The Charter Choice:
Credit Union vs. Bank
CUES Directors Conference
December 8, 2009
Presented By:
Richard S. Garabedian, Esq.
Kent M. Krudys, Esq.
Luse Gorman Pomerenk & Schick, PC
5335 Wisconsin Avenue, NW, Suite 780
Washington, DC 20015
Phone: (202) 274-2000 Fax: (202) 362-2902
www.luselaw.com
Who We Are
Luse Gorman Pomerenk & Schick is a
Washington, D.C. based law firm that
specializes in the areas of financial institutions
regulatory and transactional law, as well as
employee benefits and taxation.
Our practice focuses on regulatory compliance,
cooperative business combinations and
mergers, charter conversions, capital
formation, securities law compliance, corporate
governance, executive compensation and
employee benefits.
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Charter Conversions Completed By
Luse Gorman Pomerenk & Schick

Monadnock Community Bank

Community Plus Savings Bank

Ohio Central Savings

Beacon Federal

Carolina Federal Savings Bank

Caney Fork Cooperative CU*

Kaiser Federal Bank

Salt City Hospitals Employees

Pacific Trust Bank

Atlantic Coast Bank

Professional Teachers CU*

HeritageBank of the South

Marcy FCU*

Allied First Bank

Coastway Community Bank **

Roper FCU*
FCU*
_________
*
Merged with a pre-existing thrift immediately
following conversion
** Completed July 1, 2009
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Overview
 Comparison of the material features
of the bank charter with the credit
union charter.
 Case studies of previous charter
conversions.
 Alternative forms of capital.
3
What Charter Conversion
Means
 More flexibility to serve members and local community
at large
 Ability to serve customers and local community with
expanded products and services and increased customer
access
 Ability to attract board and management from more
sources and with expansive multi-product talent
 Greater ability to compete in an ever increasing
competitive environment
 Increased capacity to generate capital
4
What Charter Conversion Does
Not Mean
 Abandoning Members – may retain general credit union
philosophy and customer orientation
 Raising Service Charges and Other Fees
 Higher Loan Rates and/or Lower Deposit Rates – rates
remain market driven
 Changing Business Strategy – except if need to change
loan portfolio composition for regulatory compliance
purposes
 New Management/Board Members
 Compensation Pressure
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Some Questions to Ponder
 What is the future of the credit union
charter?
 Should your business plan drive your
charter or should your charter drive your
business plan?
 What is your credit union’s mission?
 Are you a credit union for the benefit of
your members or the industry?
 “all for one and one for all” vs. “protecting your
own”
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Some Questions to Ponder
 What is the likelihood of increased member
business lending authority?
 NCUA
 What is the likelihood of secondary capital?
 “No consensus”
 What will be the full financial impact of the
corporate credit union crisis and the future
failure of retail credit unions?
 NCUSIF vs. FDIC – pick your poison.
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B
A
(35)
Credit
Union
Mutual Bank
State
Chartered
- State
- FDIC or FRB
Benefits: Increased lending authority
Lower capital requirements
Ability to access capital in the future
Broader customer base
Federally Chartered
- OTS
What is a Mutual Bank?
 Member owned cooperative
 Historically – devoted to residential
mortgage lending
 Present – also makes commercial real
estate and business loans, as well as
consumer loans
 May be either state or federally
chartered
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Mutual Bank and Credit Union
Similarities
 Created to encourage savings
 Community oriented
 Serve customers
 Not for profit
 Owned by their members
 One person, one vote
 Similar balance sheets in many cases
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(17)
Mutual Bank
(600)
Stock Bank
Federally
Chartered
State
Chartered
Savings Bank
Savings
Bank
Commercial Bank
Mostly small
closely-held
community
banks
(7,000)
Mega Bank
- BOA
- Citi
Regulatory
Comparisons
12
Mutual Bank Charter Overview
 Broader business loan
authority
 Enhanced
diversification
 Access to secondary
capital
 Charter restraints are
virtually eliminated
 No NCUSIF 1% deposit
 Board stability
 Investment earnings
enhanced
 No FOM
 Retain mutuality while
adding customers
 Lower capital
requirements
 Ability of members to
become true owners
 Federal pre-emption
for federal thrifts
 Unlimited branching
for federal thrifts
 Capital leverage
13
Disadvantages of Mutual Bank
Charter
 Taxation
 Profit motivation
 Impact on members
 Loss of Credit Union Philosophy
(Stock Bank Only)
 Community Reinvestment Act (“CRA”)
 Compliance burden
 Lending risk
14
Disadvantages of Mutual Bank
Charter
 Potential reduction in marketing niche
 Compensation
 The greed factor
 Pressure to increase compensation
 Federal charter - asset limits on
consumer loans other than credit
card, educational and account
secured loans
15
Loan Portfolio Limits Overview
 Federal Thrift Limits (mutual or stock bank)







