IG: Examiners Could Have Done More to Detect Fraud at C B S Employees FCU

The National Credit Union Administration's Inspector General (IG) is critical of examiners for losses to the National Credit Union Share Insurance Fund (NCUSIF) arising from the failure of C B S Employees Federal Credit Union.

According to the Material Loss Review, the failure of the credit resulted in an estimated loss of $39.5 million to the NCUSIF.

The IG determined that the failure was due to the misappropriation of $42.2 million in cash, due to fraud. The credit union's former CEO concealed the losses by understating member share balances, primarily share certificates, on the financial statements. The embezzlement occurred unabated for almost 20 years.

The IG noted that the lack of segregation of duties and dual control allowed the former CEO to perpetrate and conceal the fraud. The former CEO possessed all of the following:

• Access to official credit union checks, which enabled him to alter the physical records of credit union checks;
• "Super-user" access to the credit union's accounting system, which enabled him to alter both the check payee information and file maintenance reports, which concealed this action; and
• Sole responsibility for financial reporting, which gave him the ability to prepare fraudulent financial statements.

While the IG report stated that while examiners recognized the risk posed by the lack of segregation of duties, it did not result in a Document of Resolution or any other formal or informal enforcement action.   The IG believed that if these responsibilities had been separated, it would have been more difficult for the former CEO to perform the fraudulent activities.

In addition, if dual controls had been in place, credit union staff could have discovered the former CEO’s embezzlement long before they eventually discovered it.

Furthermore, the IG report noted that to perpetrate the fraud, the former CEO needed a reliable source of funds. The former CEO had authority to set interest rates on share certificates. For example, the former CEO set the interest rate on one-year share certificate at 3.1 percent as of December 31, 2018, which was significantly above the market rate of approximately 1.3 percent. Despite these above-market rates, the credit union reported approximately $3.5 million in share certificates at the end of 2018. This small dollar amount of share certificates given the above-market rates should have triggered questions among the examiners; but the IG found no evidence of this in their Examination Report.

Moreover, the IG concluded that the supervisory committee audits and member account verification procedures were unacceptable.

The IG made two recommendations, which National Credit Union Administration management agreed with. Management should:

• "revise examination procedures to prioritize assessing and developing a risk response for credit unions that do not segregate certain key duties and that require dual controls. These revisions should include a framework that examiners can complete an assessment of those characteristics that indicate lack of segregation of duties at a credit union and additional procedures that examiners should perform when a lack of segregation of duties is apparent";  and 
• "amend guidance related to member account verifications. Specifically, the amended guidance should require reconciliation from the print processor to the share and loan subsidiaries when a statement verification is performed."

Read the Material Loss Review.

Loss to NCUSIF Was $765.5 Million from the Failures of Bay Ridge FCU, LOMTO FCU, and Melrose CU

The National Credit Union Administration (NCUA) Office of the Inspector General (OIG) released its Material Loss Review on the failure of taxi medallion lenders Melrose Credit Union (Briarwood, NY), LOMTO Federal Credit Union (Woodside, NY), and Bay Ridge Federal Credit Union (Brooklyn, NY).

The report found that the aggregate loss to the National Credit Union Share Insurance Fund (NCUSIF) from the failure of these 3 credit unions was $765.5 million. The OIG estimates that the losses to the NCUSIF from the failure of Melrose CU and LOMTO FCU was approximately $726 million; but NCUA will not know the final cost until all assets are sold. The failure of Bay Ridge FCU resulted in a preliminary loss of $39.5 million to the NCUSIF.

The OIG determined the failures were due to: (1) significant concentration of loans collateralized by taxi medallions, (2) unsafe and unsound lending practices, and (3) weak Board and management oversight and inadequate risk management practices.

The report noted that all three credit unions qualified for an exception from the aggregate member business loan cap, because the credit unions were either chartered for the purpose of making member business loans or have a history of primarily making member business loans prior to September 1998.

As of June 30, 2018, all three credit unions had significant concentration in tax medallion loans.

• Bay Ridge FCU had approximately 40 percent of its loan portfolio in taxi medallion loans;
• LOMTO FCU had approximately 93 percent of its loan portfolio in taxi medallion loans, and
• Melrose CU reported almost 71 percent of its loan portfolio was made up of taxi medallion loans.

