CONCORD, Calif. — No one still wants to talk about the meltdown at Cal State 9 Credit Union here, particularly since NCUA's recent warning about subprime real estate lending. But it's evident that regulatory special actions are being taken because the CU has provisioned $17 million for loan losses for the quarter ending June 30, 2007. At the end of March it provisioned $1.5 million. Still, $17 million may not be enough.

The Financial Performance Report Financial Summary and Ratio Analysis already posted on the NCUA Web site for June 2007 shows that Cal State 9 Credit Union is now undercapitalized, having lost $9 million year-to-date. A download of the NCUA Excel spreadsheet reveals the June 2007 information, and the numbers are grim indeed.

At the end of March, delinquency was 5.09%. In June it jumped to 6.81%. In March the CU had $19.4 million in delinquencies and in just three months it now has $26.3 million. This is a 35.4% spike in the delinquent loan ratio in the June quarter. But the looming threat that the one to two month delinquency category poses (it is not added to the total delinquency numbers until it reaches the three-month time frame) represents a potentially very large loss as it is now $17,119, 919.

Vice President of Marketing Jeff Peabody for Cal State 9 CU sent a letter to Credit Union Times after the initial story about the losses in HELOCs (CU Times, June 29) stating simply, “There has been a substantial correction in the real estate market. In this environment, it is not uncommon for borrowers to become delinquent. We are working diligently with our borrowers to help them keep their homes. Every member is important to us and deserves individualized attention. We offer a wide range of loan programs for a wide variety of borrowers, and Cal State 9 underwrites all of its HELOCs,” continued Peabody, without further explanation.

Cal State 9 delinquency percentage has zoomed by the quarter in the last 18 months as shown in the chart above.

The correction in the real estate market is undeniable, but the impact on Cal State is worse because it got deep into HELOCs. Real Estate Others (REO's/foreclosures) are increasing at an accelerated pace, having gone from $8.4 million to an estimated $12.1 million in just the last quarter. This is an increase in REOs of 42.0%.

No lender wants to be in the REO/foreclosure business because it is labor and cost intensive. If homeowners must be evicted there is a long, drawn-out process that can be painstaking for a credit union. All legal challenges presented by the homeowner must be dealt with and legal costs can be substantial. Even if foreclosure is the only suitable option, no credit union particularly wants to be seen as putting people out of their homes.

Once done, however, homes must be maintained in order to be in sellable condition. Empty houses can deteriorate after a time. Grounds must be kept up, air conditioning may have to be kept on to avoid mildew and other problems so electricity bills can mount. Vandalism can also be a problem, and taxes and insurance must be paid. So REOs are essentially nonperforming assets which can drain a credit union's coffers every month they remain unsold.

In December 2006 Cal State 9 had $1.1 million in foreclosed real estate loans. In March, it had $8.4 million and at the end of June it had $12.1 million, a 43.8% change. In June Cal State 9 charge-offs rose to $6.8 million up from $2.2 million in March, a 209% change.

No Response

Peabody did not respond to a detailed list of questions about just why (or how) the CU decided to go so deeply into a real estate portfolio. Calls to CEO Jackie Wong and Chief Financial Officer Richard Headrick have not been returned.

With the subprime category of real estate reeling, the stock market, and even the big money center banks changing policies and eliminating risky subprime loans, including Washington Mutual and then Wells Fargo & Co.'s Wells Fargo Home Mortgage announcement that it was closing its nonprime wholesale lending business (which processes and funds subprime loans for third-party mortgage brokers), the heat is being turned up on lenders still left with bad loans. Selling these loans will be a challenge.

As the Aite Group's analyst, Eva Weber, told Credit Union Times, about WAMU's move: “This is bad news for other players in the market, who are willing to aggressively write those kinds of loans. With a large player like WaMu no longer writing these loans, it only increases the scrutiny on anyone left, and it puts pressure on similar banks to follow suit.”

Then Countrywide, which is the country's largest mortgage lender, and does a significant business with credit unions, announced its bleak assessment that any hope of recovery in the real estate market is not expected until 2009.

Countrywide's new concern is the growing delinquency of borrowers with A and B credit. Countrywide said that 5.4% of its HELOCS to good credit borrowers were now past due at the end of June. That's up 13.4% from a year ago, they said.

Meanwhile other major banks feeling the sting of the subprime securities market and rising deterioration in the credit quality of mortgage and home equity lines have set aside greater reserves to cover bad loans. The list includes Citigroup (which put aside $2.5 billion in the second quarter, a 75% increase over last year), JP Morgan (which upped its reserves 300%), Wells Fargo and Bank of America (which added 80% to its reserves).

