Senior management "did not do their homework" when assessing the risks of the mortgage-linked investments that ended up costing Butterfield Bank hundreds of millions of dollars in write-downs.

That is the view of one former high-ranking insider at the bank, who told this newspaper that while there were many good arguments for investing in the complex products, the potential downside was not sufficiently assessed.

Like many banks, during the mid-2000s Butterfield invested heavily in securities linked to pools of US mortgages. Wall Street institutions packaged the mortgages into products such as collateralised mortgage obligations (CMOs) and collateralised debt obligations (CDOs).

Rating agencies gave many of these products the highest credit rating of AAA and, while mortgage repayments were coming in on time and property prices were rising, they were generating better returns than comparable AAA investments.

Banks all over the world bought into them, fuelling the US property boom. According to the Securities Industry and Financial Markets Association (SIFMA), annual global CDO issuance peaked at $521 billion in 2006 and $482 billion in 2007, although by the end of that year issuance was tailing off.

When such investments soured, the impact on banks everywhere was devastating. From Switzerland to Britain, from Iceland to the US, banks struggled to stay afloat. Many failed, including some of the biggest and best known, including Washington Mutual, Lehman Brothers and Bear Stearns.

After the sub-prime mortgage crisis emerged in 2007, Butterfield stopped buying the CMOs that had become a large chunk of its held-to-maturity investment portfolio, Butterfield's former CEO Alan Thompson revealed in a speech to an annual general meeting in April 2008.

According to the figures in Butterfield's annual reports, by the end of 2007 the bank had amassed CMOs at an amortised cost of $828.48 million. The fair value of these, or the estimated market price that Butterfield could get if it sold them, was $115 million less than that. By the end of 2008, Butterfield's CMO holdings had a fair value of $315.79 million, as the credit crunch and soaring delinquency rates in the US took their toll.

In 2009, mortgage-backed securities still in the bank's investment portfolio had a fair value of just over $259 million, including $200 million in the riskiest sub-prime and Alt A categories.

"The argument for holding these securities was that they were diversified," said the source, who had a significant role with Butterfield as the problems with the investments began to surface. "There were hundreds of mortgages in each security and different tiers of risk inside it. They were also rated triple-A. Management would always say there were big institutions standing behind these things and they would not walk away because their reputation was at stake.

"I really think management did not do their homework and were not sufficiently critical of these things."

However, he added that the bank did nothing procedurally wrong — it was more a case of poor judgment and the underestimation of risk that was mirrored by hundreds of banks around the world.

According to the source, the bank's audit committee did ask whether the securities had been valued according to their market value. They were told that as the intention was to hold the securities to maturity, the bank did not have to mark them to market.

"The evaluation of the securities was in line with the regulations," the source said. "But there were sufficient things going on elsewhere for us to say 'we should take a closer look at this' and not put our heads in the sand, which is what the management did. I think management relied too much on what other people were saying."

Some of the blame for the trillions of dollars suffered by banks around the world has been put at the feet of the credit rating agencies. The triple-A ratings that the likes of Standard & Poor's and Moody's attached to many of the mortgage-backed securities apparently persuaded many investment managers that they were virtually without risk.

Deven Sharma, the president of S&P, wrote in a Wall Street Journal article in January this year: "We offer our ratings as a view of relative credit risk — not a buy, hold or sell recommendation. But we recognise that rating mandates may have prompted some investors to use ratings in ways they were never intended."

Butterfield's board of directors was chaired by James King through most of the period when Butterfield was piling up the mortgage-backed securities. The bank's former Risk Management Committee chairman Brian Duperreault took over as chairman in April 2007 at the end of Dr. King's 10 year stint. Less than a year later, he departed to take over as the CEO of Marsh & McLennan to be succeeded by current chairman Robert Mulderig.

As the bank was building up its CMO holdings, was management seriously questioned about it by the board? The source said criticism of management by directors happened, but tended to be muted.

"Several members of the board were critical, but they were put off by management who argued that they were the banking professionals and they knew best," the source said.

"The culture of the bank was such that you did not criticise (ex-CEO Alan) Thompson and (ex-CFO Richard) Ferrett. If you were a critic — particularly if your criticism had got some merit and some independent evidence to back it up, then there was pressure from others to keep quiet."

The bank finally lanced the boil in the first quarter of this year, after new, mainly overseas investors came in with $550 million of fresh capital.

The money gave Butterfield the flexibility to sell off its remaining mortgage-backed securities, realising hefty losses. This was the main reason for Butterfield's $176 million net loss in the first three months of the year.

As of June 30 this year, there were no mortgage-backed securities or CDOs in the bank's investment portfolio.