The report stated that the 3 credit unions failed to monitor and appropriately monitor loans to associated members, thereby increasing concentration risk. NCUA's Member Business Loan Regulation limits lending to associated members to 15 percent of net worth. Examiners noted several instances when the credit unions violated the associated borrower limit. Because the credit unions did not identify and document loans made to associated borrowers, the OIG wrote it is not clear how often the associated borrower regulatory limit was breached.

In fact, Melrose requested forbearance in regard to the associated borrower limitation in July of 2014, requesting the 15 percent limitation be increased to 25 percent. The forbearance request was formally denied in October of 2015. However, prior to the denial, Melrose had restructured and extended approximately $113 million in loans to two different associated borrower relationships exceeding the 15 percent concentration during 2015. A September 30, 2015 examination, these two associated borrower relationships accounted for approximately $177 million in loans.

The OIG found that the credit unions engaged in inadequate loan underwriting and monitoring of taxi medallion loans. Examples of inadequate loan underwriting included frequent failure to fully analyze financial information of borrowers, did not look at the borrowers' ability to repay the loan, risky loan terms, unsupported cash out refinancings, and failure to identify and account for modified loans as Troubled Debt Restructures.

All 3 credit unions had significantly underfunded their allowance for loan and lease losses accounts.

The OIG also reported that lending decisions were based on inflated market values for taxi medallions rather than on industry accepted best practices for loan underwriting.

The report found that the credit unions did not adequately respond to issues raised by examiners, including lending practices, concentration, liquidity, and overall risk management. Poor Board oversight allowed for weak risk management practices at the 3 credit unions to go unchecked. The report highlighted the credit unions' Board of Directors, specifically Melrose and LOMTO, exhibited a lack of urgency in addressing their rapidly decreasing financial position.

The OIG concluded that if examiners had acted more aggressively through formal enforcement actions for repeat document of resolutions, NCUA may have reduced the size of the loss to the NCUSIF.

The OIG made 3 recommendations to NCUA management to more effectively capture the concentration and other risks on a credit union’s balance sheet.

NCUA management should:

• institute a formal process to regularly identify, analyze, and document concentration risk issues in credit unions or groups of credit unions and develop appropriate thresholds for different concentrations that would require increased levels of risk mitigation.
• revise examination procedures to prioritize assessing and developing risk responses for credit unions with high levels of concentration risk. For repeated unresolved recommendations, informal enforcement actions should be escalated to formal enforcement actions.
• require examiners review credit unions’ lending procedures with respect to analyzing the ability of the borrower to meet debt service requirements.

NCUA agreed to the recommendations.

Read the Material Loss Review.

NCUSIF Assisted Mergers Lack Transparency

The National Credit Union Administration's response to questions about charges to the National Credit Union Share Insurance Fund (NCUSIF) associated with assisted mergers in the fourth quarter lacked illumination.

One slide in the NCUSIF presentation at the March National Credit Union Administration (NCUA) Board meeting showed charges for assisted mergers of $39.5 million during the fourth quarter.

The following are questions to a NCUA spokesperson and the spokesperson's response.

Q: What type of assistance did NCUA offer during the fourth quarter?

Q: Was the charge associated with the merger of Bay Ridge FCU into Island FCU?

A: Slide five of the Q4 2018 Share Insurance Fund report shows the aggregate charges for assisted mergers was $39.6 million for the year and $39.5 million for the fourth quarter. The NCUA posts assisted mergers on its Conservatorships and Liquidations page, but the agency does not make public details of the type or level of assistance in an individual merger.

Q: Will the Office of the Inspector General do an audit on this assisted merger?

A: “The Dodd-Frank Wall Street Reform and Consumer Protection Act obligates the NCUA OIG to conduct material loss reviews (MLRs) of credit unions that incurred a loss of $25 million or more to the National Credit Union Share Insurance Fund. In addition, Dodd-Frank requires the OIG to review all losses under the $25 million threshold to assess whether an in-depth review is warranted due to unusual circumstances.”

We will have to wait for the semi-annual report to Congress from the agency's Inspector General to see whether a material loss review is being conducted with respect to the NCUSIF assisted merger of Bay Ridge Federal Credit Union. The Brooklyn, New York-based credit union had significant exposure to taxi medallion loans.

