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 the CU's loans, according to an NCUA report.
"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 programs operations," said the Material Loss Review of the Cal State 9 failure conducted by the Inspector General. Virtually all of the indirect HELOCs were subprime and included loans with stated income, high loan-to-value ratios, negative amortization second liens.
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 CU 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 was also caused by subprime mortgage lending.
NCUA estimates that Cal State 9, which was acquired by Patelco CU in 2008, will cost the National CU Share Insurance Fund $206 million to resolve, making it the costliest credit union failure to date.
The report illustrates the rapid growth of the CU's HELOC program, in which it bought loans on properties with inflated values from a third-party broker. The program was begun in 2003 by the CU's chief financial officer, who received bonuses tied to the loans. NCUA concluded 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." From 2006 to 2007 the CFO earned almost $400,000 in bonuses from the program.
The NCUA report does not list names, but the chief architect of the HELOC program was Richard Headrick and the CEO was Jackie Wong, both of whom departed in 2007.
The program grew rapidly, from $4.6 million in loans in March 2003 to $357 million by June 2007, when the CU was placed under NCUA's Special Actions supervision. By then, the 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 CU 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. 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 the CU to liquidate its investments to pay down its line of credit and slashed its line of credit from $90 million to just $25 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, leading NCUA to conclude at the end of 2007 that a sale of the CU was the only solution.
