OTTERTAIL, MINN. -- Thumper Pond was sinking. By March of 2006, 30 banks across the country had passed on the chance to rescue the Northwoods-themed resort from cost overruns and mismanagement.
Then came the credit unions. More than a half dozen of them, originally founded by electricians, railway workers, state highway employees and others, wanted a piece of the indoor water park, hotel, spa and upscale houses being built in this tiny town of 451, about 90 minutes east of Fargo. The $13.8 million loan deal was reached on the 18-hole golf course designed by two first-time developers, Verle Blaha and Jim Ahlfs, from Ottertail, who had never swung a golf club.
Four years and millions of dollars in losses later, Thumper Pond is in foreclosure. Lead lender Spire Federal, the 75-year-old credit union founded by oil cooperative workers, is expected to sell it later this summer for a big loss.
In a different decade, the notion of a credit union investing in risky ventures like Thumper Pond would have been unthinkable, maybe even impossible.
Like their banking rivals, however, some of this state's largest credit unions abandoned the conservative lending principles that long made them bastions of safety. They pursued bigger, riskier and more elaborate loan deals in markets far removed from their everyday customers. And they embraced the booming housing market with gusto, making some of the same exotic home loans that sank such giant institutions as Washington Mutual and Wachovia.
Losses on risky loans, from Twin Cities housing projects to out-of-state ethanol plants, are one reason why nearly half of the state's 156 credit unions lost money in the most recent quarter, compared to 35 percent of credit unions nationwide. Seven of Minnesota's credit unions are near or below capital levels the government deems adequate. And two were in such bad shape they had to be sold.
Richard Lewandowski, a now-bankrupt real estate developer, said he doesn't remember credit union loan officers ever asking him how much he had borrowed on his projects. Three of Lewandowski's credit union-financed housing subdivisions -- in Palmer, Rush City and St. Cloud -- were abandoned after the housing market collapsed, leaving 150 vacant lots and millions of dollars in losses.
"That was one thing about the credit unions, they didn't ask many questions," Lewandowski said. "Some of us in the development business, we'd sometimes smile about it. ... They were hungry to do a deal, any deal, if it meant they could get in on the real estate boom."
Not so simple
Employees of the VA Medical Center founded Fort Snelling Federal Credit Union in 1947 as a place where they could cash their paychecks and save for a new home or car.
By 2002, a credit union founded to promote thrift was allowing customers to borrow 125 percent of the value of their homes. When housing prices fell, "a lot of those people simply didn't pay," said George Savanick, 71, a retired physicist and former volunteer member of Fort Snelling's three-person supervisory committee, which analyzed a small sample of the credit union's loans each month. "And we were too small to absorb the losses."
Regulators arranged a sale of Fort Snelling in March once the credit union was close to collapse. Real Financial in Edina was also sold since late last year after loan losses wiped out most of its capital.
Credit unions, nonprofit by law and owned by their depositors, champion themselves as the opposite of banks, a place where ordinary folks can get competitive loans. Two years ago, the Credit Union National Association, the industry's major trade group, even built an entire branding campaign, complete with pins, mugs and a YouTube video, around a small cardboard cutout of a smiley-faced man dubbed the "Little Guy."
But the forced sale of Fort Snelling and Real Financial are telling examples of how far most credit unions have traveled from their modest roots.
Credit unions are larger and more sophisticated than they were just five years ago, thanks in part to legislative changes a decade ago that enabled them to expand beyond the tightly knit employee groups that had once defined them. Total assets are up 20 percent in five years, to an average of $90 million per credit union.
"It used to be that a credit union manager just wanted to serve the members of a particular group," said Jeff Schwalen, president and chief executive officer of Hiway Federal Credit Union in St. Paul. "But as they got further and further out in the community, the pressure to make bigger loans grew. ... And they started getting into areas where they didn't have expertise."
The boring, old-fashioned consumer loans, particularly the bread-and-butter car loan, were vanishing, replaced by easy credit and zero percent interest loans from automakers.
But home equity loans were hot, and credit unions rode them hard by emphasizing the tax deductions on interest payments. They encouraged borrowers to roll other debts, such as credit cards, into home equity loans to maximize tax benefits and lower their borrowing costs.
Credit unions tend to be more responsible because they hold onto most of the loans they make, rather than selling them to investors for a fee, said Mark Cummins, president and CEO of the Minnesota Credit Union Network, an industry trade group. They did not engage in some of the most extreme lending practices that took down hundreds of specialized mortgage brokers, such as issuing loans without verifying people's income.
"The numbers reflect that credit unions are conservatively run," he said.
However, data suggest credit unions embraced, along with most other lenders, some riskier loans. In addition to "125 percent loans" such as those offered by Fort Snelling, some credit unions flogged adjustable-rate mortgages with low introductory rates, interest-only mortgages, and loans that allowed borrowers to set their own payments.
About 20 of the state's largest credit unions reported holding interest-only and payment-option real estate loans on their books as of March 31. Together, these loans were worth $124 million. Nationwide, credit unions hold more than $17 billion of these nontraditional loans. Delinquencies and foreclosures on these loans now surpass subprime mortgages, according to First American CoreLogic, a market research firm.
"They were just like the banks," said Marvin Umholtz, a consultant to credit unions and a former lobbyist for the industry. "They were trying to help people take advantage of rising housing values. But they did it at just the wrong time and got burned."
Today, the average credit union in Minnesota has 57 percent of its loans tied up in real estate, up from 43 percent in 2003. A former credit union regulator said portfolios used to get more thoroughly scrutinized if 25 percent of assets were in real estate. But that percentage has continued to climb, even as the housing market collapsed.