MLR: Alleged Fraud Caused Failure of Six Small Pennsylvania CUs

A Material Loss Review (MLR) by the National Credit Union Administration (NCUA) Office of Inspector General (OIG) found that Chester Upland School Employees Federal Credit Union (Chester), O P S EMP Federal Credit Union (OPS), Electrical Inspectors Federal Credit Union (Electrical), Triangle Interests % Service Center Federal Credit Union (Triangle), Cardozo Lodge Federal Credit Union (Cardozo) and Servco Federal Credit Union (Servco) failed due to alleged fraud.

All six Credit Unions outsourced their management, recordkeeping, and maintenance of financial records to a third party provider, Service Center for Credit Unions, Inc. (SCCU), in Bensalem, Pennsylvania.

NCUA liquidated all six credit unions on April 5, 2016. The failure of the six credit unions resulted in an estimated loss of $3.2 million to the National Credit Union Share Insurance Fund (NCUSIF).

The MLR reported that the six credit unions failed due to overstatement of approximately $3.2 million in assets, primarily investments in certificates of deposit (CDs).

The MLR cited three reasons for the failure of these six credit unions:

• Management displayed a lack of integrity and did not manage the six credit unions in the best interest of their members; 
• The Supervisory Committees failed to obtain Supervisory Committee Audits that included confirmation of investments; and 
• The Boards of these six credit unions exercised weak oversight.

The MLR further stated that the alleged fraud could have been discovered sooner, if examiners "had followed National Supervision policies and identified the Supervisory Committee Audits as unacceptable, confirmed account balances directly with institutions, and addressed risks related to the failures of the Supervisory Committees and Boards of Directors." This would have potentially mitigated the loss to the NCUSIF.

Read the Material Loss Review.

NCUSIF Estimated Losses of $5.4 Million Between April 1, 2016 and September 30, 2016

The National Credit Union Administration Office of the Inspector General (OIG) reported that losses to the National Credit Union Share Insurance Fund (NCUSIF) between April 1, 2016 and September 30, 2016 were approximately $5.4 million.

In its Semi-Annual Report to Congress, the OIG provided estimates of NCUSIF losses and grounds for closing arising from the liquidation of one credit unions and emergency merger of another credit union.

Also, the OIG had contracted with Moss Adams LLP to conduct a Material Loss Review (MLR) regarding the failures of six federally insured credit union located in Bensalem and Chester, Pennsylvania. All six credit unions outsourced the management, recordkeeping, data processing, and maintenance of financial records to a third party provider, which allegedly caused each institution to fail. The MLR will: (1) determine the cause(s) of the credit unions’ failure and the resulting estimated $3.2 million loss to the Share Insurance Fund; (2) assess NCUA’s supervision of the credit unions; and (3) provide appropriate recommendations and suggestions to prevent future losses.

Director Liability

Should credit union directors be held professionally liable, if their conduct contributed to the failure of a credit union?

I know that this is a sensitive subject. Credit union advocates will say that since directors are volunteers and most directors are not compensated, it would be unfair to hold them personally liable for a credit union's failure.

However, after reviewing a number of the Material Loss Reviews conducted by NCUA's Inspector General, there is a re-occurring theme that the board of directors were negligent in their oversight of the credit union. These reports note that the board of directors failed to exercise adequate oversight of management and/or exposed the failed credit union to excessively risky business models.

Here are some excerpts from recent Material Loss Reviews.

In the case of the failure of Taupa Lithuanian Credit union, the NCUA Inspector General found that "Taupa’s Board of Directors failed in its duties to adequately oversee the activities of management. During the scope period of our review, multiple examinations identified the need for more consistent Board of Directors meetings and adequate minutes. Examiners cited Board deficiencies in examinations effective June 30, 2006; December 31, 2007; March 31, 2009; June 30, 2010; December 31, 2011; and December 31, 2012."

The Material Loss Review (MLR) for Vensure FCU concluded that "Vensure’s management and Board exposed the credit union to excessive amounts of financial risk due to its affiliation with high risk members and a high risk business model. Specifically, Vensure’s management and Board failed to manage the credit union’s risk related to its ACH payment processing activity for a member that processed payments for internet gambling websites."

