CENTENNIAL, Colo. -
For now, Centrix EVP Kevin Berry told the Credit Union Journal, "I'll be running the entity and providing services to the portfolio that remains active." The sale of Centrix reportedly involved some $1.9 billion in subprime auto loans, mostly from credit unions. The buyer, Kendrick CF Acquisition Inc. - which is Falcon Investment Advisers and Centrix CEO Robert Sutton-will trade more than $30 million in secured debt for control of the Centrix portfolio. Falcon gets 70% of equity, Everest Reinsurance Holdings Inc. gets 25% and Sutton will get 5%.
The final outcome of the sale was delayed temporarily when Sutton sought to be released of all estate claims against him, but the judge denied the request, thereby allowing creditors to pursue litigation, according to by debtor counsel Craig D. Hansen as reported by theDeal.com.
Because more than two-thirds of Centrix's portfolio is owned by about 230 credit unions across the country, there is reason to consider what happened and why, if only to learn from the outcome.
CEO Sutton claimed Centrix' problems were due to NCUA's tightened regulations, specifically the Risk Alert on Third Party Subprime Indirect Lending issued in June 2005. One year later, in a letter to Centrix partners, he termed NCUA's behavior as "un-American. It is an obstruction that is clearly ruinous to credit unions' efforts to serve the underserved, and it has injured Centrix."
There's no doubt Centrix's appeal to CUs fell within the lofty confines of helping the poor while making a profit. Some bought in, others did not.
But with its trade press ads touting a "new standard" in CU risk management for "safety, income and flexibility" in the subprime market, including in the CU Journal, credit unions, credit union leagues and industry spokesmen hopped on the bandwagon, each having a stake in promoting the Centrix method. Several leagues endorsed the Centrix program and benefited financially from that endorsement.
The story had a compelling plot: to offer loans to credit-challenged people and earn very attractive yields. People so credit-challenged, in fact, that few other subprime lenders would touch them. Centrix's Portfolio Management Program (PMP) facilitated loans to persons with FICO scores of 475 for mostly used autos at an average rate of 17.9%-18.2%. Typically, the CU making the loan through the Centrix-affilated car dealer picked up a yield of 8% to 11% with the balance paying for insurance. Centrix was also paid for underwriting services and for handling collection calls when payments were not made.
"Since 1998, the Centrix PMP has generated $4 billion in loans, assisting more than 300 financial partners in safely and profitably participating in this growing opportunity, while helping over 250,000 credit-challenged drivers discover a better way to buy a car," states the Centrix website today.
But the better way proved too bumpy for some credit unions who signed on and even for those that bought Centrix loans from other CUs through participation arrangements. Several sources alleged that at least a dozen CEOs had lost their jobs in the fallout, and many of those sources are reluctant to speak on the record because of embarrassment and fears of not finding other employment. The fiduciary responsibility of credit union board members, who had to approve the Centrix program, and monitor its progress has never been fully addressed either.
CU Fire Sale
But numbers cannot hide. The losses suffered by New Horizons Credit Union in Denver, for instance, have been attributed to Centrix loans in addition to faulty construction loans. The sight of a credit union having to be auctioned off to the highest bidder would likely strike most industry people as very sad, yet that's now about to happen to New Horizons, which reported total assets of $174 million in December 2006, down from $295 million the year before. Falling even faster has been NHCU's capital ratio: in June 2006 its net worth was 7.64%, by September 2006 it had fallen to 3.40%. The peer group average is 11.68%. New Horizons posted losses steadily from 2005 on, but the sharpest drop, almost 25%, occurred from June to September of 2006. Its net income for the year was posted as a near $20-million loss.
Thus, a parade of prospective buyers went to the Embassy Suites Airport Hotel for a bidders meeting to gather information from NCUA and the Colorado Division of Finance about acquiring the CU, which has been under conservatorship since April.
Berry said the danger of losses in a subprime program always exist, but that what happened to New Horizons wasn't solely due to Centrix loans. "No one has suffered a return that is negative to their investment," he said. "Everyone's principal is safe, by our accounting. I'm not minimizing the situation. Anyone who invests in an entity that goes bankrupt...and through our reorganization I've spoken with participants in the PMP whose expectations in bankruptcy aren't positive."