Residential real estate
Credit cards
Account secured
Educational
Consumer
Commercial real estate
Commercial & industrial
 Auto/equipment leasing
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No limit
No limit
No limit
No limit
35% of assets
4x total capital
10% of assets plus
10% for small business
10% of assets
Loan Portfolio Limits Overview
 Commercial Bank Limits








Residential real estate
Credit cards
Account secured
Educational
Consumer
Commercial real estate
Commercial & industrial
Auto/equipment leasing
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No limit
No limit
No limit
No limit
No limit
No limit
No limit
No limit
Federal Thrift / Commercial Bank

Investments





Loans-to-One-Borrower Limits


Legal lending limit – generally 15% of unimpaired capital
Branching Flexibility



Government and agency securities
Generally, investment-grade corporate debt
MBS
Mutual funds (holding permissible investments)
Federal thrifts – unrestricted intrastate and interstate
Commercial banks – generally unrestricted
Federal Preemption


Ability to “export” interest rates to other states
OTS takes aggressive position on preempting state law
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Mutual Bank
Membership Rights
 Membership Rights Following Charter Conversion
 Credit union members become mutual members
 Mutual members continue to be viewed as “owners”
of equity
 Mutual members continue to elect directors
 Voting Rights
 Mutual members can vote by proxy
 Continue 1 vote per member or 1 vote per $100 on
deposit, up to 1,000 maximum votes
 Voting rights continue with mutual holding company
 Members must vote on issuing stock or forming
mutual holding company
19
Community Reinvestment
 H.R. 1479 – would extend CRA to
credit unions
 Chairman Frank has suggested
extending CRA to credit unions
 National Community Reinvestment
Coalition Study – banks better serve
LMI borrowers, minorities, etc.
20
FDIC Capital Requirements



Required Ratios


Core Capital:
Tier 1 Risk-Based Capital:

Risk-Based Capital:
4% of assets
4% ratio of core capital to riskweighted assets
8% ratio of core capital +
supplementary capital to riskweighted assets
“Well-capitalized” Ratios


Core Capital:
Tier 1 Risk-Based Capital:

Risk-Based Capital:
5% of assets
6% ratio of core capital to riskweighted assets
10% ratio of core capital +
supplementary capital to risk
weighted assets
Risk Weighting of Assets for Regulatory Capital

Assigns assets to categories based upon asset risk classification
(0% to 100%)
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FDIC Capital Requirements
 Risk Weighting of Assets
 0% - cash, U.S. Government and agency
securities (backed by full faith and
credit)
 20% - U.S. Government sponsored
agencies, FHLB stock
 50% - qualifying single family and multifamily loans
 100% - consumer loans, commercial
loans
22
FDIC Insurance
 FDIC Deposit Insurance
 Premiums generally based on exam rating and
capital level – have recently increased. Range
from 12 to 45 basis points, subject to decrease
for unsecured liabilities and increase for
brokered deposits and secured liabilities.
 Proposed - Prepayment of premiums for 2010 –
2012 and 3 basis point increase
 No required deposit with insurance fund
 NCUSIF deposit – currently a non-earning
asset
 No entrance premium at this time
 Performance is rewarded
23
Tax Impact

Banks Are Subject to Income Taxation
 Federal income tax
 Applicable state income tax and/or franchise taxes

Credit Unions Are Subject to “Hidden Taxes”
 Higher credit union capital requirements restrict growth potential
 NCUSIF deposit – currently a non-earning asset
 NCUA disfavors long-term assets?

Exchange “Hidden Taxes” for Income Taxes in Charter Conversion
 Excess equity has potential to be fully leveraged (given lower
capital requirements)
 Bank can pursue a broader customer base, an expanded product
line and enhanced branching powers to realize such growth
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Tax Impact Illustration

Growth and Leveraging Opportunities Favor Banks



As a Credit Union
As a Bank
$100 million maximum assets
$140 million maximum assets
Similar Earnings: Assuming 1% Pre-tax ROA & 34% Income Tax



7% equity ratio requirement
5% equity ratio requirement
Greater Size Capacity: With $7 Million Equity 


As a Credit Union
As a Bank
As a Credit Union
As a Bank
Earnings = $1,000,000 (No tax)
Earnings = $924,000 (After-tax)
Illustration Does Not Incorporate Earnings Advantage of