NCUA's Inspector General cited weak Board of Directors oversight in the failure of G.I.C. FCU. The MLR reported that "[a]lthough the supervisory committee is the entity charged with primary responsibility over the records of the Credit Union, the Board of Directors acts as control over the supervisory committee by providing a forum for receiving the audit report and minutes of the Committee meetings. We believe G.I.C.’s Board failed in these responsibilities as evidenced by the Board’s failure to keep complete and accurate minutes or to obtain Board packets with information sufficient to execute its duties."

The MLR for Chetco FCU found that the "Board of Directors and management exposed the credit union to excessive amounts of credit and liquidity risk due to its failure to set appropriate limits and maintain the appropriate risk management infrastructure to support the growth in the Member Business Loan (MBL) portfolio."

As these MLRs demonstrate, the actions of these directors contributed to the failures of these credit unions.

NCUA has the authority to pursue these credit union directors, as well as officers, if their gross negligence led to the demise of the credit union. However, outside of a lawsuit suing the directors of WesCorp, it is unclear whether NCUA has chosen to exercise this power.

At a minimum, NCUA's Office of the Inspector General should conduct a study, just like the study performed by the Inspector Generals for the federal banking agencies, on enforcement actions and professional liabilities claims against institution-affiliated parties and individuals associated with failed institutions.

Loss from Taupa Lithuanian Credit Union Failure Is $33.5 Million

The Material Loss Review (MLR) of Taupa Lithuanian Credit Union (Cleveland, Ohio) by the National Credit Union Administration's Office of the Inspector General (IG) found that fraud caused the failure of credit union.

According to the MLR, the Ohio Department of Financial Institutions liquidated Taupa Lithuanian on July 15, 2013 and the loss to the National Credit Union Share Insurance Fund from Taupa Lithuanian's failure is estimated at $33.5 million.

The IG report states that Taupa Lithuanian failed primarily due to management fraudulently overstating assets and understating shares. Specifically, examiners discovered assets overstated by approximately $15.5 million, which Taupa management fraudulently reported as cash on deposit at Corporate One Federal Credit Union, and noted an $18 million share understatement, altered documents, inaccurate Call Reports, and other suspicious transactions.

The report also notes that examiners missed numerous red flags, such as excessive amounts of cash on deposit, the discovery of an unaccounted for bag of coins under the sink, an overdrawn employee account for an extended period, an overdrawn line of credit at the corporate credit union, and an evasive CEO. The report said that these red flags should have warranted expanded examination procedures.

In NCUA's November 2011 review of the state examination working papers from 2010, NCUA's examiner-in-charge noted that what was happening at Taupa Lithuanian was eerily similar with what transpired at failed St. Paul Croatian FCU. Specifically, the examiner-in-charge commented:

[M]BLs, policy updates, investment & record keeping errors, NO delinquency & NO charge offs in over 10 years, this CU looks, sounds & acts like St. Paul's Croation [sic] waiting to happen all over again.

Read the MLR.

IG Report: G.I.C. FCU Failed due to Fraud

NCUA's Office of the Inspector General (IG) determined that fraud led to the failure of G.I.C. Federal Credit Union of Euclid, Ohio.

According to the Material Loss Review, the failure of G.I.C. resulted in an estimated loss of $7 million to the National Credit Union Share Insurance Fund.

The IG report found that the credit union overstated its assets by $8.1 million, primarily through the misstatement of certificates of deposit held as investments and cash held on deposit.

The report noted that several factors contributed to the fraud going undetected, including

• senior management displaying a lack of integrity and not managing the credit union in the best interest of its members;

• supervisory committee failing to obtain supervisory committee audits for three consecutive fiscal years; and

• the Board of Directors of the credit union failing to exercise its responsibilities.

The IG report pointed out that only federal credit unions with $500 million or more in total assets are required to have a financial statement audit performed by a licensed independent auditor. However, the report makes the observation that "smaller credit unions ... often have less sophisticated supervisory committees, Boards of Directors, and/or management." The report suggested that NCUA management review various Material Loss Reviews and consult with various stakeholders whether the $500 million asset threshold is too high.

Read the Material Loss Review.

Member Business Loans Caused Chetco's Failure

The Material Loss Review (MLR) of National Credit Union Administration's Office of the Inspector General (OIG) found that Chetco FCU (Brookings, Oregon) failed because of inadequate management and board oversight of the credit union's member business loan program. In addition, the MLR points out that NCUA examiners missed numerous red flags with regard to Chetco's member business lending.

