October 12, 2005

Mr. Lee Bettis, Executive Director

Coalition for Credit Union Charter Options

500-5301 Wisconsin Avenue, NW

Washington, DC  20015

Re:  Credit Union Charter Conversions.

Dear Mr. Bettis:

This responds to your letter to me, dated September 28, 2005, and seeks
your cooperation in assuring that the interests of credit union members
are served when their boards of directors consider a proposal to convert
to a non-credit union charter.

Your letter charges that NCUA Regional Directors and I have made public
statements suggesting that credit union conversions to other depository
institutions may be motivated by credit union management's desire for
personal financial gain.  You assert that an objective credit union
regulator should refrain from evaluating credit union corporate
governance issues and business decisions regarding conversions.  You
conclude that NCUA opposes credit union conversions to mutual savings
banks. 

NCUA does not oppose a credit union's authority to convert to a savings
bank or other non-credit union charter. On the contrary, our objective
is to fulfill our obligations under our authorizing statute (1) to
administer and approve the methods by which a member vote on a
conversion proposal is taken, and (2) to promulgate rules governing
charter conversions that implement the statutory directive of adequate
notice about proposed conversions to the membership.[^1] To these
congressionally mandated ends, NCUA has promulgated regulations and
advocated legislation designed to ensure that a credit union's
member-owners have the ability to make an informed choice about their
credit union's future.  We believe that, to achieve a fair conversion
vote by an informed membership, three standards must be met.  Credit
union officials must faithfully fulfill their fiduciary duty to the
credit union's members and closely examine whether a charter conversion
is in the members' best interests.  Credit union officials must give
members full and fair disclosure regarding any conversion plan,
providing, for example, an objective analysis of the transaction,
regulatory variations, including the implications of thrift lending
limits,[^2] benefits to management, and importantly, any changes in
member voting rights. Finally, members must have a meaningful way to
communicate with credit union directors and other members so they may
share their views regarding any conversion proposal.

In implementing these policies, NCUA is mindful of Congress's charge
that it promulgate rules that are neither more nor less restrictive than
those governing other kinds of charter conversions.[^3] As such, NCUA,
like other regulators, has focused on ensuring that members receive
adequate notice and that they understand what they are voting on.

Any motivation by officials to convert in order to realize personal
financial gain presents a clear conflict in achieving the standard that
a conversion be pursued only if it serves the members' best interests. 
The statements I, and others within NCUA, have made that question the
motives behind credit union conversions are well founded.  In fact,
banking consultants, including those with which the Coalition for Credit
Union Charter Options is associated, have made public statements that
contribute to NCUA's concern.  For instance, a website promoting credit
union conversion, that includes a prominent link to your coalition,
contains an article entitled "CEO & Directors:  Salary Imbalance is
Corrected by Converting to a Bank."[^4] This article is found in a
newsletter generated by Alan Theriault, who advises credit unions
considering conversion to a mutual savings institution charter.   

The article first notes that credit union CEOs receive much less cash
compensation than bank CEOs, ranging from 20% to 57% less depending on
asset size.[^5] It also states that, while most credit union directors
are unpaid, bank directors earn between \$2,500 to over \$50,000
annually, in addition to travel and expense allowances.[^6] It then
follows by stating "\[t\]he gap in pay can be much wider at individual
institutions which utilize stock, or phantom stock compensation
programs."[^7] 

The article continues by identifying additional benefits available only
to directors and management after conversion, including a share in a
recognition and retention reserve equal to 4% of a stock bank's initial
public offering (IPO) which vests over a five year period.  The article
provides the following analysis: 

> For example, assume a credit union with \$50 million in capital
> converts to a stock bank with an IPO amount of \$100 million,
> directors would share a \$2 million grant of stock and management
> would receive an equal grant.  Each member of a five director board
> would get \$400,000 in stock, vested over five years, at the IPO
> value.  The directors would now have the incentive to increase stock
> value for the benefit of themselves and the member owners that
> obtained shares in the IPO.[^8]

Finally, the article concludes by detailing various other opportunities
for a credit union-turned-bank executive to accrue wealth.  "\[T\]he
reward for performance could lead to a \$10 million plus, ownership
stake for a capable CEO.  If the conversion is not made during the
current tenure, the next CEO in charge may very well realize the
value."[^9]

Mr. Theriault's article evidences a marketing plan by banking
consultants that persuades credit union executives to move towards a
mutual savings bank conversion and subsequent stock bank conversion
based, at least in part, on personal, pecuniary interests.  Given the
emphasis by a leading conversion consultant on opportunities for
personal financial gain by executives and officials, it is difficult to
imagine that their view is not distorted when determining whether a
conversion is in the best interests of the membership. 

