For Three Credit Unions, Converting to Thrift Charter was About Vision

ARLINGTON, Va. – The CEOs of three credit unions turned thrifts maintain that while their institutions have grown significantly after switching their charters, they did so not for the growth but in order to better fulfill their institution’s vision for the kind of products and services they wished to offer. To date, 23 credit unions have abandoned their credit union charters in favor of state or federal mutual bank charters, according to CU Financial Services, a consulting firm that advises credit unions making the switch. In the interest of shedding some light on this controversial topic, Credit Union Times spoke with three institutions which had made the shift, to ask them why they did it and how they have found life on the other side of the bank-credit union divide. The three institutions represent three possible paths credit unions can take if they want to change their charters. Rainer Pacific, an almost $500 million dollar institution in Tacoma, Washington, opted to become a state chartered mutual thrift just over a year ago. Heritage Bank, a $296 million institution headquartered in Albany, Georgia, made in effect two switches, moving first to a federal mutual bank charter in July of 2001 and then, in January 2002, making a further switch to being a federally-chartered stock holding company. The San Diego-based, $430 million Pacific Trust Bank also asked its members to vote twice. The first time to make the shift from a credit union to mutual bank charter in January 2000 and then to a stock issuing bank in August, 2002. Although the specifics of each institution’s decision differed slightly, all three agreed that they had decided to change charters after it became clear that they could not achieve their mission goals and remain credit unions. “For us it came down to how we defined the community we wanted to serve,” said John Hall, CEO of Rainier Pacific. “Did we define our community as just consumers, or did our community include small landlords, small business people and members who want to start businesses? If we defined our community broadly we had to look at whether our charter was the best one we could have.” Hall reported that prior to the conversion, Rainier’s loan portfolio was roughly 10% in commercial real estate or business lending, over 40% in consumer loans and the balance in mortgage lending. After the conversion, Hall said, the portfolio is roughly 37% in commercial real estate and other small business lending, 30% in consumer loans and the balance in different types of mortgage lending. The shift in loan portfolio has matched a 31% increase in the its assets as well. Before the conversion, Hall reported that Rainier Pacific had assets of roughly $383 million and has since grown to almost $500 million. Lee Bettis. Heritage Bank’s CEO, agreed, noting that his institution had not felt very capital-starved before the conversion, but that the then credit union believed NCUA’s capital requirements hampered its ability to serve the people it needed to serve. “I think a credit union in the future is going to find it harder and harder to meet the needs of being a full-service community financial institution under the NCUA’s regulations,” Bettis noted. Since conversion, Heritage Bank had grown from $266 million to $305 million, Bettis reported. As a thrift institution, a bank can have a capital ratio of 5% and be considered well-capitalized, according to Alan Theriault, CEO of CU Financial Services, while a credit union needs to have a ratio of 7%. And this leaves out the even higher capital ratio requirements credit unions need to qualify for regulatory flexibility, he noted. Pacific Trust Bank’s CEO, Hans Ganz, cited field of membership concerns the credit union had which led to the conversion, as well as a desire to serve a broader segment of its community. Like Heritage and Rainier, Pacific Trust has experienced very strong growth since conversion, Ganz reported, moving from roughly $225 million before conversion to a little over $450 million now. None of the CEOs reported losing significant numbers of members in the conversion. All three acknowledged that leaving the credit union world had been a difficult decision at an emotional level, but all three added that when looked at from a business, the majority of their members had agreed they had done the best thing for the good of their institutions. “I don’t believe it was a simple process for anybody,” said Bettis. “Not for me, not for the staff,” he said. But when it came down to the voting, more than 80% of the membership that voted had approved the switch, he said. “The few members I heard from who were upset by the change were among our oldest members, including some who had been among the founding members of the institution,” he said. Heritage members had to vote again, when the bank changed its charter again to allow it to become a holding company. Under the new arrangement, Bettis is both CEO of the Heritage Financial Group, a federally-chartered stock corporation, that owns 100% of the common stock of the bank and CEO of the Heritage Mutual Holding Company, a federally-chartered Mutual Holding Company, that owns 100% of the common stock of Heritage Financial Group. The new structure is slightly complicated and not of direct interest to most members, Bettis said, but will allow Heritage to purchase other financial institutions of different types should it decide to offer other products and services in the future. Pacific Trust members also had to vote twice, the second time on the controversial move to offer public stock. Ganz noted that many people misunderstood the stock offering, which he noted had been overwhelming approved by the members. “Many people do not realize that the only people who could participate in the initial public offering of the stock were members,” he said. “And many of our members bought some, and they tell me they will not sell it, it will be something they pass on in their families.” Shares sold for $12.00 each in the initial public offering, Ganz said. It sold recently for $16.23 per share. All three of the CEOs reported that, on paper, there had been some reduction in members, but Hall and Bettis added that the apparent loss could be traced to a consolidation of accounts after conversion rather than a loss of members. “As a bank we no longer have to carry $5 share accounts,” Bettis noted, “so as these accounts are rolled into others or eliminated there would be some loss of membership on paper.” Heritage was the only institution of the three that reported having to make a data processing conversion after adopting a bank charter. The previous data processing system had not allowed the new bank to make or structure some their loans they way it wanted to, Bettis said. Pacific Trust also went through an update of its data processing system but that had not been directly related to the conversion, Ganz said. The CEOs also scoffed at the notion that the credit union officers had voted for the switch in order to enrich themselves or the institution’s management. “We use the same methods for setting salaries that we did before we converted,” Hall said. “We compare our salary structure to that of other similar sized credit unions and banks.” Theriault has pointed out that an increasingly competitive environment has meant that credit unions have found it more difficult to get qualified and motivated directors and that salary and compensation plans can help them attract the people they need. All three also downplayed the role of taxation, arguing that, as a bank, the capacity to grow more strongly was necessary in order to compensate for the tax burden. Under a credit union structure, Bettis speculated, most institutions could not meet the tax requirements they had to face as a bank. But that was because they would lack the ability to offer the range of products and services to the same populations that banks did. “Part of the reason you need the growth is to pay the tax man,” he said. The bottomline, the CEOs agreed, was that after conversion their institutions were better positioned to meet more of their members’ needs and to have more of a positive impact on their communities. All three reported that their institutions offered their members more products and services than they had been able to offer as credit unions, and that more people in their communities saw the institution as a meaningful financial resource. “I think we have successfully raised Rainier Pacific’s profile,” Hall said. “I think a broader segment of the community looks to us for help meeting their financial needs than when we were a credit union.” While many of the credit unions that initially made the conversion were driven by concerns about meeting their business vision, Theriault said that the next wave may be more concerned about gaining capital flexibility. “I don’t expect that there will be a tidal wave of conversions,” Theriault noted, “but I expect three or four of five more may start the process before the end of the year.” An aggressively managed and growing credit union will be the next logical candidate for charter conversion, he remarked. He reported that he has 300 credit unions that he is working with that are “active and growth-oriented” and whose business has meant they carry capital ratio’s of only 7%. [email protected]