The NCUA’s Office of the Inspector General found both Constitution Corporate and the agency at fault in the demise of the corporate.
The OIG’s material loss review cited lack of oversight for the significant portfolio of private-label, mortgage-backed securities that were later downgraded below investment grade, exposing the corporate to financial risk.
Specifically, the report stated that Constitution’s management
· Relied heavily on ratings assigned to the securities by Nationally Recognized Statistical Rating Organizations when purchasing securities for the portfolio and when monitoring the amount of credit risk in the investment portfolio;
· Did not establish prudent sector concentration limits to reduce the credit risk exposure related to the underlying assets of the mortgage-backed securities;
· Did not properly identify and monitor credit risk exposure in the underlying mortgage loan collateral of the mortgage-backed securities held in the investment portfolio; and
· Failed to recognize the substantial risk they were undertaking with significant investments in complex mortgage-backed securities, with a substantial portion of these securities backed by subprime assets.
Constitution lost $122 million in other-than-temporary impairments on the MBS between 2008 and July 2010, which eroded net worth and the corporate’s net economic value that led to the agency’s conservatorship. Constitution was eventually liquidated and operations transferred to the then-Members United Corporate, now Alloya.
“As of July 31, 2010, undivided earnings had a deficit of $24 million and the capital ratio5 declined to negative 1.88%. NEV was negative $162 million or negative 13.55%. Constitution posted a net loss of $84 million in 2008 and $100 million in 2009 due to the OTTI charges and the write-off of $34 million related to its capital investment in U.S. Central,” the report outlined.
In the case of Constitution, the OIG wrote, “We also determined the lack of adequate and timely oversight of Constitution was partially attributable to corporate examiners not having the appropriate regulatory support, such as more specific investment concentration limits, to adequately address Constitution’s concentration risk and the exposure to credit, market, and liquidity risks.”
Examinations going as far back as 2006 mentioned the concentrations but “no significant concerns were noted and no supervisory actions recommended.”