With all the privileges credit unions supposedly have, it would seem unlikely that many would want to become thrifts.
So why are several experts on charter conversions predicting a wave of them?
"Two words: insurance fund," says Robert Freedman, an attorney with Silver, Freedman & Taff in Washington.
His firm is advising Har-Co Maryland Federal Credit Union, which announced plans this spring to pursue a thrift charter. And Freedman believes several other credit unions may follow suit this year.
This would certainly mark a dramatic change. Not a single credit union converted last year, and only one did in each of the preceding two years.
But credit unions have a unique set of challenges lately.
The National Credit Union Share Insurance Fund has come under severe pressure following the collapse of major corporate credit unions during the financial crisis. As with the Deposit Insurance Fund that protects bank deposits, any shortfall must be made up through an assessment on the industry.
However, unlike the Federal Deposit Insurance Corp., which shut down scores of insolvent banks and projected the cost up front, credit union regulators chose not to absorb the financial hit as quickly.
The National Credit Union Association put many insolvent institutions into conservatorship, without recognizing the loss on bad securities. This has led to confusion about the ultimate impact on surviving credit unions, which will have to rebuild the fund once losses are recognized.
Alan Theriault, a consultant who advises credit unions on conversions, has been expecting a glut of them since the trouble with the corporates first arose. "It surprises me that there haven't been more conversions," he says.
There are considerable hurdles to converting-including getting approval from the credit union's members and securing deposit insurance from what has been a highly reticent FDIC. Two credit unions that tried to convert in recent years withdrew their applications to do so after failing to get FDIC approval. One, Beehive Credit Union in Salt Lake City, had been financially troubled and later failed. But the other, First Priority Credit Union in Boston, is healthy, says Theriault.
He believes many are waiting to see a success story-and watching Har-Co closely to see how it fares-before attempting such a move themselves. "Everybody wants the other guy to go first," says Theriault, the president of CU Financial Services in Portland, Maine.
Conversions do tend to come in bursts, according to the Credit Union National Association. There were five conversions in 1998, and eight in 2001.
Many think the timing is right for another burst-and potentially a much bigger one.
The corporate credit unions are, in effect, service providers to the retail credit unions, offering short- and long-term funding, among other things.
Losses from the failed corporates are sequestered in the Temporary Corporate Credit Union Fund, which has been set up to spread the cost over several years. But the NCUA is exploring various methods of funding those losses through assessments on the corporates' member institutions.
"The corporates alone went under holding $50 billion in bad securities, which could turn into $15 billion to $30 billion in losses to the fund," says Freedman. "Now an industry with a net worth of $80 billion may have to rebuild that fund. A lot of people are looking at it and saying, 'This is a hell of a problem, and I have to pay for it.'"
This comes on top of assessments that already are much higher than those faced by banks. Last year credit unions paid 35 basis points on their insured deposits, while banks paid 9 basis points or less.
Banks have spent decades locked in battle with credit unions, trying to prevent them from loosening regulations, expanding their service areas and otherwise becoming more competitive.
The most frequent complaint is of the level-playing-field variety: bankers insist that credit unions' tax-exempt status is an unfair advantage.
But Freedman says the discrepancy in insurance assessments alone is almost enough to justify a change in charter for credit unions.
In addition, credit unions must hold 40 percent more capital than a bank of comparable size, which, like the extra expense of deposit insurance, financially offsets the benefit of not paying taxes, according to Theriault. "If you factor in the higher capital requirements and the higher deposit insurance costs, your tax advantage has gone away," Theriault says.
The possibility of even higher insurance assessments isn't the only specter haunting the credit union industry, says Peter Duffy, a managing director at Sandler O'Neill & Partners in New York.
He says that while bankers tend to focus on credit unions' advantages, there are quite a few regulatory restrictions on credit unions that, while not necessarily major impediments in the past, have become more so in recent years. Chief among these is their statutory inability to raise capital in the markets. If a credit union wants-or needs-to grow, it must do so through retained earnings.
Growth is the reason credit unions often cite for seeking a change in charters. They typically transform into a mutual thrift, then into stockholder-owned institutions. It is only in going public-a step taken by three out of four converted credit unions, according to CUNA-that they can raise capital through stock sales.
Thrifts are getting a new regulator this year. Under the Dodd-Frank Act, the Office of Thrift Supervision is being abolished, with its responsibility being transferred to the Treasury Department's Office of the Comptroller of the Currency. However, thrift charters will remain available, and according to Duffy, these regulators are receptive to conversion requests.
Even so, Theriault says, credit union regulators are making the switch tough. In recent years they've added more rules to the conversion process that, he argues, are meant to discourage those who might consider pursuing a thrift charter.
In Theriault's view, the new rules are having the intended effect.
"Heaping regulation upon regulation has got people nervous about going through with the conversion process," he says.
