Banks Look to Make Converts Of Credit Unions

By Albert B. Crenshaw
Washington Post Staff Writer
Saturday, February 11, 2006

After more than a decade of trying unsuccessfully to roll back the credit union movement in Congress and the marketplace, the banking industry has come up with a new strategy: If you can't beat 'em, get 'em to join you.

In a small but significant number of cases, it seems to be working.

Last year in Texas, two credit unions, each with more than $1 billion in assets, converted to mutual savings banks, and another of comparable size in Michigan is seeking to convert. These transactions would bring to 26 the number of credit unions -- out of a total of about 9,000 -- that have converted in the past decade. Of those, more than half have gone on to become stockholder-owned companies -- a far cry from the cooperative movement that spawned credit unions.

The size of the recent conversions heartens bankers and alarms many in the credit union industry, both for the same reason. As low-cost competitors, credit unions have exerted downward pressure on the fees banks charge.

Some bankers envision a wave of conversions as officers, volunteer directors and some members of credit unions realize that they can make a lot of money if they switch over to a stockholder-owned institution.

"At some point, either the management or the members or both will figure out what [their credit unions] are worth, and their enlightened self-interest takes over," Richard C. Hartnack of U.S. Bancorp told an industry meeting last year.

Congress made conversion much easier with a bill passed in 1998, which, among other provisions, eliminated the authority of the National Credit Union Administration, the federal regulator, to block conversions. The measure also eased the threshold for approval of a conversion from a majority of a credit union's members to a majority of those who vote.

Some bankers and consultants involved in conversions say the switches are needed to cope with a changing marketplace.

"I would have loved to have stayed a credit union, but I couldn't do it under the [legal] constraints" on who could join her institution as a credit union, said Kay Hoveland, president and chief executive of Kaiser Federal Bank, formerly Kaiser Permanente Federal Credit Union, in California. Medical care was changing, and the institution, created to serve employees of a health care system, needed more members, she said.

Others, such as Alan D. Theriault, president of CU Financial Services, a Maine-based consulting firm that helps credit unions convert, say that as financial institutions get larger and more complex, they need more flexibility in compensation in order to attract the caliber of management they need.

Credit unions are nonprofit, tax-exempt cooperatives. They once were primarily niche players, typically serving employees of a single company.

However, membership grew sharply in the 1980s and '90s, spurred in part by a wave of bank mergers that sometimes left depositors feeling neglected and overcharged and looking for an alternative. At the same time, changes in law and regulation allowed credit unions to take in multiple groups of members and made it easier for institutions to merge.

Today, more than 86 million Americans belong to credit unions, and, though they remain dwarfed by the largest banks, some credit unions are much larger than before.

But that growth also has made conversion more inviting for management.

This is how it benefits managers, according to a scenario sketched out a few years ago by CU Financial Services: If a credit union with $50 million in capital converts to a stock bank, directors and management would be allowed to share a reserve equal to 4 percent of the stock in the initial public offering.

If the IPO raises $100 million, the directors would get $2 million worth of stock to divide among themselves -- $400,000 each for a five-member board. With successful management, "a two or three fold increase to the $1.2 million range for each director is not out of the question," CU Financial said. Managers might also expect additional stock compensation that "could lead to a $10 million plus ownership stake for a capable CEO," the consulting firm said.

And, it warned, "if the conversion is not made during the current [CEO's] tenure, the next CEO in charge may very well realize the value."

Credit union industry officials contend that personal financial gain, rather than the best interests of members, is spurring conversions. Members may also make money off the stock if their credit union is converted, but only if they have enough money to buy it and recognize the potential.

The Credit Union National Association, an industry group, notes that several executives have realized multimillion-dollar rewards following conversions to banks, in some cases 10 to 20 times their annual pay as credit union chief executives.

The banking industry has a strategy to "contain and convert" credit unions, said CUNA head Dan Mica, and "what they are trying to do is play with the minds of our CEOs" by suggesting that if they do not convert, their successors will -- and collect the benefits. Also helping press the case for conversion is a small group of lawyers and consultants who not only encourage the process but have made a business of helping credit unions through it, he said.

Bankers say that their only goals are to make sure credit unions stay within the rules and stick to their historical mission of serving small groups and that credit union members who want their institution to convert to a bank should have a chance to do that.

They say many credit unions not only have outgrown the limited role that originally justified their tax-exempt status but also have expanded beyond what applicable laws permit. For these institutions, conversion to a bank is the appropriate move, they say.

"Our view is that people ought to follow the law, and a windfall for insiders ought not to be an issue that drives" conversions, said Ed Yingling, president and chief executive of the American Bankers Association.

The Coalition for Credit Union Charter Options, a group formed two years ago "to represent the interests of credit unions that want to preserve charter choice," calls credit union industry officials' criticism of insider profits "moralistic posturing about greed."

One executive who saw her credit union through a conversion said personal gain was not a factor in the decision.

"I got stock, but I've got to work for that stock," which vests over seven years, said Hoveland, of Kaiser. And she no longer gets a cash bonus, she added.

Hoveland said her institution opted to convert to a bank only after exploring other alternatives.

It considered becoming a community credit union but found that impractical. Merging with another credit union might have worked, but it would have cost Kaiser CU's employees their jobs, she added.

The board decided that the best option was to become a mutual savings bank. It did that and is now a mutual holding company with a stock bank subsidiary. Capital has increased from $199 million to about $800 million; there are now five branches instead of two, "and more on the way."

The stock, originally sold at $10 a share, rose quickly to $14 but now trades at about $12, Hoveland said.

In some recent cases, the NCUA has challenged management's presentation of the issues to members in a proposed conversion. In one of the recent Texas cases -- 53-year-old Community Credit Union, now ViewPoint Bank, of Plano -- the agency argued that important information was not prominently enough displayed in voting materials sent to the credit union's 220,000 members. However, a court found for the management.

But NCUA Chairman JoAnn Johnson said recently, "Unequivocally, I believe that members have the choice of charter." But she added, "It should be equally clear that consumers need to have accurate information, and it can't be misleading."

It's particularly important today "when you have credit unions that have upwards of $200 million in capital on the table" and "a minority can vote to change that," she added.

One issue the NCUA and others are debating is the use of incentives, such as raffles and cash awards, to get credit union members to vote. A concern is whether they can be used to encourage early votes, perhaps before opposition could mobilize. Another is whether they lead members to think that voting with management could increase their chances of winning some sort of prize.

The NCUA last month effectively rejected the methodology of DFCU Financial of Dearborn, Mich., which, according to the Michigan Credit Union League, used a number of $5,000 cash prizes to encourage voting.