LEHIGH ACRES, Fla.-Many remain vacant two and three years after construction. Common but handsome Florida tract homes, most single-story 3/3s on plainly named streets like 22nd and 57th, indicative of a rush by builders too busy to come up with anything prettier. Nearly all have For Sale signs planted in the swatch of St. Augustine lawn.
The houses are all painted different shades of pastel, yet all have one thing in common: They're owned by the National Credit Union Administration. And today, many of those CU-owned homes are vacant shells standing idly between vacant lots in a wasteland of home development.
In this city and in nearby Cape Coral, both real estate developments-turned-towns along Florida's Gulf Coast, are what remains of the first warning sign that tough times were coming for credit unions, as well as banks, brokerages, and Wall Street and the entire U.S. economy. Two years later, the question remains: how and why were homes in this patch of Florida financed by a credit union located 1,980 miles away in Colorado, along with others that bought participations? How did the credit union-and by default, all credit unions-come to lose more than $100 million? Where were the regulators? At least a half-dozen lawsuits have been filed seeking some of those answers.
Those losses led to the conservatorship and then sale of Norlarco Credit Union, the dissolution of its management team and the erosion of its once proud name in February of 2008, when Denver's Public Service Credit Union picked up Norlarco's $230.5 million in assets and the NCUA assumed $63 million in bad loans.
It's a story all too well known in financial circles, less so within credit unions, of a lender that lost sight of its mission, thought it knew what it was doing, and became intoxicated by Florida's rapidly appreciating real estate market-and which ignored all the signs of a bubble and the decades of history before it.
A Once-Sound Credit Union
A once-sound credit union that had shown no public signs of trouble until almost 2006, Norlarco was a $300-million-plus operation that traced its roots to 1959 in Fort Collins, a city of more than 131,000 nestled at the base of the Rocky Mountains and known for its small-town appeal. That it was located in a small market would also contribute to its demise.
Credit unions often get little press coverage, but once local media got a whiff of problems at the Norlarco, that was not the case. Its tribulations and growing losses were regularly followed locally by The Coloradoan and nationally by Credit Union Journal. With the extensive local media coverage, members began worrying about the safety of their deposits long before the word "crisis" would be applied to other institutions. Reports indicated that as many as 1,500 of those members would eventually pull their savings, putting more pressure on the credit union and helping to seal its fate.
Even prior to public disclosure of Norlarco's lending problems, at least one credit union that had considered a merger with NCU backed away after doing its own due diligence. According to one source, Bill Sterner, the now-deceased, former CEO of Elevations Credit Union and his management team visited Florida, became uncomfortable with what it found there, and broke off any further discussions.
Precisely how Norlarco got involved in the loans in Florida remains murky. But at least two sources indicated that the connection lies in an investment/mortgage broker who pitched the idea of the Florida loans to then-Norlarco CEO Chuck Mabry, who served as chairman of the Colorado CU Association prior to retiring on schedule. The Colorado-based investment/mortgage broker had ties to First Home Builders, a Sunshine State construction company eventually acquired by K. Hovnanian, the Red Bank, N.J.-based builder that has a significant presence in Florida and which is not alleged to have any ties to the scheme.
Mabry, another source said, and the credit union became enamored with the returns that were available and created two divisions within Norlarco CU, a wholesale mortgage division to make the construction loans and sell participations, and the retail division to serve the traditional mortgage loan market.
What Did The Board Know?
To what degree Norlarco's board was told of the extent of the lending is also not settled, according to other sources. But it was a board that included a number of well-connected individuals, including Peggy Reeves, a former member of the Colorado legislature.
Norlarco's financial statements show that like the broader housing market in general, its construction lending program was initially successful, perhaps in part due to the nature of mortgage lending. Whatever the reason, Norlarco ramped up its Florida loans quickly, with its portfolio going from $6 million in March of 2007 to nearly $56 million by mid-year. At the time then CEO-Bob Hamer told The Coloradoan that he had ordered a stop to the mortgage loan program shortly after replacing former CEO Chuck Mabry.
