DENVER -- Presidential primary votes aren't the only ones being registered nowadays. Creditors of Centrix Financial LLC, the subprime automobile lender have also been busy voting on its plan to exit Chapter 11 bankruptcy.
In January, Judge Elizabeth E. Brown of the U.S. Bankruptcy Court here signed off on the Centrix plan, and voting by creditors was slated to continue through March 4.
But the outcome of Centrix' failed Portfolio Management Program (PMP) for credit unions--integral to its bankruptcy filing--is far from final. While credit unions continue to make subprime and indirect auto loans, they don't do so through a third-party structure like the Centrix PMP.
On March 14, Brown will hold another hearing at which time the plan may be confirmed, should creditors accept it. The company is seeking to repay them with remaining proceeds from the sale of its assets to Kendrick CF Acquisition Inc., now known as Peak5, for $30 million. That sale became final in February and proceeds from litigation surrounding it may be a source of restitution, said court documents. Unsecured creditors' recovery depends on winning claims against former Centrix CEO Robert Sutton, also the former chairman/Chief Executive Officer of Peak5. Sutton also helped form Kendrick CF.
"The judge has approved the disclosure documents and the voting is ongoing," Sutton's attorney, Glenn Merrick told Credit Union Times. Some objections may be likely, he added, as numerous motions surrounding the case have been filed, including administrative claims made by Sutton.
Meanwhile, dozens of credit unions involved in the Centrix PMP are being sued by Lyndon Property Insurance, which provided the Default Protection Insurance (DPI) to Centrix for payments it made to credit unions. Lyndon alleges that the CUs conspired with Centrix so they could continue to collect on DPI claims; DPI coverage paid the difference between any balance remaining and the money received from the sale of a repossessed vehicle. Lyndon, which is now owned by Protective Life Corporation, admitted in an analysts teleconference on Oct 19, 2006 that it would take an approximate $35M pretax charge (about $0.32 a share), related to two discontinued lines of business, one of which was Lyndon's coverage to CUs through the Centrix PMP. According to Lyndon, "After the bankruptcy the company went and saw that there was a large number of unreported claims and that has caused it to change assumptions relating to the amount of liability that is outstanding...There are a total of 10,600 loans with a loan balance of approximately $88M..." A suit brought by Everest Insurance in the federal district court in New Jersey seeking recovery based on Sutton's personal guaranty to Founders Reinsurance for claims is yet to go to trial and money damages sought against Sutton in that suit amount to more than $76 million.
Court documents show that Sutton has incurred legal fees and costs in the defense of the guaranty suit of some $150,000. Sutton faces suits alleging fraud and breach of duty with attached claims of over $100 million.
Many credit unions reported losses associated with Centrix loans and several CU managers have left their positions as a result. Several said they felt like scapegoats for a program that was approved (and even lauded) by the boards of the CUs at the time. As Centrix loans were higher risk, they also generated higher yields and some CUs were pleased with the program. But everything changed after June 2005.
Centrix said it ran a successful PMP--underwriting vehicle loans to borrowers with less than stellar credit--until the NCUA issued a Risk Alert in June 2005 that halted future funding by making CUs conduct rigorous due diligence before any further funding of loans was allowed. Seeing its capital flow dry up killed the business, said Centrix.
Officials at the NCUA, who would not speak officially to these accusations, do not share that point of view. But many people close to the parties involved have passionately held opinions and spoke to Credit Union Times on background. Verifiable sources speaking on background, together with publicly disclosed documents, present a very different picture of NCUA's dealings with Centrix.
Soup to "Nuts!"
The NCUA initially began by questioning Centrix' 'one-stop shop' structure. "They offered a soup-to-nuts approach that said, essentially, 'we do it all for you.' We bring the borrower, we're the lender, underwriter, servicer, collector and repossessor,'" said one highly placed source close to the agency. "In the end I think that what looked at the outset as 'too good to be true' was just that, so it became 'soup-to-nuts!'" Centrix offered a safety net of insurance coverage that served to reassured normally conservative CUs that were interested in making loans to the 'underserved.' An appeal to that CU philosophy may have helped to generate a certain 'feel good' association with Centrix as well, the source noted.
But looking at the numbers left agency officials cold, said many contacted for this story. "The cost of funds was low when this started and the NCUA was worried about what might happen if the market went the other way. Centrix was offering loans at 17.9% and the NCUA usury ceiling is 18%. They couldn't charge any more interest so they figured to make up the difference in fees." These loans could only really turn a profit at 21% interest and up, they said. NCUA officials were unconvinced, as Centrix never had an answer for these concerns.
The more '"outsourced" a program is, the less control a CU exerted, and the more due diligence becomes necessary. Reports provided by Centrix were not substantial enough to satisfy growing concerns at the agency, especially when the program began to skyrocket. (Loan volume almost doubled every year from the end of 2004 into 2005 and was on pace for $2 billion in that 12-month period.)
Transparency was also a problem for the NCUA. "It was impossible to get segregated financials from Centrix. They had several limited liability companies and it was difficult, if not impossible, to see just how it operated. The thing was like a black box," said a source. When asked for audited financial statements, Centrix provided "a pyramid of all the companies."