"To have a real estate portfolio that large is like a ticking time bomb," said Bert Ely, a financial services consultant from Alexandria, Va.
Filling the cookie jar
Early in 2008, even as housing values were sliding, City-County Federal Credit Union in Brooklyn Center continued to book mortgages for 100 percent of the value of borrowers' houses.
Now it's dealing with the aftermath. Real estate losses have wiped out nearly two-thirds of the capital at the state's fourth largest credit union, which has 64,000 members in a seven-county area stretching from Stillwater to Elk River.
So many of City-County's home loans have gone sour that the credit union now has the lowest amount of capital, as a percentage of its assets, of any credit union in the state and is classified as "significantly undercapitalized" by the National Credit Union Administration (NCUA), the federal agency that regulates and insures credit unions.
This spring, CEO Jon Seeman held a series of employee meetings at City-County's branches. At each stop, he compared the credit union's fate to that of an empty cup. "The only solution is to grow our way out of this," he said, "to gradually fill that cup with more profits."
City-County has closed two of its nine branches to cut costs; even so, he estimates it will take at least four years for the credit union to replenish its capital to the regulatory minimums.
"If I could go back in time and wipe away those 100 percent loan-to-value [home] loans, believe me, I would," said Seeman, who took over as CEO a year ago. "It's going to take some time to climb our way out of this."
Credit unions and their representatives insist that most of them have plenty of cash to ride out the housing crisis. In Minnesota, credit unions' capital, as a percentage of their assets, stood at 9.8 percent as of March 31. That's down from 10.6 percent a year ago, but still well above the 6 percent threshold regulators consider "adequately capitalized."
In fact, credit unions could charge off every delinquent loan on their books -- an unlikely scenario -- and they would still have a capital ratio of 8.3 percent, according to the Minnesota Credit Union Network, the industry's trade group. In 1992, after the last severe recession, the aggregate amount of capital held by credit unions was just 6.6 percent, noted Crane Bennett, supervisory examiner for the NCUA in Minnesota and North Dakota.
"You have a couple of bad years, and that's what the capital is for, and you build that capital back up again," Bennett said.
But as recently as a year ago, both Minnesota credit unions that were rescued from financial disaster were classified by regulators as "adequately capitalized," which raises questions about whether credit unions are identifying problem loans as quickly as they could or should.
Unlike banks, credit unions can't raise money by issuing stock. Their only cushion against losses is profits earned in better times, and those have been hit with a double punch of rising defaults and mounting costs associated with the government's bailout of the so-called "corporate" credit unions (see related story on A9). Four Minnesota credit unions -- City-County, Northcountry Cooperative, White Earth Reservation and Crow Wing Power -- have seen capital levels fall below levels deemed adequate by regulators. All told, 11 percent of all capital held by credit unions in this state has been wiped out since early 2007.
"You can put a lot of money away in that cookie jar," said Dale Johnson, chief executive officer of TruStar Federal, a credit union in International Falls. "But if you're not minding the store, it can empty pretty quick."
Trusting someone else
When Matt Wohlers last year took over as chief executive officer of Teacher Federal Credit Union, recently renamed TruStone Financial, he was surprised to learn his credit union helped finance a hotel chain in Florida, a bookstore in Pennsylvania and a bankrupt ethanol plant in Rosholt, S.D. The Florida and Pennsylvania loans are still current, but TruStone's $1 million loan to the ethanol plant is more than six months past due.
The ethanol deal was brought to TruStone by a so-called "credit union service organization," or CUSO, largely unregulated companies that provide services to credit unions and have become increasingly active in the commercial lending markets. In many cases, CUSOs arranged syndicated loans for commercial real estate projects far removed from where the credit unions actually operated.
Each of these loans seemed like a good idea at the time, Wohlers said. The ethanol loan was made at the height of the ethanol boom, when gas prices were still above $3 a gallon and new plants were sprouting all over the Midwest. But the plant filed for bankruptcy last year and is no longer operating; more than a dozen credit unions are trying to recover an estimated $20 million.
"We sort of trusted that someone else had taken care of the due diligence" on the loan to the ethanol plant, Wohlers said. "But we don't know South Dakota. We brought nothing to the table -- nothing -- except money. And that's why we got burned."
The state's largest CUSO, CU Companies in New Brighton, also was involved in the Thumper Pond loan deal, bringing in a number of credit unions, including Hiway, Como Northtown, Soo Line, St. Paul Federal and Star Choice, the credit union of the Star Tribune.
Spire Federal was the lead lender. With 62,000 members, it is the state's sixth largest credit union. About half of Spire's $485 million in loans are mortgages and lines of credit backed by residential real estate.
Thumper Pond's developers said the credit unions did not seem concerned about cost overruns or the fact that seven Fergus Falls investors had backed out with "accounting concerns" the day before credit unions loaned nearly $14 million.
Blaha, the co-developer, said Spire was more interested in selling the $150,000 housing lots that surrounded the resort than in the resort itself. "I think the credit union was very gullible," said Blaha.
So far, just 10 of the 100 lots have been sold. On a recent weekday afternoon, about a dozen children and older women were sliding down Thumper Pond's winding three-story water slides and paddling through its canal in rubber tubes. But nearby, the 160-seat Red Pine Restaurant was empty, and the spa and gift shop were closed.
Staff writer Glenn Howatt contributed to this report. Chris Serres • 612-673-4308