ARLINGTON, Va. – Why didn't the $170 million Sunshine Credit Union finally become a bank? Without a final declaration from federal banking regulators, it is doubtful the overall credit union industry will ever know. But as time has passed more details have emerged that suggest that the $170 million Sunshine State Credit Union may have failed to become a bank because it was too good at the sort of lending that credit unions often do. Sunshine State, headquartered in Tallahassee, Florida, applied to change charters in 2004 and underwent the full disclosure and voting process. The membership voted to approve the charter change at the end of June of that year. But the Office of Thrift Supervision and Federal Deposit Insurance Corporation kept the application and did not approve it for weeks. In the wake of the resignation of the credit union CEO, Mark Lecain, in March of 2004, the credit union withdrew its application but has maintained that it intends to re-apply at a future date. Now as weeks have passed since the withdrawal, inside sources close to the credit union's situation have suggested that federal regulators might have not been comfortable with the number of loans on the credit union's books that they considered "subprime" and that questionable actions on the part of the credit union's CEO might have undermined the regulators' confidence in Sunshine State's leadership. Too Much Low Quality Paper? According to the sources familiar with the application, up to half of the loans that Sunshine State originated were from applicants with credit scores below 660 and this caused federal banking regulators to treat the application very cautiously The credit union's reports to NCUA appear to bear out the sources. The agency's data from June 2004, the month that credit union members voted on the charter change, showed that the credit union's loans had a delinquency ratio significantly higher than its peers (1.47 versus 0.73). Such a ratio might be expected from a loan portfolio with subprime loans. In September 2004, the delinquency ratio climbed to 1.54 before falling in December to 1.03 as, the sources observed, the loans with lower credit scores were sold off to satisfy the banking regulators. The credit union has refused to comment on the details of the application and the FDIC and OTS have also declined to comment. The problem allegedly arose because federal banking regulations, issued in July 2001 by all the federal banking regulators not including the NCUA, require banks and thrifts which have above 25% of their overall loan portfolio to carry more capital to protect from potential losses from these loans. The credit union's net worth ratio had fallen to 7.44 in June 2004 before climbing again to 8.54 in September, according to NCUA, and the capital levels would not have been enough to have allowed the regulators the comfort level they like to have, the sources said. The sources' reports of possible regulatory concern resonate with Richard Garabedian, a partner with the Washington, D.C. law firm of Luse Gorman Pomerenk & Schick, which advises credit unions making charter changes. "The bottom line is that the regulators don't want a problem," Garabedian said. "Even if from one perspective they want more charters, they still don't need a problem institution. I have known them to pass on much bigger institutions because they didn't want a problem on their hands." But Alan Theriault, a consultant with CU Financial Services, a firm which advises credit unions on the conversion process and who was providing services for Sunshine State, downplayed the importance any such loans might have played. While he specifically declined to comment on then specifics of the Sunshine State application, Theriault pointed out that banks and thrifts also make loans to people with low credit scores and that the regulators were happy with them doing so, subject to the capital guidelines. In this regard, the inside sources tended to agree with Theriault, pointing out that the credit union was used to making these types of loans and that, furthermore, Sunshine State was fulfilling a key part of its credit union mission by doing so. Geoff Bacino, an executive vice president with Centrix Financial Services, a Denver based firm which helps credit unions with their indirect lending which sometimes includes loans to members with lower credit scores, reported that his firm's figures bore this out. While confidentiality rules prevented him from revealing how many loans the credit union has with the firm, Bacino said that the credit unions' ROA from the loans it held with Centrix was 8.44% and that its net charge-off ratio was 0.78% at the time. The cumulative charge-off ratio was 1.94% as well, Bacino said. "Clearly, Sunshine State was doing very well with these loans and there was nothing inherently about them that should have caused a problem," Bacino said. But Bacino also echoed the insider's observation that while the loans to members with low credit scores might be something with which NCUA might be comfortable, given credit unions' mission to work with low income members, it may not have been something that a banking regulator will accept. "I think in the end that there may be things unique about credit unions and their business model which might make banking regulators uncomfortable," Bacino said. "They just might not be as interchangeable as some suppose they could be." Other Problems As Well But even if bank regulators had been fine with Sunshine State's loan portfolio, inside sources pointed to actions by the former Sunshine State CEO which might have caused the banking regulators to lose confidence in the CU's leadership. According to documents from the credit union obtained by Credit Union Times, then-CEO Mark LeCain made a series of transactions on loans and his checking accounts which sources alleged were not approved by the board and which violated numerous lending rules. The documents indicate that, beginning in 2003, LeCain added a total of $81,000 to the balances of mortgages, home equity lines of credit and personal loans without the approval of the credit union's board. NCUA regulations and the credit union's bylaws require any officer of the credit union who takes out more than $20,000 in loans to obtain board approval of those loan transactions. The sources also alleged that the transactions were completed without the usual origination fees, paperwork, closing costs or other procedures. The inside sources said that LeCain lost his position at the credit union after a risk audit conducted by CUNA Mutual in mid-March determined that the transactions represented an unacceptable risk. LeCain departed the credit union in the third week of March. The sources also said that state regulators have begun asking questions about the transactions and that current and former employees of the credit union have been questioned about them. Sunshine State declined to comment on the documents, citing the need to protect member confidentiality whether the member is the former CEO or not. The credit union also maintained that LeCain resigned his position and would not say anything more. LeCain as well said he had resigned of his own free will and could not be reached for comment on the transactions documented in the credit union records. "I have always said I would retire at 55 so this was just the time to go," LeCain said. Neither CUNA Mutual, nor the Florida Department of Financial Services nor the federal banking regulators would comment on the matter citing confidentiality rules. [email protected]