IG Report on Failure of High Desert FCU

NCUA’s Office of the Inspector General (IG) released this week its report on the failure of High Desert FCU (HDFCU). The IG estimated that the failure of HDFCU resulted in a $24.3 million loss to the NCUSIF.

According to the report, an excessive concentration in real estate construction loans combined with the collapse in real estate values caused the failure of HDFCU. The rapid growth in HDFCU's construction loan program was fueled by a waiver granted by the Regional Director in 2003 from NCUA’s minimum equity interest requirements associated with construction loans. The failure by management to take corrective actions and by examiners to elevate concerns to superiors for stronger supervisory actions increased the ultimate cost of the failure.

The report makes it clear that HDFCU’s management and board were engaged in extend and pretend with respect to its construction loan program. The IG wrote that “the number of loans reported as more than 12 months past their original maturity date grew from nine in March 2004 to 158 in September 2007. In September 2007, nearly 45 percent of the total construction loan portfolio was greater than 12 months past the original maturity date. This was due to management simply extending a loan once it matured. In many cases, management extended loans numerous times rather than start foreclosure procedures.”

The risk associated with excessive concentrations caused the IG to write that “NCUA should consider developing a more specific process to identify, analyze, and monitor loan concentration during exams as well as between exams. The NCUA should give strong consideration to a more detailed breakout of loan types on the 5300 Call Report to facilitate this analysis. Additionally, NCUA should consider developing concentration guidelines to assist both examiners and the credit unions in identifying and monitoring concentration risk.” (emphasis added)

Also, the IG wrote that NCUA granted a waiver in 2003 from the minimum equity interest limits to HDFCU with respect to its construction loan program. However, examiners did not require the credit union to implement a tracking system to monitor compliance with respect to the waiver until 3 years after the waiver was granted. The IG report recommended the following changes to enhance the waiver process:

1. NCUA should consider the ability of the region or credit union to track waivers. If a waiver requires the generation of detailed information from the recipient credit union that is not already captured in the Call Report or other financial reporting system, the NCUA should take into account the ability of credit union and the region's staff to adequately monitor the waiver.

2. Implementation of the monitoring process should be in place before granting a waiver.

3. Failure by a credit union to properly monitor and track a waiver, or noncompliance with a waiver during an examination, should result in suspension of activity allowed under the waiver until the credit union can reestablish an appropriate tracking model or become compliant with the waiver.

4. NCUA should consider a renewal period and/or a sunset provision for waivers granted related to significant risk areas of a credit union. At a minimum, this would include waivers related to loan concentrations, liquidity management, capital, or certain regulatory matters.