The management of Cal State 9 Credit Union made “poor strategic decisions” and lacked the experience to understand the risks of subprime lending and its HELOC program, while NCUA examiners failed to recognize the risks and take corrective action.

Those were among the conclusions of the NCUA Inspector General's report on the 2008 failure of Cal State 9 Credit Union. The estimated loss to the NCUSIF was $206 million.

The report, which was released last week, said the credit union's management funded excessive indirect HELOCs that were “rife with risky loan elements.” It also agreed with the previous conclusions of state and federal examiners that the credit union's weak underwriting standards created unnecessary credit risk and that the concentration risk was exacerbated by funding its indirect HELOC portfolio with subprime loans and letting that portfolio become a significant portion of Cal State 9's assets.

Management also created liquidity risk through “rapid and excessive” funding of high- risk subprime indirect HELOCs.

The report noted that for many years until December 2005 Cal State 9 CU had been considered a well-run credit union with CAMEL 1 or 2 ratings from state and federal regulators. However, its troubles began when it launched an indirect HELOC program with an outside mortgage broker. It noted that substantially all of the HELOCs had subprime elements, which included stated income, high combined loan-to-value ratios, borrowers with low credit scores and were in a “junior position behind negative amortization first mortgages.”

At its peak, 88% of its HELOCs represented stated income loans. Also, at one point 18% of its HELOCs went to borrowers with credit ratings below 600. The credit union performed very little due diligence, the report said.

According to the report, the credit union's HELOC portfolio grew from $4.6 million in March 2003 to $353 million in June 2007.

The report also concluded that the NCUA and state examiners made inadequate responses, especially in light of the significant problems facing the California real estate market. Examiners didn't monitor Cal State 9's liquidity position and missed opportunities to slow or stop the growth of the HELOC program.

The report also stated that examiners relied too much on management statements and didn't use available mechanisms to timely and adequately monitor the credit union's portfolio.

NCUA Executive Director David Marquis, in written response, acknowledged that while examiners escalated some of their risk assessments and issued warnings, federal and state regulators should have taken “stronger administrative actions to compel the credit union to alter or cease the HELOC program.”

The California Department of Financial Institutions did not respond to e-mail requests seeking comment.

State regulators placed Cal State 9 into conservatorship on Nov. 2, 2007, and named the NCUA conservator. The NCUA Board liquidated the credit union on June 30, 2008 and executed a purchase and assumption agreement with Patelco Credit Union.

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