securities, according to the complaint filed in federal court in Los Angeles. The U.S. is seeking penalties against S&P and its New York-based parent, McGraw-Hill Cos. that may amount to more than $5 billion, based on losses suffered by federally insured financial institutions.

S&P was aware of its influence over such firms, and knowingly “devised, participated in, and executed a scheme to defraud investors,” according to the complaint.

Ed Sweeney, an S&P spokesman, Kem Blacker, a partner at Vertical Capital, and Brandon Ashcraft, a Barclays spokesman, all in New York, declined to comment.

Default Event

Pampelonne CDO II was originated on March 26, 2007 and suffered an event of default on Nov. 9 that year, according to an S&P statement.

Eastern Financial, founded in 1937 as the original credit union for Eastern Airlines, was forced to merge with Space Coast Credit Union after being seized by regulators in April 2009.

S&P gave more than half of the Pampelonne CDO II deal its highest AAA grade, according to a prospectus from March 5, 2007. Its largest competitor, Moody’s Investors Service, offered an equivalent Aaa on the same portions.

The majority of the deal was linked to mortgage bonds, according to the prospectus. It also contained credit-default swaps used to wager on the likelihood of home-loan defaults. The completion of the deal was contingent upon garnering AAA grades from the rating companies.

Top Ranking

When S&P blessed the deal with top rankings in March 2007, it wasn’t yet known exactly which securities would be included in the transaction. CDO issuers could lay out which types of bonds would be included in deals at the time of the sale while still in the process of acquiring the debt.

CDOs pool assets such as mortgage bonds and package them into new securities with varying risks in which revenue from the underlying bonds or loans are used to pay investors.

Plage de Pampelonne is a beach in St. Tropez, and Pampelonne is a town in the south of France with a population of 718 in 2007, according to the website cartesfrance.fr.

The case is U.S. v. McGraw-Hill, 13-00779, U.S. District Court, Central District of California (Los Angeles).

To contact the reporter on this story: Matthew Leising in New York at mleising@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

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