Those brave enough to proceed also must deal with the FDIC. Since the financial crisis began, few institutions of any kind-credit unions or otherwise-have received FDIC approval for deposit insurance, even after other regulatory agencies have signed off. That has put a virtual halt on newcomers to the banking industry.
Another factor in the lack of conversion activity is the financial crisis itself.
"The sheer significance of this economic downturn has had a deer-in-the headlights effect," Theriault says. "But it's starting to wear off, and deals will get done again."
Har-Co certainly hopes so. The announcement in March that Har-Co, of Bel Air, Md., had taken steps to turn itself into a mutual thrift was no surprise to those familiar with its circumstances. Located outside Baltimore, in an area poised to welcome thousands of new employees being relocated to the U.S. Army's Aberdeen Proving Ground, the credit union is growth-minded.
Its CEO, Jim Meehan, did not respond to a request for an interview. But in its notice of conversion to members, the $186.5 million-asset Har-Co said it wanted to become a thrift to serve more people, which would improve its economies of scale and enable better pricing and branch expansion.
In 2005, Community Credit Union in Plano, Texas, switched to a mutual thrift charter and became ViewPoint Bank. The following year, it reorganized as a mutual holding company, making the thrift a subsidiary of the publicly traded ViewPoint Financial Group. In the years that followed-and in the teeth of the financial crisis-ViewPoint grew from $1 billion in assets to $3 billion and, in 2010, had its most profitable year yet.
Gary Base, president and CEO of the company and its bank unit, says a recent stock offering brought in an additional $200 million in capital. "We wouldn't have been able to raise the capital with a credit union charter," he says. "Because we have a bank charter, we've been able to grow, expand and raise the capital necessary to be successful in this environment."
According to Duffy, ViewPoint got the timing just about right. "From 1998 to about 2007, credit unions were growing profitably like the banks," he says. "Some experienced growth problems due to lack of access to capital, but they were dealing with it."
Then, circumstances became more difficult. In addition to the dismal economy, credit unions started to face some of the same regulatory challenges as banks, such as reduced income from overdraft and interchange fees.
The pressure on credit unions, Duffy says, is exacerbated by their continuing inability to raise outside capital, and could potentially be made worse by other changes to the regulatory landscape, including efforts to remove part of their federal tax exemption. One proposal floated by the Treasury Department in recent years would do away with thrift and credit union charters and replace them with a "federally insured depository institution" charter.
"Everything that could occur to the community banks in terms of new legislation that potentially erodes their margins or earnings really has more of a damaging effect on credit unions," Duffy contends. "Among credit unions, that is becoming more widely understood."
According to an analysis provided by Duffy's firm, credit unions have been scrambling to make up their lower return on assets through an increased reliance on fee income. "What's driving this is all just math. It can be modeled, and credit unions have begun to model it and understand it," Duffy says. "Due to the regulatory differences, banks even with taxes have been generating higher ROA than credit unions do with no taxes. At the same time, the community banks are very competitive on deposit offerings."
Credit union industry representatives dismiss the notion that there is any urgent drive to convert sweeping through the industry, and their objections cannot simply be waved away. Several times over the past decade, a spike in credit union conversions has been predicted, only to have the numbers prove to be a trickle, at best.
"Those credit unions that have looked at the bank charter have found that the grass is not greener on the other side of the fence," says Carrie Hunt, general counsel of the National Association of Federal Credit Unions.
Banks are equally vulnerable to many of the problems putting pressure on credit unions' balance sheets, and members of credit unions aren't typically in a hurry to simply trade one set of worries for another, she says. "We are not seeing too many folks ready to abandon the charter."
But conversion advisors like Freedman, Theriault and Duffy insist interest is high. If challenges like looming deposit insurance hikes weren't enough, there is one more issue that could push credit unions toward a charter change.
International bank regulators are debating changes to the Basel capital accords, which could raise the minimum capital requirements for banks significantly. At first blush, this wouldn't seem to affect credit unions, which are subject to different capital rules than banks. However, the Credit Union Act requires regulators to reassess capital requirements on credit unions whenever the minimum levels are increased for banks.
Considering that credit union capital requirements already are more onerous than banks', and that any increase would have to be met without the availability of alternative sources of capital, the impact on the industry may well be decisive.
"Basel III could be the final tipping point," Duffy says.
NAFCU's Hunt scoffs at the idea of credit union boards plotting conversions based on the mere possibility of changes in capital requirements. "In terms of what the capital regime is going to look like, there are some big questions there," she concedes. "But without knowing how those policies are going to change for credit unions, I don't think boards are right now doing a full analysis of whether they will need to convert."
Meanwhile, Theriault, who puts out a free guide to the conversion process for credit unions, says several hundred copies of the guide have been downloaded from his website since the collapse of the corporates started to heighten concern about the insurance fund.
"This has got people looking at conversions that never would have given it a second thought before," he says.