The loss to the NCUSIF is estimated at $76.5 million.

The report noted that Chetco experienced rapid growth in its business loan portfolio, as it took advantage of its exception to the member business loan cap of 12.25 percent of assets and its waivers of Member Business Loan regulations.

Member business loans grew from $33.2 million (21.5 percent of assets) in 2002 to a high of $212 million in 2009, before leveling off to $189.4 million (56 percent of assets) in 2010. This represented an increase in member business loan concentrations from less than 26.6 percent of total loans as of 2002 to over 60 percent as of December 2009.

The report also notes that Chetco's business lending operation expanded outside its local market area to as far away as New Mexico and North Carolina. The credit union used its wholly-owned credit union service organization (CUSO), Commercial Lending Solutions, to facilitate the growth in its business loan operations.

As economic conditions deteriorated in 2007 and 2008, especially the real estate market, delinquencies rose at Chetco. However, Chetco initially tried to use loan renewals and modification to mask the deterioration in its member business loan portfolio. NCUA examiners were tipped off to this practice by a member's complaint.

The MLR notes that Chetco management funded its rapid loan growth through a combination of borrowed funds and deposit products with above-market rates. However, as Chetco's financial condition deteriorated, its sources of liquidity became restricted.

The report further states that Chetco failed to operate its business lending CUSO in a safe and sound manner by intertwining the operations of the Credit Union and CLS with no clear delineation of each entity’s respective employee responsibilities.

The report is critical of NCUA's supervision of Chetco. It notes the lack of resources and time spent performing a comprehensive review of Chetco's business loan portfolio. Examiners did not do adequate examination of member business loan renewals and modifications.

Also, based upon training records going back to 1999, the MLR found that the Examiner-in-Charge of supervising Chetco from 2005 to 2011 had no training specific to member business lending. This is troublesome given the complexity of the credits in Chetco's member business loan portfolio.

Read the Material Loss Review.

Redacted Report Issued on El Paso's FCU Failure

The National Credit Union Administration's Office of the Inspector General (IG) issued a highly redacted Material Loss Review on the failure of El Paso's Federal Credit Union.

The IG report noted senior management displayed a lack of integrity and did not manage the credit union in the best interest of its members. The report pointed out that credit union's fee income was excessive. During the period examined, fee and other operating income as a percent of average total assets averaged 3.73 times higher than its peers.

The report stated that "senior management displayed a lack of competence and training appropriate to their position."

In addition, the credit union had deficiencies with regard to record keeping and internal controls and ineffective oversight by its Board of Directors and Supervisory Committee.

For example, "examiners found problems with the execution of loan collections and charge offs, the sufficiency of Board minutes, identification of delinquent loans, backdating of transactions, and the Credit Union's advertised field of membership."

The report also noted that the Board Chairman received questionable payments associated with Board meetings and expenses.

Read the report.

Business Lending Contributed to Easten New York FCU's Failure

NCUA's Office of the Inspector General (IG) released a report on the failure of Eastern New York Federal Credit Union. As of September 2012, the estimated loss to the NCUSIF was approximately $3.6 million.

The IG report concluded that Board of Directors (Board) gave the credit union's CEO broad authority to conduct various and significant transactions with very little oversight. As a result, these business ventures, including complex credit union service organization arrangements, unsound business loan originations, and excessive holdings of fixed assets, proved to be catastropic for the credit union.

According to the report, the credit union's business loan portfolio grew rapidly from one loan of $200,000 in 2007 to 26 loans totaling approximately $3.5 million by the end of 2009. However, 17 loans totaling $3.1 million or 88 percent of the total dollar value originated were made to two separate, but related, families creating an excessive concentration risk.

The report noted that the business loans were poorly underwritten and had almost no credit analysis. In addition, the CEO and the Chairman of the Board, who approved all these loans, did not meet the regulatory requirements related to business lending experience. Also, in many cases, loan approval documentation was not received until well after loan proceeds were dispersed.

NCUA’s Asset Management and Assistance Center estimated impairment losses from Eastern New York's business lending operations to be $2.4 million.

Read the Material Loss Review.

