Special Commentary--Credit Union or Bank: The Charter Matters

If your credit union's board of directors started talking about converting charter to some type of bank, would you--or should you--care?

If you're like most consumers, you likely wouldn't pay much attention. You'd get a long legal document in the mail asking for your vote to approve the conversion. It probably would tell you the credit union board of directors and management team "recommended" that you approve the charter change.

If you took time to read the fine print you might see that the credit union was converting to a "mutual" charter, which sounds like a member-owned company. It is. What the document doesn't say is that this is usually just an interim step. Three out of every four credit unions that have converted charters ultimately converted to a for-profit stockholder institution.

The document also won't tell you that those who get in on the ground floor--typically members of the board and management team--stand to profit handsomely when that initial public offering of stock is offered.

Of course, you won't know any of that unless you do a little homework to find out what your vote really means--and what you would give up if you approve a charter conversion.

What is a charter?

Why should you care?

After all, you just want a place to transact your financial business and the type of institution--its charter--doesn't really matter, does it?

Actually the charter is a lot more important than you think.

If your credit union converts to a stockholder institution, you would give up control of your financial institution. As a member of a not-for-profit credit union you own it. You elect its board of directors. They supervise the CEO that runs the credit union. At a bank, you have no say over its board of directors or its CEO, or any other big decision. Unless you are a stockholder, the only vote you can cast at a bank is to take your business elsewhere.

"You're giving up your decision-making rights," if you vote to change from a credit union charter, says Mike Schenk, an economist for the Credit Union National Association, in Madison, Wis.

Because a credit union is democratically controlled, each member gets one vote regardless of how much business he or she does with the credit union. At a bank, a well-heeled group of stockholders make all the decisions that matter--like appointing the board of directors and selecting the CEO.

OK, now you're not sure you want all that responsibility that ownership implies. Think about that for a minute. You don't have to be a board member ... you don't even have to vote if you don't want to. But the point is that at a credit union, unlike a bank, you make a choice whether or not to participate in the process. At a bank, you have no choice--and no say.

"I don't think anybody wants to give up the privilege [of ownership], whether or not they want to accept the responsibility," offers Jim Blaine, CEO of State Employees Credit Union in Raleigh, N.C. Blaine notes that a lot of people don't bother to vote in credit union elections. He doesn't believe it's apathy. Instead, he says, too many members just don't understand the advantages they have as members of a credit union.

Maybe they think things are going along just fine without their participation. But that all comes to a halt when members let a charter change occur--either by voting for it or failing to vote to block it.

What's wrong with converting to a bank charter?

Nothing, if you want to help the rich get richer. Seriously, look at it this way: Because credit unions are member (customer) owned, not-for-profit cooperatives, they're not operated to maximize the profits of the stockholders. They're designed to improve the financial well-being of all their members, not just a few well-fed stockholders. Being a cooperative means credit unions should have better rates than their for-profit competitors, Blaine says.

And that's what has a lot of people upset in the credit union movement. Over the years, while only a handful of credit unions (fewer than 30 of the nation's 9,000-plus credit unions) have converted to banks, the issue has grown more contentious.

What enrages many credit union people is this:

Often, the people who push for the conversion--and are your only source for information about the conversion--stand to realize significant financial gains from the initial public stock offering (IPO).

It's not illegal; it's business. But it does raise a legitimate concern among some people that putting the conversion process into the hands of those who stand to reap financial rewards is a lot like putting the fox in charge of the hen house.

In a credit union, the member-depositors collectively own the net worth (capital). That's not the case once it changes its charter to a for-profit institution. "Converting from a credit union to a bank gives the board and senior management team the right to raid your net worth," Schenk says.

To most credit union people, this loss of the credit union's assets and capital is just plain wrong.

Normally, when a group of investors forms a bank, the organizers need to raise a very large amount of money to do so. By converting a credit union, the organizers essentially commandeer its assets, capital, staff, and most of its members. It's unclear how members benefit from that conversion because, as members, remember, they built the credit union and its assets.

"Who owns a credit union's capital?" Blaine asks. "I would argue the members do." The average member stake in the equity of American credit unions is more than $800, according to a recent American Association of Credit Union Leagues report.

