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The Charter Choice: Credit Union vs. Bank

The Charter Choice: Credit Union vs. Bank. CUES Directors Conference December 8, 2009. Presented By: Richard S. Garabedian, Esq. Kent M. Krudys, Esq. Luse Gorman Pomerenk & Schick, PC 5335 Wisconsin Avenue, NW, Suite 780 Washington, DC 20015 Phone: (202) 274-2000 Fax: (202) 362-2902

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The Charter Choice: Credit Union vs. Bank

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  1. The Charter Choice:Credit Union vs. Bank CUES Directors Conference December 8, 2009 Presented By: Richard S. Garabedian, Esq. Kent M. Krudys, Esq. Luse Gorman Pomerenk & Schick, PC 5335 Wisconsin Avenue, NW, Suite 780 Washington, DC 20015 Phone: (202) 274-2000 Fax: (202) 362-2902 www.luselaw.com

  2. 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. 1

  3. 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 Charter Conversions Completed By Luse Gorman Pomerenk & Schick 2

  4. 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. 3

  5. 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 4

  6. 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 5

  7. 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” 6

  8. 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. 7

  9. B A Mutual Bank Credit Union (35) Federally Chartered State Chartered - State - OTS - FDIC or FRB Benefits: Increased lending authority Lower capital requirements Ability to access capital in the future Broader customer base

  10. 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 9

  11. 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 10

  12. (17) Mutual Bank (600) Stock Bank Federally Chartered State Chartered Savings Bank Commercial Bank Savings Bank Mostly small closely-held community banks (7,000) Mega Bank - BOA - Citi

  13. Regulatory Comparisons 12

  14. 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 Mutual Bank Charter Overview 13

  15. 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 14

  16. 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 15

  17. 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 plus10% for small business • Auto/equipment leasing 10% of assets 16

  18. 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 17

  19. 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 18

  20. 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 19

  21. 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. 20

  22. 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%) 21

  23. 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 22

  24. 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 23

  25. 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 24

  26. 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 25

  27. Structural Considerations 26

  28. Alternative Corporate Structures 27

  29. Form of Ownership Mutual Form of Ownership Members • Advantages: • No pressure from stockholders • Increased lending authority • Increased customer base • Lower capital requirements Directors Mutual Bank 28

  30. Form of Ownership “Private” Mutual Holding Company Members • 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) Directors Mutual Holding Company 100 % Subsidiary Holding Company 100 % Bank 29

  31. Form of Ownership “Public” Mutual Holding Company Members • 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 Directors Mutual Holding Company • Public Stockholders: • Members • Employees • Management/directors • Community • Others 55 % 45% Subsidiary Holding Company 100 % • Disadvantages: • Public stockholders Bank 30

  32. Form of Ownership Fully Stock Bank Public Stockholders - Depositors - Employees - Management/Directors - Community - Others • Advantages: • Maximize capital raised • Disadvantages: • Potential loss of control 100% Holding Company 100% Bank 31

  33. 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 32

  34. 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 33

  35. What Lies Ahead 34

  36. 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 35

  37. Dispelling Myths • FDIC is not granting federal deposit insurance • Bank regulators not accepting new charters • Conversions not possible due to recapitalization of NCUSIF 36

  38. 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 37

  39. 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 38

  40. 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 39

  41. 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 40

  42. 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 41

  43. 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 42

  44. 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 43

  45. 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 44

  46. LUSE GORMAN POMERENK & SCHICK A PROFESSIONAL CORPORATION ATTORNEYS AT LAW 5335 Wisconsin Avenue, N.W., Suite 780 Washington, D.C. 20015 TELEPHONE (202) 274-2000 FACSIMILE (202) 362-2902 www.luselaw.com 45

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