Examiners Missed Business Loan Red Flags in St. Paul Croatian Failure

Reading the NCUA Inspector General's report on the failure of St. Paul Croatian FCU made me madder than a wet hen.

The report demonstrates the unintended consequences associated with the Congressional decision in 1998 to exclude loans secured by shares (deposits) from the definition of a member business loan (MBL). I know that suspected fraud was present; but if it were not for this exemption from the MBL definition, it would have been more difficult for the alleged fraud to be perpetrated.

The IG report stated that although member business loans were present, these loans were not viewed as member business loans; because "examiners apparently took at face value that these loans were share secured and therefore not MBLs."

All I can say is that I’m sure glad these NCUA examiners are not arms control inspectors.

You shouldn’t take the credit union’s word at face value. President Reagan said it best --“Trust, but Verify.”

Examiners did not take any further action even though red flags were present, including:

• During the December 31, 2004 examination, the examiner stated “there were two loans that might have been business loans”;

• The examiner noted for the December 31, 2007 examination that a large number of share secured loans were for large dollar amounts and it appeared that this was a way for the credit union to make business loans without a lot of documentation;

• The December 31, 2008 examination noted there was evidence of MBLs, but all the loans were apparently share secured and therefore, not subject to NCUA MBL Rules and Regulations; and

• NCUA examiners did not take exception to many issues until after the FBI and IRS met with NCUA staff in January 2010. For example, during the December 31, 2009 examination the examiners found that the credit union had $68.6 million in member business loans - almost 29 percent of the credit union’s assets. Some of these business loans had been on the books of the credit union for years.

Moreover, examiners in the December 2009 examination found that the credit union did not have an MBL policy; did not have the data processing system to track MBLs; and business loans were not supported by adequate documentation such as corporate designation of authority to borrow.

A business loan policy is important because it addresses issues such as types of business loans that the credit union will make, concentration limits by type of business loans, trade area, collateral requirements, and so on. This is part of any sound banking practices. However, because these loans were treated as exceptions to the agency’s MBL Rules and Regulations, the credit union did not have to establish such policies.

We should keep an eye on the other exceptions to the definition of member business loans including: a loan fully secured by a lien on a 1 to 4 family dwelling that is the member’s primary residence or loan(s) to a member or an associated member which, when the net member business loan balances are added together, are equal to less than $50,000.

It makes me wonder how many other cases like St. Paul Croatian are out there; but have not been unearthed.