With housing in the worst slump in a decade and all banks and credit unions awaiting new lending guidelines, adding to reserves for loan losses makes old-fashioned common sense, say analysts. That seems to be Cal State 9 CU's plan. With delinquency of $26.2 million its losses may just be starting.

Unanswered Questions

One question still unanswered is how Cal State 9 made the decision to either underwrite or buy these loans.

Peabody's e-mail response to CU Times included this comment: “More than two-thirds of the loans in our HELOC portfolio were made to non-subprime borrowers with FICO credit scores above 640. The interest rate members paid on these loans was higher on average due to a variety of underwriting criteria.” He did not elaborate on what the criteria might be, however, nor offer any reasoning for why, if the FICO scores are so high, such big losses have resulted.

Cal State 9 denied buying HELOCs from a vendor. Peabody wrote, “First, please be assured that Cal State 9 did not purchase its portfolio of home equity lines of credit loans. Cal State 9 sourced these loans indirectly through a business partner, and every loan was underwritten by Cal State 9. All loans were made to borrowers who qualified for membership. None of our loans were secured by properties outside of California.”

What exactly constitutes “sourced these loans indirectly through a business partner” is open to interpretation, including a CUSO, a participation loan purchase or a buy from an outside vendor. Cal State's financials indicate that it has not purchased any participation loans year-to-date, but it reported $312,590,881 in Indirect Loans/Outsourced Lending Relationship (apart from Indirect Loans in the Point of Sale category, usually CUDL auto loans or a similar arrangement). And its total investment in CUSOs is near $264,000 and none of the CUSOs named broker HELOCs.

The Source: CU Funding Group

The “business partner” Peabody spoke of is CU Funding Group of Pleasanton, Calif., and Steve Iversen, president/CEO said it is not a CUSO and is wholly-owned by him. In business for eight years now, he said the company deals with 15 credit unions.

“Our funding comes from credit unions, but should a credit union not want to fund a loan (or loans) then we also have other sources, primarily banking lines,” he said. “We have a retail side and in that way we work with credit unions to provide their mortgage services. It functions much as other turnkey mortgage operations do. We also have the CU Funding Group Indirect Real Estate Lending Program. In that capacity we use a network of 14,000 brokers in California.”

Iverson laid out how the program works: CU Funding Group takes the credit union's underwriting guidelines and sends them to its select broker network. It markets through its network of brokers, screens applicants to see that they meet the guidelines, then underwrites the loan, sends it to the credit union, which approves or denies it. If they approve the loan, CU Funding collects the information on membership and draws up the documents, send them to title after it passes quality control then it goes to the credit union and they do their own quality control and fund the loan. The CU may either keep and service the loan in its portfolio or sell it to Fannie or Freddie or whomever.

Cal State 9, had a five-county restriction (due to membership qualifications of its field of membership) he said, and so CU Funding Group “went out and found potential members in those areas, which were the counties of Santa Clara, Oneida, Contra Costa, San Francisco and Sacramento.” The estimated number of brokers in those five counties is about 10,000. “We've done business with Cal State 9 since 2002. I think the results they had show that the program works phenomenally well. It generated 7,000 new members for the credit union. The CU funded $750 million in HELOCs in less than five years. (At the end of June Cal State 9 had $449.3 million in assets.) It is an extremely well thought out program because it allows a CU to pick the member profile they want to lend to and we find them in the geographic location they select.”

Aggressive Lending

“Cal State 9 was aggressive [in its underwriting guidelines],” Iversen allowed. “They had high expectations when they came to us. Back in 2002 they were a struggling credit union. They've skyrocketed since then, achieving high ROI (return on investment). When they approached us they were 3%-5% in lending in the Contra Costa and Alameda Bay area and have since grown membership by 6% and increased their real estate portfolio by more than 400%.”

“Unfortunately, it's a bad time for Cal State 9 now. They got caught up like so many of the Wall Street people did. But I think that their CFO, Richard Headrick is an extremely gifted and talented individual. I read a quote in Credit Union Times recently from Dr. Kevin Freiberg, who spoke at the Florida CU League meeting, saying, credit unions need to 'have the guts to be radically different.' I think Cal State 9 tried to do just that, but it appears they are having troubling times right now.”

Peabody said that Cal State 9 “adjusts the composition of its loan portfolio [and overall business strategy] in response to changes in the marketplace” and it seems the marketplace (and regulators) are now forcing that adjustment.

California regulator Beth Dooley was contacted again for this story, but did not return calls. Her response to the initial story stands: “I'm sorry, but due to confidentiality concerns, I cannot discuss the financial condition of any particular credit union,” she said.

It may be that Cal State 9's board will consider merger options if the losses continue to mount through the end of the year. They may also reconsider the ALM strategy that has now backfired on such a heavy bet in real estate as the market was soaring, and continuing to invest as it retracted.

–[email protected]