Conversion proponents acknowledge this conflict of interest.  A
well-known banking expert, Bert Ely, provided insight behind the drive
to convert credit unions to savings banks.  In an article published by a
credit union trade magazine, Mr. Ely was quoted as saying "\'\[i\]t
really was a no-brainer.  .  .  You had all this money sitting there
without anyone's name on it.'"[^10]  It was also reported that Mr. Ely,
"who is firmly on the pro-conversion side of the debate, would not call
greed the primary motivating factor behind the conversions but said it
came in a close second."[^11] 

A review of the past ten years indicates that a credit union conversion
to a mutual savings bank is typically followed by a conversion to a
stock charter as soon as possible.  This trend provides further evidence
that, not only does a conflict of interest exist, but directors and
managers usually take the next step towards profiting from their
decision to convert by subsequently converting to a stock-issuing
financial institution.  Of the 27 federally-insured credit unions that
have converted or merged into a non-credit union institution between
1995 and 2004, 20 became a stock bank or merged into an existing stock
institution; simply put, nearly three-fourths of these former credit
unions stepped away from a mutual form.  These numbers suggest the
significant likelihood that a converting credit union will convert again
from a mutual to a stock institution. 

In the spirit of full and fair disclosure to members, credit union
officials should inform members that if they vote to convert to a mutual
thrift:  1) their voting rights may change; and, 2) the mutual may later
convert to a stock institution.  Credit union members should know that
their voting rights may change from one vote per member to the typical
thrift voting method of one vote per \$100 on deposit.  This disclosure
is important, especially if the credit union's directors intend on a
second-tier conversion, because members must understand that their right
to decide on a subsequent conversion to a stock bank may be limited in
comparison to their initial vote to convert the credit union.  Under the
commonly-used mutual thrift voting method, individuals with greater
amounts on deposit will decide whether the mutual becomes stock-owned;
this allows insiders and others with large deposits to control a
conversion vote that will reap monetary rewards for them as
individuals.  While NCUA is not the regulator for the second-tier
conversion, we believe credit union officials have a responsibility to
make these critical disclosures in order to present a full and accurate
assessment of the credit union's future.      

    

Investment experts claim "conversions from mutual-to-stock ownership
have also provided potential windfall opportunities to individual
investors.  Because the depositors own the mutual thrift, they are first
in line for subscription rights to purchase shares of the newly formed
stock company."[^12]  Unfortunately, it seems that a relatively small
percentage of credit union members-turned mutual depositors purchase
shares in the new stock institution.[^13] 

Furthermore, "\[o\]wnership control of credit union-converts almost
always ends up in the hands of a small handful of insiders\--directors
and officers\--after the institution converts to a stock-owned savings
bank."[^14]  This is initially accomplished through stock ownership in
an amount up to 14% of the equity of the newly public savings bank and,
later, "by control over the employee stock ownership plan and a
charitable foundation where a chunk of the newly minted stock is
parked."[^15] There are several examples of officials of recently
converted credit unions who have positioned themselves to control at
least 25% of the resulting stock institution's shares.[^16]  

These trends provide ample support for NCUA's unease.  We also note that
NCUA is not the first regulator to raise concerns about conflicts of
interests within the context of conversions.  The Office of Thrift
Supervision expressed similar concerns in a 1994 interim final
rulemaking by stating in the preamble: 

> Given that mutual savings associations currently seeking to convert
> generally are well-capitalized, the OTS has become increasingly
> concerned that the association's management may be undertaking
> conversions for reasons other than the need for capital.  Some thrift
> insiders may be sacrificing the interests of their associations and
> mutual account holders to acquire significant amounts of conversion
> stock and other benefits as cheaply as possible in the conversion
> process.  In addition, in some cases the issuance of conversion stock
> to a MRP \[management stock benefit and recognition plans\] lessens
> the opportunity for depositors to obtain conversion stock.[^17]

NCUA views the conflicts of interest inherent in credit union conversion
deliberations as undeniable.  NCUA asks you to join the agency in
seeking legislation that would ensure directors approve of conversion
plans in the best interests of members and would enable members to make
informed decisions about charter options promoted by unbiased
directors.  The version of the Credit Union Membership Access Act of
1998 initially passed by the House of Representatives included a
provision entitled "Assuring Independent Decision Making In Connection
With Certain Conversions."  It would have prohibited all directors,
committee members and senior management of a credit union, or an
institution that converted from a credit union, from receiving any
economic benefit with regard to their shares or interests in the
converted credit union or any resulting institution, if they served at
any time during the 5-year period before the conversion.[^18]  We
believe the enactment of a similar statutory prohibition would assure
that only unbiased officials would evaluate whether a conversion plan
serves the membership and direct the conversion process, including
notices and disclosures, in a manner that serves the interests of the
member-owners.   