Following the filing of lawsuits, Mabry told The Coloradoan that the loans were "a good risk, well-secured and very profitable for us." The newspaper quoted him as saying he "had absolutely no idea" what went wrong.
The text of several lawsuits naming Norlarco as defendant painted a picture of a CU that ignored creditworthiness when approving construction loans for homes in Cape Coral and Lehigh Acres, allowing low- and middle-income borrowers to make down payments of only $4,000 on some loans of more than $800,000.
In the lawsuit filed against Norlarco by Superior Choice Credit Union in Wisconsin, the plaintiff alleges that in August 2003 Norlarco joined with First American Mortgage of Denver and First Home Builders of Florida to provide construction loans for homes. Under the plan, borrowers were to get short-term construction loans from First American Mortgage that would then be purchased by Norlarco. The suit states that First Home Builders guaranteed to make payments for each construction loan until permanent financing could be closed. The key allegation in the lawsuit is that in June 2005 an addendum was added that released First Home Builders from any responsibility to pay off construction loans should the buyer default. Superior Choice alleged that when it was approached later in 2005 by Norlarco about participating in the loans, Nolarco did not disclose the addendum and the risk to participating CUs should the loans go sour.
Those guarantees, as regulators would eventually discover, were big reasons Norlarco management had felt confident in the program's ongoing success.
Niether Superior Choice nor Norlarco nor any other participant initially had any reason to worry. The Florida real estate market was as hot as a July afternoon. But the bubble was becoming apparent in 2006, and by 2007 it burst with a bang. As home values plummeted, many of the buyers, apparently speculating on the homes, defaulted and Norlarco's delinquencies skyrocketed to $68.6 million by the end of August 2007.
How confident its leaders were in another aspect of the lending is unknown, but Norlarco's then management also felt it had solid borrowers for the perceived-to-be-solid collateral. If it seems odd or unusual that a Colorado-based credit union would have so many members living on Florida's Gulf Coast and looking to buy homes, that's because the "members" would come to join the credit union in an unusual way. A symbiotic relationship developed between several parties that never worked together directly, but did have something in common: a lender that needed borrowers, borrowers who needed a lender-and a middleman (see relaeted story, facing page).
Another important link was needed, as well. Hundreds of real estate investors and home buyers qualified for membership by joining unaffiliated non-profits that were part of Norlarco's FOM. Investors were able to join Norlarco by paying nominal membership fees to groups such as the Rocky Mountain Bird Observatory, Boys and Girls Club of Larimer County (Colorado), or Legacy Land Trust.
Not That Kind of 'Wealth'
Regulators said the move did not signal that the credit union's program was stepping out of bounds, as applications for select employee groups are not generally questioned by the state regulator or NCUA. But others were concerned. Kathi Wright, executive director of the Boys and Girls Club of Larimer County, eventually had issues with Norlarco's intentions.
Wright said former Norlarco Operations VP Martha Lemert approached her about the Boys and Girls Club coming on board as a SEG, which would bring donations to the non-profit and which Wright said the arrangement accomplished. But when asked by Credit Union Journal about Norlarco adding her organization simply as a way to bring in Florida members, Wright said, "I can't be certain . . . But I never had any idea that (the arrangement) was going to be harmful (to Norlarco)."
Fallout from the program reached well beyond Norlarco to the credit union and banking communities, with Norlarco persuading 16 credit unions and two banks to take loan participations totaling $170 million. In the case of the $153-million Superior Choice CU, for instance, it cited "false representation and deceptive practices" in its litigation.
Two failed credit unions, New Horizons Community FCU in Denver and Huron River Area FCU in Ann Arbor, Mich., were connected with Norlarco in several published reports. But discussions between Credit Union Journal and regulators laid little blame to Norlarco for their demise. New Horizons failed primarily from deals with subprime auto lender Centrix Financial, having only limited exposure to Norlarco loan participations. Huron River, while directly involved with the construction projects in Lehigh Acres and Cape Coral, did not partner with Norlarco, according Roger Little, director of the Credit Union Division of the Michigan Financial Institutions Bureau, who confirmed that "Huron River's problems were their own doing."
