Massive Fraud Leads to Failure of St. Paul Croatian

The NCUA's Office of the Inspector General (IG) issued its Material Loss Review regarding the failure of St. Paul Croatian FCU. The IG concluded that suspected fraud was the direct cause of St. Paul Croatian's failure, which resulted in a loss of $170 million to the National Credit Union Share Insurance Fund.

The report notes that a substantial majority of the credit union's loans were supposedly secured by members' shares. Specifically, 52 percent of all loans were share secured in 2004, 70 percent in 2005, 66 percent in 2006, 76 percent in 2008, and 88 percent in 2009. However, many of the loans were secured by deposits (shares) of members unrelated to the loan recipients.

But a December 31, 2009 examination discovered that "the majority of the loans were not actually share secured and a number of them were allegedly fraudulent."

A number of these supposed share secured loans were actually member business loans, even though the credit union did not have a member business loan (MBL) policy. In fact, "St. Paul had an MBL portfolio of 133 loans valued at $68.6 million with $2.4 million originated prior to 2008, $18.6 million in 2008, $41.8 million in 2009, and the remainder during 2010." As of the end of 2009, almost 29 percent of its assets were in business loans. But because these loans were supposedly shared secured, they were not subject to NCUA's MBL Rules and Regulations.

The report also found that the chief executive officer (CEO) of the credit union "manipulated loan records and masked the suspected loan fraud by constantly refinancing certain loans or making advance payment on those loans."

The IG report states:

"According to credit union employees, during previous examinations when NCUA examiners requested loan files, the CEO stated the files were stored at the other branch and the CEO would have them available the next morning. The credit union employees alleged the CEO gathered the entire staff that evening and directed them to create loan documentation to support the loans the examiners selected. Since a majority of the loans was supposedly share secured, the CEO instructed the staff to find a member with sufficient shares in their account to cover the pledged shares. This account was listed on the share pledge security agreement for that borrower. Credit union staff would then allegedly “witness” forged signatures on the share pledge agreement. Furthermore, credit union staff members stated they would have members with large share balances sign blank share pledge agreements in the event credit union members needed a loan in a hurry.

According to NCUA staff, the CEO would then deliver the alleged fraudulent loan documents to the examiners the following day."

The IG report also noted that there was a lack of segregated duties as the CEO performed most of the accounting and lending processes. As a result, there was no institutional constraints to prevent the suspected loan fraud.

The report points out that the credit union did not have the data processing system "to freeze shares used to secure loans." In addition, the data processing system truncated large numbers, when printing loan documents with large amounts.

Moreover, the credit union's data processing system failed to generate reports related to compliance with the Bank Secrecy Act. It could not differentiate between cash and check transactions and inadequately monitored for suspicious activities. St. Paul's Board did not complete the required BSA training. In addition, Office of Foreign sset Control (OFAC) "lists of suspicious persons were not verified against the recipients of out-going wire transfers; the wire transfer log was manually kept; documentation for wire transfers was inadequate; and St. Paul staff did not update the OFAC list on a regular basis."

A disturbing finding of the report was after the credit union was placed into conservatorship, the credit union's staff lacked the basic knowledge to run the credit union's operations without the direction from the CEO.

The IG report faults NCUA for not adequately identifying the risk at St. Paul Croatian. The report notes that examiners missed warning signs. For example, one red flag was that "the credit union reported zero delinquency and charge-offs from, at least, 2004 through 2009. Examiners believed this was reasonable, stating that faith-based credit unions ... usually have low delinquency."