Doing the Math
Starting from the notion that making loans to those with poor credit can be continually profitable was problematic, according to the source. "Giving loans at high rates of interest to people with FICO scores as low as 475, we didn't understand how it could make money." The agency told CUs involved in the PMP to validate their yields.
The agency was also doing a few calculations on the possible impact to the NCUSIF and found that if all outstanding loans defaulted it would exceed the reserves of the fund. While the odds on all loans defaulting is the extreme worst case scenario, Sutton's claim to Everest was that as much as 40% of loans go into default, which the agency source found to be too high. The insurance to cover defaults, including DPI and Vendor Single Interest (VSI) were provided by AAA-rated insurance companies. If a vehicle wasn't recovered within a certain period of time after default, it would be considered a "skip" and the VSI carrier would pay the loss.
"That insurance wasn't free," said the source. "Credit unions paid for it up front, when a loan was booked and funded and Centrix was supposed to pay the premium. But Centrix allowed the VSI coverage on $3 billion worth of loans to lapse and never told credit unions about it."
The lapse became public during the discovery process on Centrix' bankruptcy filing. Sutton and Everest agree in court documents that the VSI insurance lapsed. In contention is whether or not Everest knew this at the time it was paying claims. Everest claims it was unaware but Sutton claims the insurer chose to "voluntarily" pay claims. Everest's contention is that the lack of VSI raised its exposure risk because it expected that insurance to kick in before the company's DPI insurance.
Having so many questions and feeling thwarted by the agency termed an incoherent response from Centrix, the NCUA began an informal outreach to several prominent CU proponents of the program, including several league presidents and other officials. "Leagues were really pushing this program even after the agency told them about its concerns. Some of them were in the agency's face," said a source close to the NCUA.
Leagues received an income stream based on the volume of loans funded but none of the CU leagues would disclose how much they made. "The whole league politics thing comes into play here," said another source close to the NCUA "Most league directors had knowledge of the problems with the program and continued to market it anyway."
Whereas helping the underserved while making a profit by outsourcing control to a third-party-vendor may reflect an ethical challenge, the yields from such loans were purported by Centrix to be between 9%-13%, which was tempting for margin-squeezed credit unions. The NCUA never believed the estimated yields could be that high, and Centrix later lowered it to 8%. The agency subsequently demanded that CUs in the PMP validate the underwriting criteria.
Reaction at the NCUA to Sutton's contention in a Credit Union Times exclusive interview (CU Times, Jan. 16, 2008) that the June 2005 risk alert came as a sudden body blow to the program ranged from anger to shock, said a source. "People at the NCUA were concerned about Centrix long before the risk alert was issued. They want people to think that the NCUA let this thing slip for a long time and then overreacted, shutting it down, but that's nonsense."
Documents received through the Freedom of Information Act and from sources clearly back up the assertion that the NCUA was advising CUs to apply caution long before the risk alert. In June 2003 it provided a Centrix Yield Analysis it encouraged CUs to apply. "This model is being provided to facilitate a CU's analysis. CUs are encouraged to develop their own models. Of key importance was to define the model with supportable underlying assumptions including prepayment rates, default severity, and other expenses associated with the program (salaries and overhead attributed to monitoring, etc.)," reads the document. NCUA wanted CUs to use data from a "seasoned pool" of at least two years' age and all other statistics (delinquencies, etc.,) from the same in order not to skew the outcome from portfolio growth (delinquency can be understated if new loans are included in the pool). A letter on Centrix Program Findings was also issued in early 2004.
The NCUA further wrote that "running a 'what-if' analysis may be beneficial" to understanding the potential range of yields. Assumptions may change over time affecting performance so updating on a regular basis will take that into account, the agency said. Centrix also deferred some payments making it even harder to calculate yields to maturity. In the end, no credit unions earned yields in the 7%-8% range, a source close to the agency said. "That's an outrageous claim. Centrix manipulated payments by subsidizing them with income from new loans to pay existing loans."
Within the first year of an auto loan the payments tend to be regular, then fall off, particularly in the subprime category. Centrix wanted to calculate yield based on a return of average assets, but that method isn't as reliable as a static pool analysis. "So the more loans a credit union bought, the better the portfolio looked," said the source.
The NCUA asked Centrix for data on loans made in 2000 and received it 3.5 years later to find the default rate was 32%. Centrix later told the agency it sent faulty data but subsequently never resubmitted corrected data. Volume was now growing and the agency was concerned about the net worth exposure some credit unions were facing. "Some CUs had 200% exposure and at least one had 400% of exposure in Centrix loans," said a highly-placed source. "To say that the NCUA was behind the eight-ball on this is simply untrue. Examiners began to look at this thing as far back as 1998." A Catch 22 prevented those credit unions that wanted to back away from the program from taking over the servicing of loans because the contract with Centrix wouldn't allow that without invalidating the insurance.
The NCUA has reissued advisory letters to CUs about third-party vendor relationships and stressed the careful monitoring of outsourced relationships. Although doing business with third parties is deemed essential, it begs reality to assume that what one source close to the agency termed "such massive outsourcing" as took place with the Centrix PMP could ever be permitted again.
The litigation against CUs now awaits a jury trial, which would make more information public than has already been released. In the end, the victory may prove pyrrhic, no matter who wins. But Sutton's attorney Glenn Merrick is clear on what victory would look like. "Mr. Sutton being vindicated and his reputation in the business community restored would be a good outcome."