In the absence of a legislative change that addresses the conflicts of
interests discussed above, NCUA will do its part to fulfill its
statutory obligation to see that votes are fairly conducted and that
credit union officials comply with their fiduciary duties to members,
provide full and fair disclosures to members, and permit members to
participate in the process as the current statute contemplates.  We will
continue to evaluate how the agency's rules and procedures can better
accomplish these goals for credit union members.

Finally, it is important to address the other issues you raise in your
letter related to the safety and soundness of the credit union system
and to correct the record by providing more complete and accurate
information:

-   You raise concerns regarding the long-term solvency of credit
    unions.  In 2004, 13.15% of federally insured credit unions (1,183)
    experienced a net operating loss.  Indicative of their small size
    (average of \$12 million), the combined assets for these credit
    unions represent only 2.3% of NCUSIF insured assets.  For
    comparison, 532 insured banking institutions operated at a loss in
    2004 representing 5.9% of those institutions and 0.9% of insured
    assets.  However, the average size of unprofitable insured
    (profit-motivated) banking institutions is much larger at \$170
    million.  Credit unions, as non-profit organizations, return
    earnings in excess of capital needs to their members in the form of
    lower loan rates, lower fees, and higher dividend rates. 
    Considering the fact that the average net worth ratio for
    unprofitable credit unions is high at 14.1% (and only declined 52
    basis points from the operating loss), incurring a loss to return
    excess retained earnings to members through better rates and adding
    services is a sound strategy.  Further, the increase in the number
    of credit unions experiencing operating losses is not surprising
    given the very flat yield curve over the last few years and the
    conservative (i.e., short-term) stance these credit unions have
    taken in terms of their investment and lending portfolios.

-   You assert that about 40% of credit unions earn less than 40 basis
    points in return on assets.  In 2004, 23.3% of federally insured
    credit unions (2,099) generated a profit of less than 40 basis
    points.  Indicative of their small size (average of \$23.6 million),
    the combined assets for these credit unions represent only 7.7% of
    NCUSIF insured assets.  These credit unions have a high average net
    worth ratio of 13.9%, actually increasing their net worth ratios by
    11 basis points on average despite the lower profitability levels. 
    There is no evidence to support that these credit unions
    collectively are engaging in riskier activities due to lower
    profitability levels, especially given their high capital levels.

-   You claim that 10% of credit unions represent 90% of the share
    insurance fund.  As of June 30, 2005, 25.9% of federally insured
    credit unions hold 90% of federally insured credit union assets.  In
    comparison, the largest 13.3% of insured banking institutions hold
    90% of total insured bank assets.  Thus, though the credit union
    industry has become more concentrated, the concentration risk for
    banks is much higher.

-   You attribute negative statements to the Government Accountability
    Office (GAO) regarding NCUA's supervision of corporate credit
    unions.  GAO's review found corporate credit unions to be in sound
    operational and financial condition.  The final report, *Corporate
    Credit Unions:  Competitive Environment May Stress Financial
    Condition, Posing Challenges for NCUA Oversight,* provided several
    recommendations to enhance our supervision efforts.[^19]  We
    appreciated GAO's insight and implemented a number of their
    suggestions.  However, it would not be accurate to characterize
    GAO's findings as an indication that our existing supervision
    efforts were found to be lacking in ensuring the safety and
    soundness of the corporate credit union system.

```{=html}
<!-- -->
```
-   You state the issue of secondary capital is driving most
    conversions.  Since 1991 credit union assets have grown by 185
    percent.  Despite this strong level of asset growth, net worth in
    relation to assets increased by 75% to an historic high of 11% as of
    December 31, 2004.  In terms of prompt corrective action, almost all
    (98%) of federally insured credit unions are considered well
    capitalized.  Even the fastest growing credit unions have
    demonstrated the ability to maintain safe and sound capital levels
    without the need for alternative forms of capital.  Consider, for
    example, the 100 credit unions that have grown the fastest over the
    last five years (not counting new charters or credit unions that
    have taken in mergers).  These 100 credit unions have on average
    grown 172% over the last five years, with growth levels ranging from
    114% to 655%.  They currently enjoy a high average net worth ratio
    of 10.5%, experiencing on average a decline due to the very strong
    asset growth of only 82 basis points over this five year period.  In
    fact, one-third of these credit unions actually had increases to
    their net worth ratios.

