The Conversion Myths
Conversion proposals usually recycle the same eight arguments.
Most of the
time these arguments are only partially true or don't apply in the specific
case, and the conversion might not benefit the member-owners even if they
did. Here are the conversion myths—busted.
- We need to convert for more capital.
- We need to convert to make more business loans.
- We need to convert to expand access to new members.
- We should convert in order to grow faster.
- We need to convert to open new branches.
- We don't believe a new tax of 34-45% will lead to worse rates.
- A mutual bank is basically the same as a credit union.
- We will convert to mutual holding company, not a stock bank. It's the best of both worlds!
Claim 1: We need to convert to make more business loans.
Most credit unions are limited to holding 12.25% of their assets in business loans.
1
Most mutual banks are limited to 20%
2, and so conversion would allow a credit union
to make more business loans.
The Conversion "Experts"
The same few consultants and attorneys have managed most credit
union conversions. In many cases, they approached the credit
union's management with the conversion proposal.
Learn more.
Truth: Credit unions are not prevented from lending by the
business loan cap.
If a credit union reaches the maximum amount of business loans it is allowed to hold, it
does not need to stop making business loans. It can continue making those loans and selling
them to other credit unions for a profit. However, most credit unions making this argument
are well below the 12.25% limit anyway. Furthermore, becoming a bank creates additional
restrictions on business lending and raises the limit to just 20%.
For example, First Basin Credit Union stressed the need to make more business loans in its
letter to members proposing conversion. What First Basin did not say is that as a credit union,
it can expand its business lending five times over and still be below the 12.25% cap. Even if
First Basin did reach this cap and was unable to sell its loans, raising its limit to 20% would
only allow it to make 61 more loans— enough to serve just 0.26% of its members.
3
Of course, that small service would come with a 34-45%
4 tax on income, probably
leading to higher costs for all members. If the business lending advantage is of so little
use to First Basin and comes at such a cost, why is First Basin using it as a central reason
for converting?
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Claim 2: We need to convert to expand access to new members.
A credit union's membership is limited to those of a set community. If we become a bank,
we can reach more customers.
Truth: Most credit unions already have access to many potential customers. Becoming
a bank will probably not benefit current or potential new members.
Most credit unions today have wide fields of membership.
Credit unions using this justification for converting often have many potential members
still available within the community they were chartered to serve. For example, Beehive
Credit Union and First Priority Credit Union have both claimed the need to reach outside
their membership limits, but currently serve only 2.19% and 0.31% of their potential members.
Nationally, the credit union average is 24.8%.
5
Furthermore, new members will probably benefit little from access to yet another bank, while
the current members – to whom the board and management owe a fiduciary duty – will probably
not benefit from losing their credit union.
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Claim 3: We need to convert for more capital.
After converting to a bank, former credit unions have access to additional capital,
allowing them to make more loans. As a mutual bank, they would be required to keep 5%
of their assets as available capital rather than loans, which is slightly lower than a
credit union's 7% requirement. Issuing stock can generate significant new capital.
Truth: New capital at the cost of lost ownership and worse
rates and fees does not benefit members, and most converting credit unions don't need the
capital anyway.
The 2% capital advantage of a mutual bank comes along with a 34-45% tax on income. This may
force the former credit union to choose between losing money or charging worse rates and
fees. Not only are the costs high, credit unions using this argument are generally well
above the 7% minimum capital requirement anyway, and so have little to gain from a lower
minimum. For example, the four credit unions with conversion proposals pending as of August
2007 all used this argument. However, they hold from 8.9% to 17.3% of their assets as capital,
well above the 7% minimum.
6 As for the capital gained by issuing stock, such stock
is generated by selling the members' ownership without compensating them.
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Claim 4: We need to convert in order to grow faster.
By using more capital and reaching new members, conversion to a bank could allow our credit
union to grow faster.
Truth: If conversion allows a credit union to grow faster,
but causes rates and fees to get worse and allows management to appropriate the members'
ownership, that is not a success.
Unlike a bank, a credit union's mission is not to generate profits or even to grow. It is
to serve members with the best rates, fees, and services possible.
