Florida regulators balk at Eastern Financial report
The Florida Office of Financial Regulation is taking issue with a blistering report that suggests it should have taken more of a role in helping to prevent the downfall of Eastern Financial Florida Credit Union.
The report by Crowe Horwath LLP, a respected banking consultant hired by the National Credit Union Administration’s Office of Inspector General, stated that both federal and Florida regulators could have taken steps to curtail the risky investment and lending practices at Eastern Financial. While the NCUA filed a response to the report that acknowledged it should have acted sooner, the OFR did not issue an official response.
Miami-based banking analyst and economist Kenneth H. Thomas said he found that surprising.
He noted that state regulators gave the credit union permission in 2005 to invest in the collaterized debt obligation (CDOs) that ultimately killed the credit union.
OFR spokeswoman Flora Beal said her agency did not sent Crowe Horwath a response to its report. Here’s how the OFR responded to the Business Journal’s questions about the matter.
OFR: The Florida Office of Financial Regulation (OFR,) does not agree with the conclusions made by Crowe Horwath LLP, who conduct the review for the National Credit Union Association (NCUA) Inspector General. In response to your specific questions, please see the Q&A below.
SFBJ: Did Florida regulators do anything to ensure that Eastern Financial comply with the restrictions it placed on CDO investments in its 2005 letter?
OFR: Yes. During the Office of Financial Regulation examinations, our examiners verified that all investments complied with the credit union's investment policy.
SFBJ: Have Florida regulators decided to place new restrictions on credit unions investing in CDOs, in addition to other complex investment vehicles?
OFR: No. There is no market for CDOs; therefore, no investments in CDOs are being made. CDOs are still permissible investment under state statutes. However, we would take into consideration the lessons learned from the market changes. Florida regulators continue to enforce statutory requirements for investment vehicles, while making every effort to ensure proper policies and procedures are in place to manage the risks associated with any complex investment vehicle.
SFBJ: How could Florida regulators not see the two large construction and development loans that were misclassified? (Eastern Financial provided a total of $60 million in loans to two South Florida developers, both of which ended up filing for foreclosure. The loans were not originally classified as risky construction loans, but as less risky member business loans) payday loan lenders.
OFR: During Florida's October 2006 exam, which reviewed financial documents through June 30, 2006, only one of the loans existed. At the time, that existing commercial loan was only weeks old, was properly secured and was not delinquent. Regulators did not have any reason for concern. Based on the alternating examination schedule, NCUA conducted the 2007 exam. The credit union's miscategorization (sic) was identified based on changes in the real estate market and the delinquent status of the loans. The issue was properly addressed and the loans were adversely classified assets in subsequent reports and examinations.
SFBJ: What steps did Eastern Financial take to hide the purpose of two rather large loans?
OFR: There is no evidence that the credit union's management made a deliberate attempt to hide the purpose of the loans.
SFBJ: Why weren't the examinations in 2006 and early 2007 more critical of the CDOs and the construction loans at Eastern Financial?
OFR: Through July 2007, CDOs complied with Florida statutes regarding the permissibility of the investment and were performing investments as to the payment of interest and principle. The crash of [the] CDO market during the third and fourth quarters of 2007 was unforeseen by everyone, including rating agencies, corporate investors, private investors and mainstream America. Regulators were no exception.
SFBJ: Has your office changed the way it conducts examinations to take a closer look at such problems?
OFR: There has been no change in the manner in which continue to enforce state financial regulations, conduct examinations and take every opportunity to inform management of known risks associated with certain types of investments and loans.
After reviewing the OFR’s statement, Thomas called it one of the weakest responses he’s seen by a regulator addressing a financial institution failure review.
He is concerned that the OFR said it has not changed the way it conducts examinations and that it hasn’t placed more limits on risky investments such as CDOs for credit unions.
"This should not be business as usual regarding the regulation of investments by credit unions,” Thomas said. “This should be a major wakeup call that we have to take a very hard look at where we allow credit unions to lend beyond their traditional lending areas and, especially, where we allow them to invest.”
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