Sources close to Norlarco suggest the collapsed loan scheme and subsequent losses resulted from a situation in which three parties needed each other: the lenders, the broker - First American Mortgage - and the builder, with none performing extensive due diligence. If that, in fact, was the situation, Norlarco's former leadership is not saying. Former president Chuck Mabry, former Board Chairman John Olienyk, and Vice President Martha Lemert all declined comment when contacted by Credit Union Journal.
State and federal regulators say they are still putting together some of the pieces, but in many ways Norlarco's crash was not an uncommon story: after Norlarco's construction loan program started growing quickly, the credit union sought to take even greater advantage of the then appreciating Florida housing market, overlooking warning signs as the economy worsened, paying little attention to the actual quality of borrowers, and getting caught flat-footed when the Florida housing bubble burst.
"I guess that's a question (how the program accelerated so quickly) that will never really be answered other than the credit union saw an opportunity to make large-scale asset and revenue gains, and sold that prospect to the board of directors who adopted it and ran with it," said David Francis, supervisory examiner for the Colorado Division of Financial Services, who also served as acting commissioner from mid 2005-early 2006. "It's one of those things - if you have a tree in your back yard growing money, you keep pouring water on it as fast as you can."
Before that money tree rooted, Francis said the program had modest beginnings.
"Mid-2004 we conducted an exam at Norlarco and made a note of this new line of construction business with First American. At the time it was mostly in Colorado," he explained. "It actually didn't raise any concerns initially because there wasn't a huge concentration of it. It was just a notation made in the examination report. Frankly, I don't even think it was even in the open part of the report."
If there was any concern, it was with the broker, First American Mortgage, Francis explained. The Colorado Division of Financial Services already had credit unions express concerns about "issues" with First American regarding properties not being finished and "valuation issues."
"Norlarco's management assured us that they were well aware of those concerns and were monitoring them. We said, 'OK.' It was a credit union that had a long, healthy history and a good reputation. Management was well thought of by our division and we had no reason to be overly concerned about the situation at that time."
From the time the state regulator made that first "notation" until it visited again, the situation changed rapidly, with the Colorado regulator becoming much more concerned during its 2005 exam of Norlarco. Between the 2004 and 2005 exams, the Norlarco program had ramped up quickly, Francis said.
"We felt they had a very large concentration in a loan product that didn't appear to be the primary role of a Larimer County-based credit union," said Francis regarding its 2005 review. "And since they hadn't taken any losses on the program, they had not posted any loan-loss reserves. They had many documented reports signed off by their auditors that they were in compliance with GAAP. I just had a really a hard time believing that."
Market 'In The Toilet'
At the exam's close, Francis asked Board Chair John Olienyk and the rest of the leadership team what they were going to tell the "loyal customers and depositors in Larimer County" if the credit union got in trouble because the Florida real estate market "went in the toilet."
"I didn't get any answer," Francis said. "I think they figured that was a rhetorical question. I think they thought things were just fine. At the time, they didn't know and we didn't know that many of these borrowers were speculating on these homes and weren't going to come to closing when the market went in the tank."
Later on, when Norlarco fell under NCUA's Special Actions group, state and federal regulators learned more about the nature of the buyers, including their limited financial means.
The Colorado Department's 2005 exam was conducted jointly with the NCUA, according to John McKechnie, NCUA's director of public and congressional affairs, who reported that the federal agency's interest in Norlarco began in 2004. "Following our joint exam in 2005, we focused our efforts on improving the credit union's risk concentration and liquidity," he said.
Norlarco's board was also asked to establish a limitation on the percentage of assets it could hold in such loans, which it had yet to do.
The board listened and responded "respectfully," recalled Francis, who came away believing Norlarco's management team and board did not share the regulators' level of concern. "I don't believe that before the Florida market tanked they felt that they were at great risk. They were making a fine yield relative to the going investment rate at the time."
