No one would argue that failure to achieve a business plan brings
with it all sorts of problems. But success - in the form
of faster growth - carries its share of problems, too.
One of the biggest problems facing successful credit unions is
a chronic shortage of capital. A 2002 survey of NAFCU members concluded
that an astounding 42% expect to need capital soon in order to maintain
growth, to meet Prompt Corrective Action (PCA) requirements, or
other reasons. Exacerbating the problem is the 7% core capital ratio
CUs must maintain, compared to 5% for banks. CUs also take a 'capital
haircut' because of concentrations in real estate loans, business
loans, and certain investments. And they have no access to the capital
markets without converting to a bank charter.
The Trend to Mutual Holding Companies
Far from the inevitable stock conversions being decried by the likes
of the NCUA, the facts are these: Of the 29 conversions done (or
in the pipeline), only seven have raised capital by moving - sooner
or later -- to full stock through an IPO. Six merged with other
'like-minded' mutuals. Another eight have formed, or are in the
process of forming, a mutual holding company.
Mutual banks can raise capital in a number of ways. One obvious
way is a public offering of shares, to which the former credit union's
members have first right of refusal up to a certain limit. But because
not all members will choose to participate, or participate to the
same degree, the ownership composition of the institution will be
What may make more sense for some credit unions contemplating a
charter change is the mutual holding company (MHC). Under
this option, the members' ownership rights in the credit union are
converted to ownership rights in a non-stock holding company.
The MHC, in turn, will own the shares of a bank holding company,
which can sell stock to members of the institution and the community
up to 49% of the capitalization. It is this stock-based holding
company that would own the stock-based operating thrift, plus any
number of subsidiaries for mortgage lending, insurance, securities
or other businesses permitted and fitting the institution's objectives.
In the same way a credit union owns a CUSO, which is stock-based,
the co-operative operating philosophy is filtered downward. Control
Without selling any stock, the MHC can raise capital in other ways.
It can arrange a commercial loan at the stock holding company level
or organize a non-voting trust to offer shares to institutional
investors. The proceeds are pushed downstream to create core capital
in the subsidiary bank and for the support of its operating companies.
Keeping the voting rights at the top level -- still in the hands
of the original members -- allows the institution to retain its
co-operative philosophy, community focus, management team, directors
"It's really the best of both worlds," claims Alan Theriault,
president of CU Financial Services, a credit union consulting firm
specializing in charter conversions. "The mutual holding company
is depositor-owned and non-stock, allowing the members to keep control.
Two levels down, management can raise all the capital it needs to
pursue its business strategy and opportunities, without the same
burden faced by managers of public companies in answering to stockholders.
Stock-based compensation programs transition this hybrid into a
member and employee-owned cooperative, thus capitalizing on superior
consumer attitudes toward both of these co-operative business structures."
In conclusion, expansion-minded credit unions exploring a charter
conversion have four primary options: community credit union; mutual
savings bank; stock-based bank; and mutual holding company.
The community charter addresses the field of membership problem.
But it still leaves the CU stuck with severe limits on its powers
and forced to build capital at a snail's pace.
The mutual savings bank option lifts the limits on activities such
as real estate and commercial lending. But building core capital
is mostly limited to increasing retained earnings and other capital
strategies efficient for large institutions only.
Converting to a publicly traded, stock-based institution offers
broad powers for product diversification and opens the doors wide
to capital. But it strays from co-operative roots, and some critics
feel that demutualization amounts to disenfranchisement of some
On the other hand, moving to a mutual holding company - a hybrid
structure that combines co-operative ownership with capital-raising
powers -- is a neat balancing act. You can serve your members and
build the strength to serve the community at large. Mergers and
acquisitions are also facilitated.
This scenario held true for HeritageBank of the South, a $340 million-asset
bank that started life as AGE Credit Union of Albany, GA. After
a successful conversion in 2001, the new bank's growth blossomed,
particularly in mortgage lending and commercial banking. In 2002,
it reorganized under the mutual holding company structure.
Len Dorminey is president and CEO of Heritage Financial Group,
a stock holding company (owned by a non-stock MHC) that owns 100%
of the stock of the bank. A strategy of measured, well-grounded
growth has given Heritage a strong foundation for future expansion
in people, systems and infrastructure. Len explains: "We've
built tried and true best practices and we know they work. We have
a lot of expertise we can replicate and share, if others want to
With 9% capital, and access to more, Heritage Financial is well-equipped
to explore mergers with credit unions attracted by the possibilities
of a mutual bank charter. And this course of action is a bold new
alternative to the typical CU-to-CU merger. On top of their operating
efficiencies and deep talent pool, progressive mutuals like Heritage
allow the merging entity to retain its board of directors, corporate
identity and co-operative philosophy.
Across the credit union system today, there is an abundance of
news and comment about conversions past, present and future. Unfortunately,
there is much misinformation, some of it politically motivated.
For any credit union contemplating a conversion to mutual savings
bank status, which I believe is one of the most revolutionary and
exciting opportunities ever made available to CUs for achieving
successful growth, it pays to deal with experienced professional
advisors. If you think you'll need regulatory capital in the next
few years, call CU Financial Services at 800-649-2741 today.
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