If you ask Susan Ralston, she will tell you the credit union competition in Virginia Beach, Va., is fierce. Nearly 32 credit unions, some with community charters, vie for loans and deposits within a 10-mile radius of her bank's main branch.
Until January 2004, Bank @LANTEC, where Ralston is president and CEO, was one of those credit unions. But membership at @LANTEC Financial Federal Credit Union was waning, dropping to 14,255 in 2003 from 22,000 six years prior. Ralston and her team saw opportunities in small business and mortgage lending, but Bank @LANTEC was limited in those activities as a tax-exempt credit union.
The solution, Ralston decided, was to switch to a mutual bank charter. One memberwide vote with a near 72 percent approval rating and a whole lot of paperwork later, Bank @LANTEC is now a highly capitalized mutual bank with about $8 million in commercial loans booked in the past six months. It holds $90 million in assets.
"It wasn't an easy decision to convert," says Ralston, who considered making the transition for six years and hired two outside consultants to assess the idea. "But it's what's best for the customers and the viability of the institution."
Bank @LANTEC isn't alone in converting from a credit union to a bank. Approximately 30 credit unions have made the switch to mutual bank charters or are in the process, according to Alan Theriault, president of CU Financial Services, a firm in Portland, Maine, specializing in credit union conversions.
These institutions range in assets of a few hundred million dollars to $1.7 billion-asset Community Credit Union in Plano, Texas, the nation's largest community-chartered credit union and, if successful in its conversion, the largest credit union to ever to become a bank. "Among the driving forces that have credit unions converting are the ability to raise regulatory capital, enhance consumer awareness and get product and market flexibility," he explains.
Critics have unfairly charged that credit union conversions to mutual bank charters are little more than get-rich-quick schemes for bank management and Johnny-Come-Lately shareholders with minimal benefit for members. An inaccurate picture has been painted of fat-pocketed directors extolling higher interest rates on helpless consumers. But the decision to convert to a tax-paying bank is one that is made as part of an overall business plan, and one that no tax-exempt credit union takes lightly, experts suggest.
Pros versus Cons
Like any other business decision, conversion from a credit union to a mutual bank is an investment in time. From filing a business plan and sorting out the legal issues to undergoing scrutiny by regulators and preparing members for the vote, it's a process that can be fraught with frustration and protests or a smooth transition. Most important of all, it's a slow and steady course where member needs and institutional stability come first.
Credit Union of Pacific in Seattle, Wash., was a bit of a misfit in the typical credit union mold. While credit unions are meant to have a consumer focus, limited in their portfolios to 12.25 percent commercial lending, Laurie Stewart, president and CEO of Pacific, saw her financial institution developing more and more business in the commercial real estate area. Rules requiring credit unions with portfolios heavy in real estate lending to carry more capital were putting a damper on the institution's growth.
"If you looked at our balance sheet, we looked more like a thrift than a credit union in composition of loan products," says Laurie Stewart, president and CEO of the former credit union. "The regulatory environment for a thrift was more appropriate for the kind of business model that we had."
So that's exactly what the credit union became. In May 2003 Pacific converted to Sound Community Bank and has since grown its real estate and small business portfolio and can offer more commercial products and services-all without losing the institution's mutual heritage.
"People in our field of membership were promised the same faces and culture, and we delivered," says Stewart.
The Right Way
While credit unions lobby for expanded business lending powers, Sound Community Bank expanded into commercial lending the proper way-conversion to a tax-paying mutual bank, says Chris Cole, ICBA's regulatory counsel.
"When a credit union increases its commercial lending rate, it only diverts focus from its tax-subsidized mission of helping consumers of low and moderate means," says Cole. "By converting to a bank, a credit union trades in its tax exemption for the ability to serve other markets."
The concept of forgoing tax-exemption in the wake of increased lending products is not new. Mutuals too once were tax-free, until Congress increased mutual banks' lending powers and the institutions lost their tax subsidy in 1952, notes Cole. Since then mutual savings banks have competed successfully with commercial banks, serving their communities and their customers well.
Of course, not every credit union that converts to a mutual charter stays that way. Ten among the 30 converted companies have sought extra capital by converting to a mutual holding company, where depositors still control up to 51 percent of the bank's stock, while seven others have had full stock offerings.
The opportunity to offer stock is one of the biggest incentives for conversion. By law credit unions are required to retain 7 percent capital, compared with 5 percent for a bank, because credit unions serve a limited consumer market and don't make many commercial loans. Capital can only be accrued through retained earnings. A bank stock offering, meanwhile, can raise capital to fuel growth.
Citizens Community Federal in Altoona, Wis., formerly Citizens Community Federal Credit Union, raised close to $10 million with its initial 33 percent stock offering last year to help the bank grow. The credit union became a mutual bank in 2001.
"We think growth is critical and important to maintain the rates and products we want to deliver to members and depositors," says Jim Cooley, president and CEO of the bank. "Quality growth is what I'm discussing, and for that we need capital."