Barry admitted that the returns from loans were far less than expected. "Management didn't experience what was anticipated." He also said he personally was not involved in the selling side or the investment side at Centrix, so demurred when asked to explain what went wrong.
Those expectations were at the time touted to be in the 11% to 13% range. "We have $1.3 billion of loans on the books, and some credit unions may decide to sell out. But we're servicing the portfolios for 242 credit unions and 241 of them still signed the new agreement."
As far back as 2001, NCUA examiners were ringing bells about the Centrix business model, the CU Journal has learned, and initiated meetings with Centrix officials. In the fall of 2001, NCUA sent a Letter to Credit Unions on Due Diligence Over Third Party Service Providers, which outlined safety and soundness considerations for the unique risks associated with those relationships.
The agency has historically taken pride in credit union loan volume and growth, saying that it is the historical mission of credit unions to expand loans to members, given CU philosophy, as long as standards of risk mitigation are maintained. But delegating the underwriting and servicing of loans to people who only become CU members at a car dealership because Centrix can arrange a loan when other lenders cannot raised flags when problems were encountered in examinations. (Other sources of indirect car lending are available, through CUDL, for example, a CU-owned CUSO.)
NCUA's Director of Public and Congressional Affairs John McKechnie said in a statement, "In recent years, specialized indirect auto lending programs have become more prevalent in the credit union industry. NCUA strongly believes it is essential that credit unions have effective controls in place commensurate with the risks associated with these types of programs." He would not comment beyond that, but the record of NCUA's mounting concern can be found in its public documentation.
In February 2003, NCUA issued internal guidance to exam staff for indirect, outsourced and subprime lending programs. Then, in September 2004, NCUA issued a Letter to Credit Unions on Specialized Lending Activities, to introduce new concerns and the new AIRES exam questionnaire.
Then came the June 2005 Risk Alert, which Centrix claimed started the ball rolling on its demise. In December 2005, NCUA proposed a rule to limit concentration of certain indirect lending programs serviced by third parties. In March 2006, the Agency released an internally-developed white paper on performing static pool analysis to supplement the Risk Alert. Finally, the Third Party Servicing of Indirect Vehicle Rule was finalized.
Sutton's take on this regulatory action was defiant. He claimed that "the NCUA's intention remains obvious: to prevent credit unions from making subprime auto loans to their members in general, and, specifically, through Centrix." He wrote to Centrix partners in July 2006 that "after a year of effort, only a couple of credit unions with extremely limited fields of membership have been allowed to resume business with us. Many credit unions complied with the Risk Alert and DORs only to enter into an endless regulatory morass."
A Sad Tale
Those that did resume business were forced to comply with "insurmountable ongoing reporting requirements." Centrix had to lay off origination employees and was forced to raise servicing fees in order to "maintain a high level of service," he wrote. Claiming the fee was held at an artificially low level "because it was combined with the up-front rate participation fee on each new loan," the fee would now need to be adjusted to industry standards. "This adjustment may affect your yield somewhat..."
Some analysts liken the above to subsidizing yield on old loans with the fee income from new loans, similar to a Ponzi scheme. Sutton said Centrix was "moving aggressively in other financial areas, including banks," calling that a positive sign. He promised to dedicate $150 for every new loan originated to settle "outstanding credit union obligations."
Will those obligations be settled for credit unions any time soon? The promises of guaranteed safety provided on each loan through insurance with "A-rated" companies against the principal loss in case of default hit a snag in July 2005, when the policy lapsed. As Barry noted in a letter to partners in October 2006, "The policy covering VSI claims on loans originated prior to July 2005 lapsed in July 2005. This was a 'month-to-month' coverage plan and any claims submitted subsequent to its lapsing are classified as unsecured obligations of the Company and have been reported to the Bankruptcy Court as such." Barry said he was exploring the possibility of purchasing coverage for loans made prior to July 2005, but only if CUs would pay for it.
