"We just wanted to find out what would happen if we got to the end of the loan and needed more time," Lee says of his first meeting with Scott Coles, Mortgages Ltd.'s CEO at the time.
"Scott said, 'I will not increase the principal or interest. I'll rewrite it or extend it. Don't worry. I've got you taken care of. I won't increase the interest rate,'" he recalls.
The year was 2005, and Lee's deal was not a big one by commercial real estate standards. Still, he wanted Coles' word that the loan could be extended at its fixed payments — should the church fail to secure a long-term lender. Coles gave him that promise, he says.
So after a handshake and a look in the eye, Lee signed a one-year loan for $1 million. He and his congregation used the money to convert an abandoned Luby's Restaurant into the Covenant Christian Center.
For 12 months, the members of the church paid $10,402.66 on time, every month. They poured their sweat equity into the property, too, working evenings and weekends to tear out drywall, retile floors, and fix the outside of the building.
In March 2006, the church was set to transfer the loan to a 15-year mortgage with a conventional lender. Then, at the last minute, the lender pulled out.
Lee immediately called Coles to make sure the loan could be extended at the same rate — as the two had agreed in person. Coles didn't return Lee's messages, Lee says, so the church sent another check for $10,402.66 on its usual payment date.
The check was returned, and Mortgages Ltd. immediately filed a notice to foreclose on the property (worth about $2 million at the time). Records show the church's interest rate then jumped from 10 percent to 67.75 percent APR.
Mortgages Ltd. eventually claimed the church owed more than $2.5 million on its $1 million loan. If Mortgages Ltd. had finished the foreclosure, it could have sold the building for about $2 million, paid investors, and then kept the remainder of about $1 million as profit.
That's exactly what was going to happen. Until attorney Donald Gaffney intervened. Gaffney is a partner at the high-end firm Snell & Wilmer. His billing rates are beyond the price range of most Phoenix residents, Pastor Lee included. When Gaffney heard about the 67 percent interest rate and hidden fees, he offered to represent Lee's church for free.
In the process, Gaffney uncovered a pattern in Mortgages Ltd.'s records. The lender's aggressiveness with Pastor Lee reflected a broader strategy of saying one thing and doing another — with investors and borrowers alike, Gaffney says.
Coles had apparently rigged a system in which he made more money on a foreclosure than on a paid-off loan, by selling defaulted loans to a second group of investors — who then paid off the first investors.
Gaffney learned that Mortgages Ltd. investors had no idea how much extra money Coles was pocketing on defaulted loans — or that Mortgages Ltd. was subjecting investors to higher risks so the company could make extra fees and interest on defaulted loans.
Mortgages Ltd. spent more than $500,000 wrangling with Gaffney about the $1 million loan. They eventually settled the case.
"He promised us one thing and stabbed us in the back, knowing he could get the property, even though we never missed a payment," Lee says of Coles. "Without the help of Don Gaffney we would have lost everything."
Gaffney has experience with fraud in Arizona. He earned his stripes by working as a lead attorney against Charles Keating during the savings and loan crisis of the late 1980s. As Gaffney pried into Mortgages Ltd., he smelled the same sour deceit that he'd unearthed in Keating's business.
So much so that on November 21, 2006, Gaffney wrote a six-page letter to state regulators, warning them about Mortgages Ltd.'s practices. He addressed the letter to Susan Segal, chief counsel at the Arizona Attorney General's Office and mailed a second copy to the Arizona Department of Financial Institutions.
"Mortgages Ltd. appears to be engaged in a serious breach of proper mortgage brokerage practices . . . Based upon inquiries with other attorneys in Phoenix, this scheme may be a pattern of illegal loan activity conducted by Mortgages Ltd." Gaffney wrote.
"We earnestly request the assistance of the State of Arizona in investigating [this company] and their practices," he concluded. He attached 54 pages of financial records and documentation to the letter.
What happened next is exactly nothing.
For another year and a half, Mortgages Ltd. continued to do business, attracting more investor dollars and loaning those dollars to increasingly larger and riskier projects.