Long before Citizens was a $152 million-asset bank, it was an insolvent credit union. When Cooley took over in 1988, he had to spend his first five years rehabilitating the institution before he could look towards serious growth. But the challenge of maintaining a sufficient capital ratio while expending funds for the type of growth for which his institution was capable was disheartening, he says. It was particularly challenging once the credit union started to lose market share in the auto loan business to dealerships, but found itself unable to recoup the lost income in the real growth areas-real estate and commercial loans-due to lending level restrictions, he says.
The Conversion Battle
Citizens' first attempt to convert to a mutual charter in 1997 was met with a massive protest from the Wisconsin Credit Union League, which took out ads in a local newspaper to encourage members to vote against the conversion. Rules at the time dictated that unreturned ballots counted as a vote against conversion, says Cooley. Had solely returned ballots been counted, the proposal would have passed by a margin of two to one. Instead, Citizens had to withdraw its application.
By the time Citizens made its second referendum in 2001, federal rules had been changed to count only ballots that had been cast. Members voted in favor of becoming a mutual bank and in 2004 voted again to make the change to a mutual holding company.
At its initial limited offering, Citizens sold 978,650 shares at $10 per share to bank members and employees. To qualify, depositors had to have at least $50 in an account at the bank since Dec. 31, 2001. Employee investments were limited by length of employment that not even a senior vice president could skirt.
"We had an employee, one who runs marketing, ask to buy 10,000 shares. But because he was a new employee, he could buy fewer than 1,600 shares and he's a senior vice president," says Cooley to critics who claim bank management benefits more than members.
Credit unions like Citizens that try to convert to mutual banks will encounter more difficulties in the future since the National Credit Union Administration finalized rules requiring converting credit unions to include a four-part disclosure statement with every written communication to a member concerning the conversion. For example, a converting credit union has to disclose, in boldface, that a conversion to a mutual savings bank usually is the first step in a two-step process to convert to a stock-issuing bank and that in a stock conversion, executives typically profit by obtaining stock far in excess of that available to the institution's members. An independent third party would have to conduct the vote by secret ballot.
ICBA has criticized these new disclosure and voting requirements. In a letter to the NCUA, ICBA said the disclosures are so misleading and slanted that one can only assume that NCUA is trying to discourage credit union members from ever voting for a conversion. ICBA also said that the proposal exceeds NCUA's statutory authority under the Credit Union Membership Access Act (CUMAA) and should be retracted.
Since Citizens made its initial conversion the bank has attained 26 percent quality growth, says Cooley. Within six months of the conversion, new deposits had increased to $5.4 million from $177,000 and new loans were up to $3.9 million from $333,000. As of September 2004, the bank had $4.6 million growth in loans. It has also acquired and built several branches, and a member survey reports 91.8 percent of customers believe efforts to grow the bank make it a more desirable place to do their banking. As of press time, Citizen's stock (CZWI) traded at $15 per share.
"Loan demand and growth has been very exciting," says Cooley. "We have all the loan demand we can handle right now. And we have potential for diverse geographies for branching."
Bank @LANTEC has found success with its new bank charter, having helped ease members into the transition and neutralized opposition by explaining the ways a mutual bank could serve their needs in a way a credit union might not.
"A lot of members who have grown up with the credit union might be small business owners," says Ralston. "They had needs we couldn't fulfill and in the past we had to refer them to another financial institution. Now they are getting a more full-service experience."
Members of Sound Community Bank have embraced their newly converted bank as well. Of the 20 percent of the members who voted, 81 percent were in favor of the conversion. Membership has remained strong, losing just a handful of accounts in the process. And the bank's new status as a taxed entity has had no impact on deposit or loan rates. In fact, an October 2004 promotion at the bank featured the best rate on money market accounts in the nation, says Stewart.
"We've had good growth, and we're trying to leverage that access to more clients and maintain competitive rates," she says.
Along with increased access to capital and greater product offerings comes taxation. Yet conversion brings other expenses. The costs of buying new computer systems to handle new products and regulations are not small. Unlike credit unions, banks are subject to the Community Reinvestment Act, and the new lines of business recently converted banks enter bring regulator interest in more diverse areas.
"Banks have a bigger burden when it comes to rules like CRA and some rules that aren't emphasized in the credit union world like the Bank Secrecy Act certainly are in the banking world," says Ralston.
The transition from credit union to bank is one filled with many questions. Yet the central question is whether customers and the institution will benefit from converting. For the 30 or so credit unions that have made the change, the answer has been yes.
"People are not just hung up on licenses, but on how we run the business itself," says Ralston. "That's why we wanted to make sure that the people and the organization and the culture wouldn't change, and our local community supported that. They knew they had needs we couldn't meet as a credit union, and we wanted to meet them."
And in these cases, the best way to meet them was as a community bank.
Credit unions share stories of conversion success to the tax-paying side
Among the driving forces that have credit unions converting are the ability to raise regulatory capital, enhance consumer awareness, and get product and market flexibility."
-Alan Theriault, credit union consultant
If you looked at our balance sheet, we looked more like a thrift than a credit union in composition of loan products. The regulatory environment for a thrift was more appropriate for the kind of business model that we had."
-Laurie Stewart, Sound Community Bank
Kelly Pike is Independent Banker's staff writer. Reach her at email@example.com.…