During 2005 Norlarco began building loan participation relationships with other credit unions and banks inside and outside of Colorado, Francis said. When Chris Myklebust was named Colorado Commissioner of financial services in the spring of 2006, one of the first things he, along with NCUA, did was take a closer look at those participations. "In addition to the concentration risk, now there is systemic risk throughout the credit union system," said Myklebust, noting the agencies' review led to a cease-and-desist order. "We couldn't document contractual obligations between the credit union, the builder, and some other intermediaries. Finally there were a significant number of completed homes that had been issued certificates of occupancy, but there was no one living in them. Further evaluation led me to formally recommend that NCUA take on the Norlarco case under a special action as early as August 2006."
Close to that same time, Norlarco CEO John Mabry retired, with Bob Hamer named to fill the position in August. While Myklebust's office and the Norlarco board did not always see eye to eye, the relationship between NCUA and the state regulator was good and of a common mind when it came to Norlarco, according to Myklebust.
"It was absolutely a joint effort," he said. "We had an excellent working relationship and I valued it. (Then) Region Five Director Melinda Love worked quickly and hard on the case, and Norlarco was designated as an NCUA special action on Sept. 6, 2006."
It was clear to all there were big clouds forming in the Sunshine State.
"The problem did not develop rapidly, but instead over approximately a 20-month time period. From about October 2004 through June 2006," said McKechnie. "NCUA was aware of the situation and we used progressive enforcement steps to resolve the problems. Basically those enforcement steps included a document of resolutions, some state directives issued by Mr. Myklebust, a C&D and, ultimately, a conservatorship."
Yet even as those red flags were being run to the top of the pole and even up to the point at which the CU was placed under special action, Myklebust pointed out that the loan portfolio was making money "hand over fist." "Melinda and I took the risk that this special action could be considered arbitrary, because there hadn't been any money lost," Myklebust said. "As late as the meeting with the board at Norlarco on Aug. 21, 2006, I was personally reminded very strongly by that board that Norlarco and loan participants had received substantial benefits from the program with zero losses. They were very strong in saying they had spent substantial energies and resources to comply with all the edicts of the regulators."
Myklebust's reaction was measured, understanding the cyclical nature of investments and having strong concerns about the Florida housing market holding up. "My feeling at that point was that this may have been a great program, but programs don't remain great forever," he said. "There is a time to start cycling out."
With Norlarco under special action, state regulators and the NCUA were able to "start tearing apart this extremely sophisticated program," recalled Myklebust. The Colorado regulator had an exam team of 13, but the full group met at Norlarco's headquarters building only once. Normally, the team was made up of Myklebust, Francis, and two other examiners. Formal on-site meetings with the Norlarco board and management team were once a month, with other meetings conducted by phone, the commissioner stated. NCUA's involvement during the special actions became "frequent and detailed," said McKechnie.
"At this time we learned about the relationships and the types of loans they were, and it prompted us to order that the credit union reclassify the loans as business loans," Myklebust said. "Because up to that time, all of our examinations showed that these were member construction loans. After further analysis, we said these look like business loans and asked Norlarco to reclassify them. That was one of the major turning points in the regulatory action."
Myklebust said the reclassification prompted his office to consider the loans riskier as the result of concerns over how the loans were collateralized. Around the same time a team from the NCUA traveled to Florida to look more closely at the properties. Flying into Tampa, the federal team made the two hour trip south to Cape Coral.
"I learned a lesson here," Myklebust admitted. "All of these properties were in Florida, so as a state regulator in Colorado I couldn't hop in my car with a couple of examiners and drive down to see them. When NCUA was able to get in a plane and go down there and do an analysis, that's when we knew there were some serious problems with the portfolio."
Myklebust recalls sitting in his office in April 2007 and getting the call from the NCUA team on the ground in Florida. "I remember them saying the analysis showed that there weren't, in fact, any guarantees, and that the appraisals had come back significantly below our expectations. They also said the loans were not paying off as they should be. Now we knew we had the problems and were very much aware of the systemic risk to all participants involved."
