Findings fom Telesis Community's Material Loss Review

NCUA's Office of the Inspector General (IG) released the Material Loss Review (MLR) on the failure of Telesis Community Credit Union (Chatsworth, CA) with an estimated loss to the National Credit Union Share Insurance Fund of almost $77 million.

The report blames Telesis Community Credit Union’s management and Board for the credit union's failure and resulting loss to the NCUSIF.

Here are some of the highlights from the report.

A heavy concentration in member business loans, especially commercial real estate loans, led to the credit union's failure. The MLR notes that Telesis Community Credit Union has an exception to the member business loan (MBL) cap of 12.25 percent of assets and "leveraged this exception to originate a number of large business loans with industry and geographic concentrations in areas vulnerable to economic downturns." The report notes that examiners believed that Telesis needed a capital (net worth) ratio of at least 15 percent to support the risk due to its heavily concentrated loan portfolio.

The MLR report also found that Telesis Community Credit Union used wholesale funding -- borrowings from the Federal Home Loan Bank and Western Corporate FCU and brokered certificate of deposits -- to originate its business loans. This resulted in significant borrowing costs. Additionally, the requirement to pledge loans as collateral for its borrowings created pressure to inflate the grading of its loans.

The MLR report noted that the credit union rapidly grew its business loan portfolio and had loans in 29 states. The report concluded that "[s]uch a wide dispersion indicates that management was branching into areas outside of its area of geographic expertise."

The report points out that between 2007 and 2011, the credit union "had difficulty generating income because of high loan losses and decreased loan demand, which resulted in lower loan and fee income." As a result, the credit union saw an erosion in its net worth ratio. To buttress its net worth ratio, management at the credit union adopted a strategy of selling assets, which eliminated healthy loans from its portfolio leaving only the underperforming loans.

The MLR states that given the wide geographic area of its business loan portfolio, the credit union needed "a robust methodology for calculating" its allowance for loan and lease loss. However the credit union’s "calculations included inappropriate assumptions about individually considered loans and relied upon historical trends, which did not reflect actual conditions, to anticipate losses in loan pools." For example, the credit union applied "a zero percent historical loss rate over MBLs based on three-year historical data when current delinquency data internally and industry-wide predicted significantly higher loss rates." The report notes that the ALL was underfunded and examiners and external auditors required $8 million in adjustments.

The report also found that over concentration in MBLs was not the only strategic missteps by management. The MLR is critical of the credit union's decision to acquire two credit union service organizations (CUSOs), AutoSeekers and AutoLand. The report notes that the credit union did not perform appropriate due diligence. In addition, there is the potential of a conflict of interest as the CEO of AutoSeeker was related to the CEO of the credit union. NCUA examiners and Regional officials believed that credit union purchased both CUSOs for the benefit of the related party. The Board minutes show no discussion of conflict of interest.

Another conflict of interest cited in the report dealt with another Telesis CUSO, Business Partners. The report stated that the CEO of the credit union was the Chair of the Board for Business Partners and a credit union EVP was the CUSO's CEO. The report goes on to state that the CUSO held $12 million deposit at Telesis Community, despite the credit union being undercapitalized -- raising doubts that this was an arm's length transaction.

The report further suggests that the credit union's board rubber stamped management's decisions. "The Board tended to follow her [the CEO's] recommendations with little discussion."

One interesting tidbit from the report was that their was infighting between the EVP and CEO as Telesis Community's financial conditions deteriorated. The EVP alleges that "the CEO had acted unethically and threatened retaliatory action against the EVP." However, the director of human resources for the credit union found no evidence to suport the claims.

The report is critical of NCUA examiners finding that enforcement actions were not timely or aggressive. Despite receiving a CAMEL composite rating of 4 in September 2007, NCUA did not sign a Letter of Understanding and Agreement (LUA) with the credit union until June 2010. NCUA amended the LUA in May 2011 to allow NCUA to run the bidding process for a potential merger partner; but did not hold a meeting with bidders until November 2011. However, the credit union could not find an appropriate merger partner. In March 2012, the NCUA approved an NCUSIF-guaranteed line of credit for $73 million. Shortly thereafter, the NCUA authorized a temporary Cease and Desist Order and subsequently the state regulator placed Telesis Community into conservatorship. On June 1, 2012, Telesis Community was placed into liquidation.

Read the report.