And in a perfect and fair world, the credit union would liquidate and give back some pro-rated share of the capital to its members. But what means would you use and how would you divide it among all those people who helped build the credit union over its lifetime? "From an economic standpoint, that would be fair," Schenk says. "But how would you reward those members who helped build the credit union and have died or left the credit union?"

In the democratic-ownership system, it is the members, as owners of the credit union, who have the right to decide on the structure and operations of their credit union based on what is in their best interests. But to make that decision, they must have full and candid disclosure--sort of like the "informed consent" that patients need to make medical decisions.

If the choice is so bad, why have some credit unions converted charters?

There are two sides to every story. Herb Moltzan is president/CEO of BUCS Federal Bank (formerly known as BUCS Federal Credit Union), Owings Mills and Columbia, Md. BUCS converted first to a mutual and then to a stockholder institution. Moltzan recently wrote a long and thoughtful letter to the editor of an industry newspaper (Credit Union Times) in which he claimed credit union people were making misleading statements about the process and motives of those who convert charters.

He claimed his customers have not suffered any loss in service and have not had to pay higher rates for loans or earned lower interest rates on savings since BUCS went for-profit. And Moltzan also said insiders don't get rich when a credit union converts to a for-profit bank. But his editorial also reported that participants in BUCS' IPO have seen a nearly 200% return on their investment in only four years.

That's a nice return if you can afford it. Sadly, not all members could afford to buy in.

Rick Schaberg, an attorney in Washington, D.C, has been handling charter conversions for more than 20 years. He recently told an audience of credit union CEOs that the board and management team of a converting credit union are eligible for a sizable segment of the initial public offering--at least 35%.

Indeed, an investment-industry newsletter, SNL Financial, reported that four credit unions that converted to banks in 2004 saw an average increase in their IPOs of nearly 23% on their first day of trading. "Individuals [investors] who were members of those credit union were handsomely rewarded," the article said. Remember--only those members who had cash to invest see these gains--not all members. One credit union saw its IPO jump nearly 70%, rewarding its well-heeled investors with thousands of dollars.

If you were to ask the management team members of a credit union seeking to convert why they wanted to do so, most would respond they want "to grow the credit union." Blaine has worked in credit unions for more than 30 years. He's never once had a member ask him to grow a credit union. Instead, Blaine has heard many times that his job is to "do what's in the best interest of the membership." Blaine also believes that well-run credit unions have a number of options available to them to grow or provide business services if their members want them.

Blaine, Schenk, and numerous others are critics of credit unions converting to a bank charter. They're true believers in the credit union cooperative concept, convinced that well-run credit unions can succeed without converting to bank charters. And they are absolutely convinced credit unions offer their members a better deal as a credit union than as a bank.

Frank Pollack, president and CEO of Pentagon Federal Credit Union, Alexandria, Va., wonders how many credit unions even would consider converting to for-profit entities if boards and management teams were prohibited from profiting from a conversion.

What's in it for you?

Why should you care that your credit union remains a credit union?

Credit unions save you a lot of money. Collectively they saved their members $6.3 billion last year. Individually, they saved every single member an average $76 annually and every member household an average of $149. If you use your credit union for most or all of your family's financial services, you likely saved even more.

How does your credit union save you money? Credit unions are member-owned, democratically controlled cooperatives that pay higher rates on savings, charge lower rates on loans, and assess fewer and lower fees. As not-for-profit cooperatives they pay no income tax. They pay taxes, yes, just not income taxes because earnings go to improve service to all members, not to line the pockets of stockholders.

To illustrate, take a look at this chart from Datatrac, a Milwaukee-based company that collects all kinds of data from financial institutions across the country. Take a look at today's report here. It's no secret credit unions, on average, are a better buy for consumers.

What should you do if your credit union's thinking of converting?

First, ask why it's necessary. Don't be tricked by some car giveaway--yes, that's been tried--to buy your support and your vote.

Second, take a long-term view. Once a credit union switches to a mutual charter, you're likely to lose some control. When it converts to a for-profit-charter, you absolutely lose control.

Third, try to find out what's in it for you. What happens to the equity in the credit union that you helped build? What happens to your local ownership and control? How will it improve the services you want?

Fourth, ask yourself: Do I want to give up my right to elect the board of directors?

Fifth, ask the board and management team: How much money will you gain personally if the credit union converts to a for-profit institution?

Sixth, ask the members of the board and management team if they will promise--in writing--not to participate in a future IPO.

Published October 25, 2005