Conservatorship has bankers shaking heads

The process that led Norlarco Credit Union into conservatorship has the bank industry crying foul, while the credit union industry counters that banks are crying wolf.

Regulators from the federal National Credit Union Administration took control of Fort Collins-based Norlarco at the end of July and continues to operate it. In its June 30 financial report to regulators, Norlarco showed $54.4 million in delinquent real estate loans – a large number of them in Florida. In its March 31 report to NCUA, the credit union reported just more than $340,000 in real estate loans delinquent.

The action took customers and the financial community by surprise, and Norlarco has yet to give formal notice to its members regarding the status of the credit union, or what the conservatorship means to them.

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The situation has bankers shaking their heads, claiming such a thing would not be allowed to happen at a bank. Banks – which are taxed as corporations – and credit unions – which are nonprofit membership organizations – have long been at odds.

The bank industry claims credit unions are overreaching their intended purpose of serving a defined membership and should have to start paying taxes if they want to have increased lending capabilities. The credit union industry claims that banks are grasping at straws because they would like to eliminate competition.

“I think the bigger story about credit union regulation has very little to do with the Norlarco situation,´ said John Dill, president and CEO of the Credit Union Association of Colorado, a statewide trade group based in Arvada. He argues that credit unions are the most regulated financial institutions and across-the-board regulations, such as the Bank Secrecy Act, are more financial burdensome on relatively small credit unions than on banks.

“We spend a great deal of time in the area of advocacy,” he said.

For the past six years, industry trade groups have been trying to pass the Credit Union Regulatory Improvement Act, also known as CURIA. The bill has a number of provisions, but the two that would have the biggest impact on credit unions would allow credit unions to decrease the capital requirements and change the limits on business lending. Not surprising that these are the most contentious for banks.

‘Living, breathing example’

Dill said the situation with Norlarco is an isolated event and not indicative of the industry as a whole. But bank industry supporters have a different view.

“Norlarco is a living, breathing example of most of the arguments we have made in the past decade or two,´ said Don Childears, president of the Colorado Bankers Association, headquartered in Denver. He pointed specifically to CURIA and its provisions for capital requirements. “We thought it was a bad idea before and feel doubly about that now.”

Childears said he would be surprised to see the measure pass this year, although it currently has 125 co-sponsors in the U.S. House of Representatives.

“That would just literally be heading in the wrong direction,” he said.

But Dill argued that the act is really just moderate regulatory relief and that the banking industry is just carrying on a long-standing fight that it continues to instigate.

“It’s a lot of ‘crying wolf’ on the part of the banking industry,” he said. He pointed out the impact of Norlarco’s situation will be limited to the uninsured depositors – those with more than $100,000 in an account.

Dill might be correct that there won’t be an impact to the industry on a local or national basis, but already the banking industry wheels are turning at the national level.

On Sept. 6, the Independent Community Bankers of America released a statement blasting the credit union industry’s attempt at gaining concessions in light of the recent events.

“The unfolding situation, where tax-exempt credit unions around the nation invested in a Florida real estate scheme called ‘Millionaire University’ is a wake-up call on an industry lobbying heavily to further expand their commercial lending powers,” ICBA President Camden Fine said in a prepared statement.

According to its Web site, Millionaire University is “a 12-week educational course that combines the Biblical Wealth message with good sound business principles.” The school is included a lawsuit alleging it encouraged students to invest in the failed Florida developments financed in part by Norlarco and Michigan-based Huron River Area Credit Union. That credit union has also been placed into conservatorship.

“Tax-exempt credit unions are not tax-paying banks and should not be investing in such deals,” Fine continued. “Congress explicitly placed limits on the types of lending tax-exempt credit unions can do for a good reason – so credit unions can focus their efforts on serving people of modest means with a common bond. Unfortunately, this unfolding Florida scheme is a prime example of how credit union activities have strayed far from that mission.”

Regulatory differences

Regardless of what either industry’s trade group is claiming, the Norlarco situation does shed light on the regulatory differences between the two types of financial institutions.

David Barr, spokesman for the Federal Deposit Insurance Corp., said that in most cases when the bank regulator and insurer is asked by a state agency to take control of a bank, it immediately closes the bank and puts it up for sale.

Technically the bank closes, Barr explained, but it usually is so seamless that customers would not even notice a change. The FDIC tries to close banks on a Friday afternoon so that by Monday the location can open as a branch of the purchasing institution.

In fact, the FDIC will start confidentially marketing the bank for sale prior to closing it, providing basic financial information to other institutions that might be interested, then supplying more specific information only for those serious about making an offer.

If a buyer is not found, the FDIC mails checks to all insured depositors and alerts loan customers as well.

“We have only had a few instances of conservatorship,” Barr said.

He explained that the FDIC will only take control and operate a bank when there is a franchise that has value. By operating the bank for a short time, the FDIC hopes to put the finances in order so that the bank, and its name, can be sold for the best price.

A big difference between the current situation with Norlarco and with any bank conservatorship or closing is the way it is handled publicly.

“We issue a press release the day the institution is placed into conservatorship,” Barr said.

The credit union equivalent of the FDIC is the National Credit Union Administration. It insures all credit unions, but is responsible for examining federally chartered credit unions only. State regulators, such as the Colorado State Division of Financial Services, are responsible for examining all state-chartered credit unions, such as Norlarco.

John McKechnie, spokesman for NCUA, said the regulator usually issues press releases when a credit union goes into conservatorship or when an administrative order is issued. However, McKechnie said in the case of Norlarco no release was issued at the request of Colorado regulators.

Regulations protect customers

Financial services, in general, make up a heavily regulated industry. Regulations are often in flux as new market conditions arise and overly burdensome rules are pared back.

“We’ve seen a decrease in (bank) failures,” Barr said.

That is not saying much when compared to the 1980s, when commercial bank failures became so commonplace that they were considered non-events. However, until this February more than two years had passed without a failed bank, the longest stretch in FDIC history.

“We are working with banks to make sure they are operating in a safe and sound manner,” Barr explained.

The FDIC and the Colorado Division of Banking alternate reviewing Colorado-chartered banks, while the Office of the Comptroller of the Currency is responsible for reviewing nationally chartered banks. The criteria for the exams are referred to as CAMELS – capital adequacy, asset quality, management, earnings, liquidity and market sensitivity.

Chris Myklebust, commissioner for the Colorado Division of Financial Services, said that the state follows nearly the same exam criteria as the NCUA – CAMEL, with no S.

When there appears to be an issue with either safety and soundness or consumer protection, the FDIC usually takes several steps. The first is typically a memorandum of understanding – an internal agreement between the bank and the FDIC to get an issue resolved.

If a memorandum of understanding is not reached or does not elicit the desired results, the next step is an enforcement action. Enforcement actions, such as cease-and-desist orders and civil money penalties, are made public and contain a set of issues the bank must resolve. Sometimes an enforcement action will go so far as to require the bank to hire experts to deal with a specific line or product.

Myklebust said that the state tries to take steps when dealing with problem credit unions. Since Myklebust became commissioner in April 2006, two Colorado-chartered credit unions have gone into conservatorship. Prior to that, he said that there had maybe been only one in the past 20 years.

Myklebust said he believes the reason for the increase could be the softening economy. The division tries to take steps before reaching the point of conservatorship.

“We try to negotiate and work with credit union management and boards to cure things,” he said.

The division also issues enforcement actions – having issued “only the two” since his service as commissioner began. Altogether, Myklebust is positive about the state’s credit union industry.

“Times are tough, no one would dispute that,” he said. “I do feel that (the industry) is healthy as a whole.”