> As the GAO report, *Credit Unions -- Available Information Indicates
> No Compelling Need for Secondary Capital* notes, there are key
> unresolved issues regarding secondary capital, such as whether or not
> secondary capital instruments would be commercially viable, to whom
> these instruments could and should be sold (e.g., inside versus
> outside investors), the effects on the member-owned cooperative
> structure of credit unions, and any safety and soundness and systemic
> risk implications posed by this activity.[^20]  In view of these
> issues and the fact that the vast majority of insured credit unions
> maintain extremely strong capital positions notwithstanding a recent
> prolonged period of rapid share growth, there is a lack of consensus
> within the credit union system on the need for and appropriate
> structure of secondary capital instruments.

Thank you for your letter and the opportunity it has provided us to set
the record straight concerning the serious conflict of interest that
exists in the current conversion process and concerning the financial
strength and safety and soundness of the credit union system.

 

           
                                                     Sincerely,

                                                                 Robert
M. Fenner

                                                                 General
Counsel

05-1019       

cc:   Chairman JoAnn Johnson

        William DeSarno, Inspector General

        Rep. Michael G. Oxley

        Rep. Barney Frank

        Rep. Jeb Hensarling

        Rep. Patrick McHenry

  

[^1]: [See]{.underline} 12 U.S.C. §1785(b)(2)(C), (G).

[^2]: [See]{.underline} 12 U.S.C. §1467a(m), the qualified thrift lender
    test.

[^3]: 12 U.S.C. §1785(b)(2)(G)(i).

[^4]: Theriault, Alan D., *CEO & Directors:  Salary Imbalance is
    Corrected by Converting to a Bank,* CONVERTING FROM A CREDIT UNION
    FAX UPDATE, Sept. 16, 2002, *available at* http://www.cufinancial
    .com/pdfs/ NL2002.pdf.

[^5]: [Id.]{.underline}

[^6]: [Id.]{.underline}

[^7]: [Id.]{.underline}

[^8]: [Id.]{.underline}

[^9]: [Id.]{.underline} at 2-3.

[^10]: David Morrison, *For Years, Consultants and Greed Have Driven
    Coops in Other Industries to Go Stock-owned; CU Wave May be Just
    Starting,* CREDIT UNION TIMES, March 17, 2004, at 1.

[^11]: [Id.]{.underline} at 51.

[^12]: SNL Financial's web page discussing mutual thrift conversions at
    http://www.snl.com/

    bank/conversions/.

[^13]: "IGA \[Federal Credit Union\] had opened in 1975 and served just
    Peco workers.  It, too, was evolving:  from a credit union, to a
    mutual bank owned by its depositors, to a publicly traded company,
    all in the space of a year. .  .  .  Though IGA executives said the
    1999 stock sale was meant to benefit the Peco workers who had built
    the credit union, he \[Richard Balentine\] was among only about 5
    percent of depositors who chose to buy stock."  Mario F. Cattabiani,
    Jennifer Lin & Craig R. McCoy, *A Fast-moving and Enriching Merger;
    Fumo's Bank Aimed to Merge Quickly with a Former Credit Union, But
    Ran Into Regulatory Yellow Lights,* THE PHILADELPHIA INQUIRER, May
    16, 2005, at A1.

[^14]: *Insiders Gain Control Of CUs After Conversion,* THE CREDIT UNION
    JOURNAL, June 13, 2005, available at
    http://www.cujournal.com/archive/.

[^15]: [Id.]{.underline} 

[^16]: "\[I\]n the case of First PacTrust Bancorp., known until January
    2000 as Pacific Trust FCU, 11 directors and managers now own 15% of
    the bank\'s equity and the ESOP owns 9.9%, totaling approximately
    25% of the publicly traded shares\--which is considered by the SEC
    as control of a publicly owned company.  In the case of Rainer
    Pacific Savings Bank, known until 2000 as Rainier Pacific CU, 17
    directors and executives own 12% of the equity, the ESOP owns 9.41%
    and the charitable Rainier Pacific Foundation holds 7.09%\--for a
    controlling 28.5% of the public float.  Similar scenarios have
    occurred in BUCs Federal Savings Bank, formerly BUCs FCU, where
    insiders own 21.1% of the shares and control the ESOP\'s 8.9%;
    Allied First Bank, formerly Allied Pilots FCU, where 10 officers and
    directors own almost 24% of the stock; Citizens Community Bancorp,
    once Citizens Community CU, where almost a third of the publicly
    trade stock is controlled by directors and officers; and Synergy
    Financial Savings Bank, formerly Synergy FCU, where 12 insiders own
    half of the public float."  [Id.]{.underline}

[^17]: 59 Fed. Reg. 22725, 22729 (May 3, 1994).

[^18]: 144 CONG. REC. H1871 (daily ed. April 1, 1998).

[^19]: GAO 04-0977, September 10, 2004. 

[^20]: GAO 04-849, August 2004.