NCUA’s Inspector General (IG) released its Material Loss Review on the failure of
Eastern Financial Florida Credit Union (EFFCU). NCUA estimates that the failure of EFFCU imposed a loss of $40 million on the National Credit Union Share Insurance Fund.
The IG concluded that the “failure can be attributed to inadequate management and Board of Directors (Board) oversight that exposed the credit union to excessive amounts of risk due to investments in complex private-placement Collateralized Debt Obligations (CDOs), weak business loan underwriting and credit administration, poor earnings resulting from an aggressive growth strategy, and an inadequate strategic plan.”
Excessive Exposure to Risky CDOsThe report found that EFFCU had significant losses related to large investments in CDOs backed by subprime home equity/auto loans and corporate debt. Management and the Board of EFFCU relied too heavily on rating agencies’ grading of CDO investments; failed to fully evaluate and understand the complexity of the CDO investments; and created a concentration risk by investing a total of eighteen CDOs for $149 million, of which nearly $100 million were backed by home equity loan asset backed securities.
In September 2005, EFFCU wrote the state supervisory authority (SSA) about the permissibility of investing in CDOs. The Florida CU supervisor concluded that it was a permissible activity. The report makes the point that Eastern was the only federally-insured state chartered credit union to invest in CDOs.
In the first half of 2007, Eastern Financial significantly ramped up its investments in CDOs. Between March and June of 2007, it purchased $94.8 million in CDOs, bringing its total investments in CDOs to $149.2 million. However, once purchased, these CDOs rapidly deteriorated in value.
“By early 2009, twelve CDOs were completely written off for a $106 million loss the remaining CDOs had a $43.2 million book value with unrealized losses totaling $37.9 million. In the end, EFFCU essentially charged off all eighteen CDO investments, resulting in losses of $149.2 million between June 2007 and June 2009,” according to the IG report.
The IG wrote that the “September 2005 CDO letter should have prompted the Florida SSA to require that EFFCU implement strong CDO policies to include prudent limits on initial CDO purchases to ensure EFFCU could properly manage the complex investments.” The planned investment in CDOs should have been viewed as high risk activity requiring greater supervisory oversight, especially since EFFCU was the only natural person credit union to hold these investments. The IG concluded that examiners missed an opportunity in 2006 and early 2007 to review the credit union’s ability to effectively manage the risk its CDO investments.
Concentration in Construction LoansThe IG report also notes that EFFCU had numerous violations associated with its member business loan program and experienced increasing delinquencies and loan losses, especially from two large construction and development (C&D) loans.
Examiners uncovered that EFFCU had not classified land intended for income producing property as C&D loans – understating its exposure by $61 million. Once properly classified, EFFCU had over 40 percent of its net worth in C&D loans (over $90 million),
which exceeded the regulatory limit of 15 percent of net worth.
Additionally, the report points out that EFFCU requested waivers from the requirement that borrowers have at least a 25 percent equity stake in projects being financed. Examiners recommended that NCUA regional office deny the waiver request, because it could lead to lead to unsafe and unsound banking practices. However, NCUA and the Florida CU regulator granted several of these waivers.
The IG report noted that EFFCU was experienced increased delinquencies with respect to its member business loan program. The report cites that in 2007 one larger delinquent member business loan ($30 million) was not properly classified – understating the credit union’s delinquent loan ratio. The actual delinquency ratio for the credit union was 2.58 percent, while the credit union’s September 2007 Financial Performance Report stated that delinquency ratio was 0.66 percent. Examiners determined the construction project was cancelled; however, EFFCU continued to accrue interest despite the loan being 5 months delinquent and there being no more funds in the interest reserve.
Other FindingsThe IG cites additional factors that demonstrated the lack of effective management and Board oversight of the credit union. These factors include: costly branch expansions, too heavy of a reliance on overdraft privilege fees, lack of management succession plans, and excessive use of outside contractors (three of the largest contracts had exorbitant termination fees).
A final point I would like to make deals with the lack of transparency with regard two enforcement actions. The IG report references two regulatory enforcement actions that were taken against Eastern Financial, however, they do not appear on either the NCUA’s or Florida regulator’s website. First, the IG report states that NCUA and the Florida regulator issued a joint Letter of Understanding and Agreement on January 25, 2008. Second, the state credit union regulator issued a temporary cease and desist order against EFFCU on December 18, 2008. Neither enforcement action is publicly available.