The NCUA and Myklebust also learned that heading into the spring of 2007, the Florida housing market was taking a marked downturn.
"The potential losses we always feared were just beginning to manifest themselves. We started to see extensions being granted on late loans," Myklebust said. "Because we were realizing those fears, with support of my financial services board I conserved Norlarco in May 2007."
NCUA placed Norlarco under federal conservatorship in July 2007, removing the board but leaving the management team in place.
While both Credit Union Journal and The Coloradoan reported that the move to place the credit union into conservatorship had been kept secret, Myklebust argued that it was not. Instead, while the action was public record, it simply was not announced, he said.
"Norlarco was not at all a secret conservatorship. If you look at Colorado statute, at that time, even though an action is public it has always been the policy of the division, based on statute, not to announce when we take an action, whether that is a cease-and-desist or when we conserve an institution. We do not announce it.
"I talked it over with the financial services board, and we discussed the possibility of salvaging Norlarco," Myklebust continued. "One of the best ways to do that is to ensure depositors remain calm, and let them know that deposits are insured. So behind the scenes we wanted to take care of business, get Norlarco back on its feet and be out the door. There are a lot of actions that regulators take all the time that we don't issue a press release on. We quietly go in, fix the problem, and back our way out. That maintains confidence in the system."
Sources close to Norlarco contend the decision to not formally announce the state's conservatorship eventually heightened press attention, and possibly member concern, when the conservatorships finally hit the media.
"As a result of Norlarco, legislation was passed so the Colorado Division of Financial Services can share information with other agencies within the Department of Regulatory Agencies," Myklebust said. "We also received permission, if we take a formal action that is a public action, to make that information public, unless there is an imminent risk of a run."
Today, former Norlarco members have likely put the failure behind them, many moving on to become members of Public Service CU, whose bid beat out several others for Norlarco's assets. The bad loans absorbed by NCUA, PSCU's biggest challenge became overcoming Norlarco's tarnished name. It bought advertising, CEO David Maus made appearances and did press interviews, and hired former Colorado State University football coach Sonny Lubbick, who is popular locally, as a community liaison.
But the affects of Norlarco's real estate gamble remain evident in the vacant Florida homes, several pending lawsuits, and the red numbers on the NCUSIF's balance sheet.
Myklebust understands that a question will always be asked: "Where were the regulators?"
"In the U.S. we enjoy a free market system that prioritizes economic growth. If this weren't true, then we would have an economy that is planned by a central government and regulators would have complete authority over what the financial markets can and can't do," he responded. "But that isn't true here. Businesses and markets are free to develop, compete, and even fail.
"So my priority as a regulator is to maintain confidence in our financial system by protecting member deposits at all costs, and then to protect the insurance fund. To the greatest extent possible, that's exactly what happened. If those asking 'where were the regulators' were to dig a little deeper, I think they would find that regulators were dragged along with our free market kicking and screaming over the past few years."
NCUA's McKechnie reminded that the agency looks primarily at a CU's concentration of risk and liquidity in its exams, more than the type of service being offered to members. "In this case the balance sheet risk was concentrated in an unacceptably high fashion, and we also saw liquidity problems," he said. "When you have that situation, coupled with the significant downturn in the real estate market, the reality is the credit union was unable to sustain viable operations."
Despite the regulators' stances, perhaps the most important question still on the table is: Were enough questions asked? Did Norlarco ask enough questions of its construction lending partners? Did regulators challenge Norlarco leadership as well as they should have?
In retrospect, Colorado's David Francis can't recall the Norlarco board and management entertaining any discussions about "what they were thinking" or "why did you do this?"
"I certainly believe there was a significant profit motive in it," Francis acknowledged. "Not an evil motive as far as 'Look at all the money I can make and the size I can make the credit union.' I have been doing this job a long time, and most of the time business decisions that lead to these situations are just bad. The credit union simply made mistakes."
