Filene Report Argues NCUA Should Allow CUs to Convert Directly To Stock Banks; Receiving a Per Member Share of CU Only Way to Protect Member Interests

Credit Union Times   June 14, 2006
By David Morrison

MADISON, Wis. - NCUA should consider allowing credit unions, which choose to do so, to convert their charters directly to stock-issuing banks, according to a former chief economist for the Office of Comptroller of the Currency, the regulator for national banks.

That is one of the conclusions Dr. James Wilcox, the former economist who now teaches with the Haas School of Business at the University of California at Berkley, presented in Credit Union Conversions to Banks: Facts, Incentives, Issues and Reforms, a newly issued report from the Filene Research Institute.

Allowing credit unions seeking to convert to distribute stock to their members on a pro-rata basis, according to their deposits and/or loan activity with the institution, would better protect their interests in the retained earnings of the institution, Wilcox argued.

Wilcox pointed out in the report that allowing such CU-to-stock demutualization, in conjunction with an initial public offering of stock, would "lessen many of the less savory incentives to converting credit unions" by reducing transfers from members who, under current OTS and FDIC regulations, may not receive retained earnings when the mutual thrifts convert.

"Since the OTS is unlikely to permit direct credit union-to-stock thrift conversions under rules other than the standard conversion method," Wilcox wrote, "the NCUA could develop a set of rules to . use the demutualization model and that, thus, greatly reduce (or eliminate) transfers of value across members and from members to external investors."

Wilcox maintained that in the current rules, credit union members who are attempting to make a decision about a proposed conversion which will lead to a later public offering of stock are not being asked to trade their joint claim on retained earnings for shares of stock or cash in proportion to their deposits. Instead, upon conversion, their pro rata claims on retained earnings are exchanged for individual, nontransferable, preferential rights to purchase stock and individual claims to retained earnings that would be senior to those of stockholders in liquidation.

These purchase rights, he pointed out, have not usually been exercised by the vast majority of CU members and the failure to do so leads, in effect, to a transfer of ownership from the CU members to others who can buy shares in excess of those to which they would receive in a pro-rata distribution.

Wilcox's proposal is not terribly new. Demutualization has been suggested before as a way of handling conversions in a fair manner. But he also argues that NCUA already has the authority to authorize credit unions to make these sorts of demutualized conversions and suggested that it may have the authority to require converting credit unions to offer their members the demutualization option as part of the conversion decision.

"I don't see why a credit union proposing conversion could not be required to tell its members about option C, the one in which they will not trade their ownership interest in the institution for the ability to purchase stock, but instead for an actual amount of stock with some real worth."

Wilcox's proposals of different ways to reform the conversion process provided only one part of a 116-page report which looked at conversions both inside and outside the credit union industry and included mention of two institutions which converted from thrifts to CUs.

The $127 million EMBSLA CU, headquartered in Milwaukee, Wisconsin, started life in 1914 as a mutual thrift and became a credit union in November 1997. The $2.7 billion ESL Federal Credit Union was chartered in 1920 as Eastman Savings and Loan Association by George Eastman, founder of Eastman Kodak Company and became a CU in February 1996.

Of the two, ESL's story is more familiar to many within the CU industry, but the story of EMBSLA is less known.

According to Jennifer McClone, CEO of the credit union, the shift to becoming a CU was both simpler and more difficult than the institution had imagined it would be.

"EMBSLA is an acronym of our former name," McClone said, "the Employees' Mutual Saving, Building and Loan Association. Becoming a credit union was easy in one sense because we already had many similar attitudes and practices to credit unions. Our board of directors was already volunteer," she pointed out, "and we were formed to do many of the same basic things CUs were formed to do."

The savings and loan was formed to serve the employees of the Wisconsin Electric Company, something the CU has maintained, as the Milwaukee based utility remains its sole sponsor.

McClone explained that the fallout from the savings and loan crisis forced the institution to make some hard decisions about its future. It had never had insurance before, but the crisis in the late 1980s led to more pressure on the institution to get at least private insurance. But at the same time, the crisis raised the price of the premiums sharply, making the insurance much more expensive. The institution calculated that the costs of a deposit with the National Credit Union Share Insurance Fund, combined with the institution's philosophical rapport with CUs, made it simpler to decide to become a credit union.

Simpler in one sense, but still a little complicated. McClone said the savings and loan had been of the sort depicted in the movie It's a Wonderful Life. "Our teller windows even looked the same," she laughed, and that the savings and loan was heavily invested in mortgages. The problem was that at that time, 1997, neither NCUA nor state regulators were terribly comfortable with credit unions being so heavily invested in mortgages. "I like to think it just took the rest of the industry a little time to catch up to the idea," McClone said.

She explained that the CU's history has given her a somewhat singular perspective on the topic of charter conversions. She differentiates, she said, between credit unions that need to convert because their economic or business circumstances require it and they need to convert to keep going, and CUs which appear to convert because someone in the CU wants to make a little money.

"What I marvel at is how little the issues have changed between the time when it was savings and loans going through a similar process and converting to banks," she said. "It's some of the same issues, insiders making a lot of money and small depositors getting shafted. It's remarkable that so little has changed."

© 2007, Used with permission from The Credit Union Times. All rights reserved.

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