Material Loss Review on O.U.R. FCU

NCUA's Inspector General released a Material Loss Review on the failure of O.U.R. Federal Credit Union, a low-income credit union in Eugene, Oregon.

According to NCUA, the failure of O.U.R. FCU will result in an estimated loss to the National Credit Union Share Insurance Fund (NCUSIF) of $3.7 million. While the loss did not exceed the $25 million threshold, the Inspector General Office concluded that the circumstances surrounding the loss to the NCUSIF were unusual enough to warrant a review.

The IG report found that several factors contributed to the failure of O.U.R. FCU:

• Suspcious activity;
• Ineffective board oversight;
• Weak controls; and
• Inaccurate accounting.

The IG report was also critical of NCUA examiners noting that the agency missed the opportunity to prevent or reduce the loss to the NCUSIF, including incomplete examinations and ineffective resolution of issues raised during examiniations.

The report notes that the credit union was under a net worth restoration plan since March 2010. In addition, the credit union was issued a Letter of Understanding and Agreement (LUA) in August 2010, which specifically listed concerns and expectations related to record keeping, the debit card program, interest rate risk, and capital levels. Neither regulatory action was made public by NCUA.

Read the IG Report.

Material Loss Review of Vensure FCU

NCUA's Office of the Inspector General (IG) recently released its Material Loss Review of the failure of Vensure Federal Credit Union. The estimated loss from the failure of Vensure to the National Credit Union Share Insurance Fund is $39 thousand; but it could go higher if the Department of Justice seeks to recover Vensure’s earnings related to processing illegal internet gambling ACH transactions.

The IG report found that NCUA's decision to seize Vensure arose from a Department of Justice action against several on-line poker companies. As a result, the Department of Justice seized all funds of one of Vensure’s members - Trinity Global Commerce Corp. (Trinity), a processor of on-line gambling transactions. Trinity was Vensure’s largest depositor at the time and nearly all of Vensure's earnings (nearly 90 percent during 2010) came from transaction fees processing Trinity’s internet gambling transactions.

After Trinity’s funds were seized, Vensure had an Automated Clearing House (ACH) receivable of approximately $877,000 as a result of subsequent return items. When Vensure recognized the loss from the uncollectible ACH receivable, the credit union became insolvent.

In addition, the IG report concluded that Vensure’s management and Board did not operate the credit union in a manner consistent with typical natural person credit unions. Vensure had minimal loans in 2009 and no loans during 2010 and 2011.

The report states that "the significant and rapid increase in Vensure’s fee related income, as well as the size of the individual and cumulative ACH wire transactions given the small size of the credit union, the significant change in the make-up of its management and Board, and its few traditional sources of income, should have triggered ... examiners to expand the scope of their on-site examinations and supervision contacts to thoroughly evaluate the credit union’s income to determine the nature of its source and why it increased so rapidly." But there is no evidence that examiners did a detail review regarding the nature and scope of the business fee income nor questioned the Board and management over the change in Vensure's business model.

Read the report.

Material Loss Review on Southwest Corporate FCU

The failure of Southwest Corporate FCU (Southwest) will cost the Temporary Corporate Credit Union Stabilization Fund (TCCUSF) $141 million, according to a recent report released by NCUA's Office of Inspector General (IG).

The IG report found that the failure of Southwest can be attributed to management's implementation of an aggressive investment strategy that led to a significant concentration of investments directly in privately-issued residential mortgage backed securities (MBS) and additional indirect exposure through U.S. Central Federal Credit Union’s investments in MBS.

Between March 2004 and July 2007, Southwest increased its direct concentration of privately-issued MBS 263% from $1.39 billion to $5.05 billion. This growth in its private-label MBS was fueled by an increase in Southwest's investment policy limit from 400% of capital in 2004 to 900% of capital in 2006.

In 2007, approximately two-thirds of Southwest’s $4.8 billion MBS exposure was collateralized by riskier non-prime mortgages, just when the housing market became dislocated.

Moreover, its MBS exposure was heavily concentrated in one state -- California. The California concentration represented 319 percent of Southwest’s capital.

The IG report also criticized NCUA Office of Corporate Credit Unions (OCCU) staff. It found that staff did not adequately and timely address the risks associated with Southwest’s direct concentration of and indirect exposure to privately-issued MBS. The report also criticized OCCU staff for not taking exception to the geographic concentration of Southwest's private-label MBS portfolio.