Potential for broader product line and customer base
Expanded presence through enhanced branching
Capital raising capacity to fund expansion and diversification
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Structural Considerations
26
Alternative Corporate Structures
1. Mutual
Form of
Ownership
2. Mutual
Holding
Company
No Public
Stock
Structure
Options
4. Stock
Holding
Company
100% Public Stock
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3. Mutual
Holding
Company
<50% Public
Stock
Form of Ownership
Mutual Form of Ownership
Members
Advantages:
• No pressure from
stockholders
Directors
• Increased lending
authority
• Increased customer
base
Mutual
Bank
• Lower capital
requirements
28
Form of Ownership
“Private” Mutual Holding Company
Members
Advantages:
• Create maximum
flexibility for mergers
and accessing capital
Directors
Mutual Holding
Company
• Can raise capital
incrementally in future,
as needed
100 %
• Can raise equity
without public
stockholders (trust
preferred securities)
Subsidiary
Holding Company
100 %
Bank
29
Form of Ownership
“Public” Mutual Holding Company
Advantages:
• Control remains with MHC
• Raise capital
• Equity ownership for
employees, management and
directors
• Stock based benefit plans to
reward, attract and retain
employees/management/
directors
Members
Directors
Mutual Holding
Company
55 %
Subsidiary
Holding Company
100 %
Disadvantages:
• Public stockholders
Bank
30
45%
Public Stockholders:
- Members
- Employees
- Management/directors
- Community
- Others
Form of Ownership
Fully Stock Bank
Advantages:
• Maximize capital raised
Public Stockholders
- Depositors
- Employees
- Management/Directors
- Community
- Others
Disadvantages:
• Potential loss of control
100%
Holding Company
100%
Bank
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Mutual Holding Company Stock
Issuance

Member Subscription Rights




Mutual members have priority subscription rights to purchase
stock
Directors and officers have no greater right to buy stock than
the members
In most cases the members buy all the stock that is offered
Benefits to Employees

Stock should provide employees with real ownership incentive

An Employee Stock Ownership Plan (ESOP) provides an
additional retirement plan

Benefit plans such as stock options and restricted stock can
also be used

These stock benefit plans are heavily regulated by the bank
regulators
32
Strategic Acquisition Opportunities
 Acquisition Opportunities as a Mutual Bank




Credit unions
Mutual banks
MHCs
Stock banks and commercial banks
 Acquisition Opportunities as a Bank in MHC Form




Credit unions
Mutual banks
MHCs
Stock banks and commercial banks
 Acquisition Opportunities as a Stock Bank


Credit unions, mutual banks or MHCs
Other stock banks and commercial banks
33
What Lies Ahead
34
Future of Thrift Charter
 The Administration’s Regulatory Reform Proposal would
eliminate the federal thrift charter
 The Proposal does not affect the state thrift charter
 The Proposal does not address the mutual federal thrift
charter
 Likely that a mutual national bank charter would be
created to cover existing mutual federal thrift charter
 Federal thrifts would become national banks through a
transition period
 National Credit Union Act would need amendment to
allow conversion to the mutual national bank charter
35
Dispelling Myths
 FDIC is not granting federal deposit
insurance
 Bank regulators not accepting new
charters
 Conversions not possible due to
recapitalization of NCUSIF
36
Due Diligence
 Deciding whether to convert or
remain a credit union is a process,
not a snap decision
 Do your homework, talk with
advisors, other converted institutions,
engage in a financial analysis
 Your duty is to your members, not
the industry
37
Key Regulatory Issues with
Conversion
 Capital is King
 At least 8% equity
 Control growth if necessary
 Asset Quality
 Trends are very important




Exam Rating
Business Plan
BSA
Move forward when strong
38
Conversion Business Plan

Business Plan Requirements





Must comply with interagency business plan guidelines
Should follow this plan for first 3 years following conversion
New FDIC policy – extends to 7 years for its supervised banks
Must receive prior approval to materially deviate from plan
Financial Projections: 3+ years, prepared quarterly



Generally consistent with quarterly regulatory financial reports
Include balance sheet, income statement, capital, key ratios
Demonstrate ability to meet growth, diversification,
profitability objectives and strategies
39
Conversions Completed to Date
 8 mutuals
 11 full stock conversions plus Omni
 5 MHCs with public stock outstanding
 10 mergers (mutual to mutual,
mutual into stock)
 2 in process
40
Coastway Credit Union
 Converted to a Rhode Island mutual
savings bank in July 2009
 Main reason for conversion – member
business lending
 Conversion will allow more growth
and public presence
 80% of the membership voted in
favor
41
Allied Pilots Association FCU
 In 2001 converted to an Illinois mutual
savings bank – Allied First Bank
 Main reason for conversion – capital
 Converted to stock in 2001 to raise capital
 Grew 110% in eight years
 Continues to have a strong pilots’ base
42
Beacon FCU
 Converted to Beacon Federal in 1999
 Main reason for conversion – membership
growth
 Acquired four credit unions from 2000 to
2006
 Converted to stock in 2008 and raised $74
million in new capital
 Grew 600% in ten years
 Branches in four states
43
Kaiser Permanente FCU
 Converted to Kaiser Federal Bank, a federal
thrift, in 1999
 Main reason for conversion – membership
growth
 Formed a mutual holding company and
raised $56 million in new capital in 2004
 Grew 600% in ten years
 Continues to have a strong Kaiser
Healthcare base
44
LUSE GORMAN POMERENK & SCHICK
A PROFESSIONAL CORPORATION
ATTORNEYS AT LAW
5335 Wisconsin Avenue, N.W., Suite 780
Washington, D.C. 20015
TELEPHONE (202) 274-2000
FACSIMILE (202) 362-2902
www.luselaw.com
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