Why is your credit union talking about increasing growth rather than about serving
members? According to pro-conversion consultant Alan Theriault, "Directors,
management, and staff benefit from higher growth opportunities and greater compensation
tied to asset size."
7
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Claim 5: Converting will allow us to open new branches.
As a bank, we could open branches outside of the community we are chartered to serve.
Credit unions are limited in the amount of money they can spend on branches, so converting
would allow us to open more branches.
Truth: Credit unions are not prevented in opening new branches
by these limits.
Credit unions can open unlimited branches by leasing property, and are able to share branches
with other credit unions, which mutual banks are not. If a credit union has reached the
"fixed asset" cap and wants to
own new branches, it applies for permission
to do so. Permission should be granted if the credit union can demonstrate that exceeding the
limit on real estate is in the best interests of members. However, most credit unions using this
argument are well below the "fixed asset" limit anyway.
For example, First Basin Credit Union, which has told its members that its needs to convert in
order to build more branches, could actually build many more branches of the same average cost
of their current six, and still be below the limit.
8
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Claim 6: We don't believe a new income tax of 34-45% will lead to
worse rates.
Truth: Studies show that credit unions that have converted now
charge worse rates.9
If costs increase—and paying taxes is a real cost—a credit union has two options: a) earn less
money, or b) charge worse rates and fees. The mutual charter offers very little that could
generate enough income to make up for its tax cost.
For example, First Priority Credit Union has told its members that, "We do not expect that
these taxes and additional operating expenses would cause increases in the rates and fees we
charge for our products and services."
10 But for First Priority to avoid raising
rates (or losing money), the questionable business advantages of a bank charter would need to
cause the credit union to grow in one year more than fifteen times the amount it has grown in
the last five years combined.
11 If a credit union sells stock, this may generate
enough cash to pay for the new tax, but it means members may lose ownership of the credit union
without compensation, and rates and fees are still likely to get worse, as the mission changes
from benefiting members to making money for shareholders.
(More on
conversion and rates.) Why isn't the credit union talking about
offering better rates?
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Claim 7: A mutual is basically the same as a credit union.
Truth: There are many important differences, and converted credit
unions aren't likely to stay as mutuals anyway.
According to a study by the University of Wisconsin-Whitewater, mutual bank status "is
simply a stage. The credit union that converts to a mutual is simply creating the device
through which it can issue an IPO and become a commercial bank."
12
As for the differences between credit unions and mutual banks: A credit union's board of
directors are volunteers. A mutual's directors are paid. Credit unions are not-for-profit
and untaxed. Mutuals are not. Credit union governance is democratic, one-member-one-vote.
Mutuals are usually one-dollar-one-vote. Unlike credit unions, mutuals use "running
proxy" voting, which effectively disenfranchises members. Credit unions are able to
hold more consumer loans, while mutuals have some advantages in business lending. Perhaps
most importantly,
average rates are worse at credit unions that have converted to
mutuals.
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Claim 8: We will convert to a mutual holding company, not a stock
bank.
A mutual holding company is the best of both worlds: members keep their ownership, and the
institution has access to more capital.
Truth: A mutual holding company is the best of both worlds—for the board of directors.
In a conversion to a mutual holding company, directors get all the gains of a stock bank
conversion, but can't be voted out of office by stockholders (because the mutual holding company
keeps majority ownership of the bank). They probably can't be voted out by mutual owners either,
because proxy voting allows directors to control a large block of members' votes. On top of that,
they may be paid two salaries—one as directors of the mutual holding company, and another as
directors of the stock bank that the holding company owns.
For members, the conversion is just as bad. Rates are likely to get worse, and as for
ownership, mutual holding company ownership is generally worthless, without the ownership
rights either a credit union or stock bank would afford. Mutual holding company members
cannot sell their stock interests and may not receive dividends either. At the same time,
they have lost the credit union members’ right to better interest rates and lower
fees.
13 This is ownership in name only, without benefits. For more information,
read this
article
explaining insider enrichment in conversions to mutual holding company form.
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For more pro-conversion information, see the
website
of conversion consultant Alan Theriault.