Read the report.

Material Loss Review Issued on Constitution Corporate FCU

NCUA's Office of the Inspector General (IG) issued its report on the failure of Constitution Corporate FCU. NCUA estimated as of July 2011 that the failure of Constitution Corporate FCU resulted in a loss of $145 million to the Temporary Corporate Credit Union Stabilization Fund.

This IG report is similar to the other IG reports that examined the failures of other corporate credit unions.

The Material Loss Review cites that management and Board failed to identify and manage their risk exposure to the mortgage-backed securities (MBS) prior to the market dislocation in mid 2007. At that time, Constitution Corporate had significant holdings of private label MBS including Alt-A and subprime paper.

Constitution Corporate's decision to expand its investments into private label MBS was driven by the need to be rate competitive with other corporate credit unions that were actively soliciting Constitution Corporate's members.

The IG report notes that:

1. there was an over-reliance on credit ratings by management when purchasing securities and monitoring credit risk in the investment portfolio;

2. management did not set prudent sector concentration limits;

3. management did not properly identify and monitor credit risk exposure in the underlying mortgage loan collateral of MBS held in the investment portfolio; and

4. management did not recognize the risk they were undertaking with significant investments in complex MBS, with a substantial portion of these securities backed by subprime assets.

The report also criticizes NCUA for failing to assess or timely identifying key risks associated with Constitution Corporate FCU's investment portfolio, until it was too late.

Read the report.

IG Report: Ethic Breaches Played a Role in Certified FCU's Failure

The Inspector General (IG) found that Certified FCU failed because of weak internal controls, weak board oversight, and inadequate risk management practices. The failure of Certified FCU resulted in a loss of $9 million for the National Credit Union Share Insurance Fund.

The IG report found that improprieties and fraud played a major role in the credit unions failure. According to the IG report, allegations of fraud and improprieties first surfaced through anonymous telephone calls to the NCUA in April and May of 2005. However, a 2005 investigation by NCUA found no evidence to substantiate the fraud allegations, although they determined the CEO had abused his position to enrich himself personally at the credit union’s expense and potentially engaged in money laundering. The report notes that NCUA officials failed to take decisive action about these ethical breaches and the CEO stayed in his position until May 2010.

A 2010 forensic review found evidence that there was a breach in the fiduciary duties by the CEO, including check kiting and receiving "potential kick backs from vendors and from loan origination fees and commissions paid to one of the Credit Union’s loan officers."

For example,

"The CEO had a consulting company, which contracted for a 20 percent share of commissions paid to the loan officer’s mortgage servicing business. The loan officer generated low quality loans with high origination fees, which were then approved by the CEO. The loan origination fees were paid by Certified in the form of commissions to the loan officer’s company, which then paid the CEO’s consulting business its 20 percent share."

Additionally, the report notes that the credit union failed to manage liquidity risk. High cost nonmember deposits, which I've previously written about with respect to other credit union failures, rose to 18 percent of total deposits increased the liquidity problems confronting the credit union, especially given its heavy concentration of fixed rate real estate loans.

Additionally, the IG report found that NCUA examiners failed to:

1. adequately assess the management component of CAMEL rating system;

2. adequately consider external audit findings and reviews when developing their examination procedures; and

3. appropriately apply remedies when their fraud investigation unearthed serious safety and soundness concerns due to the CEO’s business practices and ethical behavior.

Read the IG Report.

IG Report on Beehive's Failure

NCUA's Office of the Inspector General released it material loss review on the failure of Beehive Credit Union. The NCUA estimates the loss to the National Credit Union Share Insurance Fund (NCUSIF) at $27.6 million, but the final cost will not be known until all assets are sold.

The IG concluded that Beehive Credit Union's management and Board of Directors' weak oversight and risk management policies, coupled with inaccurate financial reporting related to delinquencies and reserves, contributed directly to Beehive's failure.

For example, examiners in their 2008 examination report noted weak risk management practices related to underwriting, including unsigned tax returns, the lack of sufficient employment and income verification to demonstrate repayment ability, inadequate lot loan documentation, and unsupported property valuations.

