ALEXANDRIA, Va. – The 2008 collapse of Cal State 9 CU was caused by the one-time $440 million Concord, Calif., credit union’s ill-fated foray into subprime mortgage lending, which eventually comprised more than 92% of all the credit union’s loans, according to a new report issued Friday by NCUA.
“Specifically, management committed an exorbitant percentage of the credit union’s assets in an indirect Home Equity Line of Credit program without adequate controls in place to oversee and manage the risks in the program’s operations,” said the Material Loss Review of the Cal State 9 failure conducted by the Inspector General for NCUA. Virtually all of the indirect HELOCs were of the subprime variety and included loans with stated income, high loan-to-value ratios, negative amortization second liens, and most went to borrowers with low credit scores.
More troubling, according to the report, was that the risky loan program even jeopardized at least three nearby credit unions and one bank with the sale of $190 million in non-recourse loan participations to those four institutions.
The report on the collapse of Cal State 9, the biggest credit union failure ever in California, comes as members of a U.S. Senate Subcommittee on Permanent Investigations is holding hearings on the collapse of Washington Mutual, the biggest bank failure ever – which also was caused by subprime mortgage lending.
NCUA estimates that Cal State 9, which was acquired by Patelco CU in a 2008 purchase and assumption agreement, will cost the National CU Share Insurance Fund $206 million to resolve, making it the costliest credit union failure to date.
The new report illustrates the rapid growth of the credit union’s HELOC program, in which Cal State 9 bought loans on properties with inflated values from a third-party broker. The program was begun in 2003 by the credit union’s chief financial officer, who received bonuses generated from the loans. NCUA concluded that the CFO “had no incentive to ensure the credit union had an effective quality control system in place because any loan turned down from the broker would, in effect, take money directly from his bonus.” During 2006 and 2007 the CFO earned almost $400,000 in bonuses from the HELOC program.
The NCUA report does not list names, but the chief architect of the HELOC program was Richard Headrick, who departed in the fall of 2007, and the CEO was Jackie Wong, who also departed that year.
The program grew rapidly, from $4.6 million in loans in March 2003 to $357 million by June 2007, when the credit union was placed under NCUA’s Special Actions supervision. By then, subprime HELOCs made up more than 92% of Cal State 9's total loans.
By December 2005, 82% of the HELOCs were comprised of stated income loans, commonly referred to as “liar loans.” By July 2006 the figure was 86%. At that point, 28% of all of the HELOC loans were credit tier C paper and 18% of them were to borrowers that had credit scores below 600. Also at that point, 61% of the HELOCs were in a junior position behind negative amortization first mortgages.
The credit union became increasingly reckless as the subprime program expanded, according to the report, by selling off investments to raise additional liquidity, increasing borrowings from WesCorp FCU and jacking up savings rates to raise new money. All the while, property values were starting to crash, causing rising delinquencies and charge-offs among the loans. Even still, “although Cal State 9's liquidity was worsening, examiners did not require management to slow the growth of the program early on or to stop funding indirect HELOC loans prior to being placed under Special Actions,” concluded the Inspector General.
“We believe that as a result of examiners’ lack of adequate monitoring and not taking aggressive supervisory actions, examiners missed numerous opportunities during or between contacts to slow or stop the funding of indirect HELOCs,” said the report. “Ultimately, we believe if examiners had taken more aggressive actions sooner, they would have likely mitigated the loss to the NCUSIF.”
As delinquencies and charge-offs continued to rise in 2007 Cal State 9 began to experience a classic liquidity crunch. In June 2007 WesCorp required Cal State 9 to liquidate its investments to pay down its line of credit with the corporate and slashed its line of credit to $25 million from $90 million. As a result, management started pumping up CD rates to attract new funds, but when it reduced rates to respond to the market, depositors began withdrawing money in large sums. This led NCUA to conclude at the end of 2007 that a sale of the credit union was the only solution.
In answer to a request for comment, NCUA referred to a response to the report by David Marquis, the agency’s executive director. In it Marquis cites guidance that NCUA recently issued on concentration risk, which was, in part, prompted by the Cal State 9 experience. NCUA also has conducted special examiner training in both Region Two and Five regarding "best practices" in evaluating risk in loan portfolios.
Neither Wang nor Headrick could be reached.
