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The Charter Choice:Credit Union vs. Bank
Presented By:
Richard S. Garabedian, Esq.Kent M. Krudys, Esq.Luse Gorman Pomerenk & Schick, PC5335 Wisconsin Avenue, NW, Suite 780Washington, DC 20015Phone: (202) 274-2000 Fax: (202) 362-2902www.luselaw.com
CUES Directors Conference
December 8, 2009
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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
Ohio Central Savings
Carolina Federal Savings Bank
Kaiser Federal Bank
Pacific Trust Bank
Atlantic Coast Bank
HeritageBank of the South
Allied First Bank
Roper FCU*
Community Plus Savings Bank
Beacon Federal
Caney Fork Cooperative CU*
Salt City Hospitals Employees
FCU*
Professional Teachers CU*
Marcy FCU*
Coastway Community Bank **_________ * 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.
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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
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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.
Credit Union
Credit Union Mutual BankMutual Bank
State Chartered
State Chartered
Federally CharteredFederally Chartered
- State - OTS
- FDIC or FRB
Benefits: Increased lending authority
Lower capital requirements
Ability to access capital in the future
Broader customer base
A B
(35)
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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
Mutual Bank(600)
Mutual Bank(600) Stock BankStock Bank
State Chartered
State Chartered
FederallyChartered
FederallyChartered
Savings BankSavings Bank Commercial BankCommercial Bank Savings Bank
Savings Bank
Mostly small closely-held community
banks (7,000)
Mostly small closely-held community
banks (7,000)
Mega Bank
- BOA- Citi
Mega Bank
- BOA- Citi
(17)
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Regulatory Comparisons
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Mutual Bank Charter Overview 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
Broader business loan authority
Enhanced diversification
Access to secondary capital
Charter restraints are virtually eliminated
No NCUSIF 1% deposit Board stability Investment earnings
enhanced
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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
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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
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Loan Portfolio Limits Overview
Federal Thrift Limits (mutual or stock bank) Residential real estate No limit Credit cards No limit Account secured No limit Educational No limit Consumer 35% of assets Commercial real estate 4x total capital Commercial & industrial 10% of assets plus
10% for small business
Auto/equipment leasing 10% of assets
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Loan Portfolio Limits Overview
Commercial Bank Limits Residential real estate No limit Credit cards No limit Account secured No limit Educational No limit Consumer No limit Commercial real estate No limit Commercial & industrial No limit Auto/equipment leasing No limit
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Federal Thrift / Commercial Bank Investments
Government and agency securities Generally, investment-grade corporate debt MBS Mutual funds (holding permissible investments)
Loans-to-One-Borrower Limits Legal lending limit – generally 15% of unimpaired capital
Branching Flexibility 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
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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.
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FDIC Capital Requirements Required Ratios
Core Capital: 4% of assets Tier 1 Risk-Based Capital: 4% ratio of core capital to risk-
weighted assets Risk-Based Capital: 8% ratio of core capital +
supplementary capital to risk- weighted assets
“Well-capitalized” Ratios Core Capital: 5% of assets Tier 1 Risk-Based Capital: 6% ratio of core capital to risk-
weighted assets Risk-Based Capital: 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 multi-family loans
100% - consumer loans, commercial loans
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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
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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 7% equity ratio requirement As a Bank 5% equity ratio requirement
Greater Size Capacity: With $7 Million Equity - As a Credit Union $100 million maximum assets As a Bank $140 million maximum assets
Similar Earnings: Assuming 1% Pre-tax ROA & 34% Income Tax As a Credit Union Earnings = $1,000,000 (No tax) As a Bank 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
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Alternative Corporate Structures
2. MutualHolding
CompanyNo Public
Stock
2. MutualHolding
CompanyNo Public
Stock
4. StockHolding
Company100% Public Stock
4. StockHolding
Company100% Public Stock
3. MutualHolding
Company<50% Public
Stock
3. MutualHolding
Company<50% Public
Stock
1. MutualForm of
Ownership
1. MutualForm of
Ownership
StructureOptions
StructureOptions
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Form of Ownership
Mutual Form of Ownership
Members
Directors
Mutual Bank
Advantages:
• No pressure from stockholders
• Increased lending authority
• Increased customer base
• Lower capital requirements
30
Form of Ownership“Private” Mutual Holding Company
Members
Directors
Mutual Holding Company
SubsidiaryHolding Company
Bank
100 %
100 %
Advantages:
• Create maximum flexibility for mergers and accessing capital
• Can raise capital incrementally in future, as needed
• Can raise equity without public stockholders (trust preferred securities)
31
Form of Ownership
“Public” Mutual Holding Company
Members
Directors
Mutual Holding Company
SubsidiaryHolding Company
Bank
Public Stockholders:- Members
- Employees- Management/directors
- Community- Others
45%55 %
100 %
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
Disadvantages:
• Public stockholders
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Form of OwnershipFully Stock Bank
Public Stockholders- Depositors- Employees
- Management/Directors- Community
- Others
Bank
100%
100%
Advantages:
• Maximize capital raised
Disadvantages:
• Potential loss of control Holding Company
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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
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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
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What Lies Ahead
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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
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Dispelling Myths
FDIC is not granting federal deposit insurance
Bank regulators not accepting new charters
Conversions not possible due to recapitalization of NCUSIF
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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
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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
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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
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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
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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
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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
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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
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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
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LUSE GORMAN POMERENK & SCHICK
A PROFESSIONAL CORPORATIONATTORNEYS AT LAW
5335 Wisconsin Avenue, N.W., Suite 780Washington, D.C. 20015
TELEPHONE (202) 274-2000FACSIMILE (202) 362-2902
www.luselaw.com