The report cited that management did not effectively plan, manage, or control liquidity risk. Specifically, management allowed real estate concentrations to rise to over 66 percent of total loans, with most loans at fixed rates. Management also allowed high-cost nonmember deposits to rise to 18 percent of total deposits.

The IG report noted that brokered loans were the main source of Beehive's construction and lot loans as of September 2008. The report also states that a growing percentage of the real estate loans were Construction Take Back loans , which were inherently high-risk, because it provided funding primarily to members who could not obtain permanent outside financing after the construction phase of the project was completed.

In addition, the IG wrote that the Utah and NCUA examiners could have mitigated the loss to the NCUSIF had they performed timelier supervisory contacts and not allowed a 32-month gap in supervision to occur. The IG believed this supervisory lapse may have prevented examiners from detecting the deficiencies and curtailing the risky lending practices that eventually led to Beehive's insolvency.

Read the report.

IG Releases Material Loss Report on Members United

NCUA's Office of the Inspector General (IG) released its material loss report on the failure of Members United Corporate FCU. NCUA has estimated that as of February 28, 2011 the Temporary Corporate Credit Union Stabilization Fund (TCCUSF) had recorded a loss of $400.1 million for Members United.

The IG report found that management and the Board provided inadequate oversight, which resulted in Members United purchasing significant holdings of private-label mortgage-backed securities (MBS), many of which were later downgraded to subprime and Alt-A. Specifically, Members United management:

1. Did not establish timely investment concentration limits;

2. Relied too heavily on ratings assigned to the securities by Ratings Agencies to monitor the amount of credit risk in the investment portfolio;

3. Relied on monoline insurers to provide credit enhancement to a portion of the non-agency mortgage-backed securities in the portfolio;

4. Did not properly identify and monitor credit risk exposure in the underlying mortgage loan collateral; and

5. Relied on the corporate credit union structure to provide financial strength and liquidity. Members United did not adequately evaluate the risk of investing with and having its only line of credit with U.S. Central.

As a result of the dislocation in the credit market, the actions of management and the credit union's Board had serious consequences for the Members United. The corporate credit union experienced a deterioration in the market value of its MBS portfolio. The decline in the market value of its investments limited its ability to sell securities hampering its ability to meet the liquidity needs of member credit unions. Public confidence in Members United debt eroded due to ratings downgrades, which impeded its ability to issue debt to meet its liquidity needs.

The IG report also notes that NCUA failed to adequately assess or timely identify key risks related to Members United's investment portfolio.

The first time that NCUA examiners commented on Members United exposure to subprime and Alt-A MBS was in August 2007. At that time, Members United held almost $4.9 billion in MBS, of which 67 percent was subprime or Alt-A. However, examiners did not raise supervisory concerns or issue a document of resolution.

In May 2008, NCUA examiners expressed concerns regarding the corporate credit union's significant concentration in mortgage-backed securities and issued a document of resolution about the appropriateness of the existing concentration limits.

The IG report states that NCUA also placed too much reliance on credit ratings and failed to recognize the lack of diversification in Members United's investment portfolio.

Read the IG Report.

Beehive Will Cost NCUSIF More Than $25 Million

NCUA's Inspector General stated that it will perform a Material Loss Review on Beehive Credit Union. The Inspector General in its 2011 Annual Performance Plan stated that the loss to the NCUSIF from this soon-to-be closed credit union will exceed $25 million.

What is odd is that while NCUA's Inspector General has announced that it preparing to look into the causes of this credit union's failure, neither the Utah credit union regulator nor the NCUA have bothered to seize this credit union.

Recap of 10 Costly Credit Union Failures

NCUA's Inspector General (IG) issued a report summarizing significant findings associated with 10 costly natural person credit union failures between November 2008 and October 2010. The report notes that (1) poor strategic planning and decision making; (2) inadequate policies and internal controls; and (3) fraud contributed to these failures.

The following table lists areas of concern that were common with each failure (click on table to enlarge).












Appendix B lists various recommendations to NCUA management to address concerns identified by the IG report and managements comments regarding these recommendations.

For example, to address concentration risk, the IG recommends that credit unions provide more information on their call report breaking out unfunded commitments by loan type. NCUA management agreed with the recommendation and will add two additional categories of unfunded commitments not currently captured on the 5300 Call Report: indirect and third-party loans.