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Conversion Conversation

With all the privileges credit unions supposedly have, it would seem unlikely that many would want to become thrifts.

So why are several experts on charter conversions predicting a wave of them?

"Two words: insurance fund," says Robert Freedman, an attorney with Silver, Freedman & Taff in Washington.

His firm is advising Har-Co Maryland Federal Credit Union, which announced plans this spring to pursue a thrift charter. And Freedman believes several other credit unions may follow suit this year.

This would certainly mark a dramatic change. Not a single credit union converted last year, and only one did in each of the preceding two years.

But credit unions have a unique set of challenges lately.

The National Credit Union Share Insurance Fund has come under severe pressure following the collapse of major corporate credit unions during the financial crisis. As with the Deposit Insurance Fund that protects bank deposits, any shortfall must be made up through an assessment on the industry.

However, unlike the Federal Deposit Insurance Corp., which shut down scores of insolvent banks and projected the cost up front, credit union regulators chose not to absorb the financial hit as quickly.

The National Credit Union Association put many insolvent institutions into conservatorship, without recognizing the loss on bad securities. This has led to confusion about the ultimate impact on surviving credit unions, which will have to rebuild the fund once losses are recognized.

Alan Theriault, a consultant who advises credit unions on conversions, has been expecting a glut of them since the trouble with the corporates first arose. "It surprises me that there haven't been more conversions," he says.

There are considerable hurdles to converting-including getting approval from the credit union's members and securing deposit insurance from what has been a highly reticent FDIC. Two credit unions that tried to convert in recent years withdrew their applications to do so after failing to get FDIC approval. One, Beehive Credit Union in Salt Lake City, had been financially troubled and later failed. But the other, First Priority Credit Union in Boston, is healthy, says Theriault.

He believes many are waiting to see a success story-and watching Har-Co closely to see how it fares-before attempting such a move themselves. "Everybody wants the other guy to go first," says Theriault, the president of CU Financial Services in Portland, Maine.

Conversions do tend to come in bursts, according to the Credit Union National Association. There were five conversions in 1998, and eight in 2001.

Many think the timing is right for another burst-and potentially a much bigger one.

The corporate credit unions are, in effect, service providers to the retail credit unions, offering short- and long-term funding, among other things.

Losses from the failed corporates are sequestered in the Temporary Corporate Credit Union Fund, which has been set up to spread the cost over several years. But the NCUA is exploring various methods of funding those losses through assessments on the corporates' member institutions.

"The corporates alone went under holding $50 billion in bad securities, which could turn into $15 billion to $30 billion in losses to the fund," says Freedman. "Now an industry with a net worth of $80 billion may have to rebuild that fund. A lot of people are looking at it and saying, 'This is a hell of a problem, and I have to pay for it.'"

This comes on top of assessments that already are much higher than those faced by banks. Last year credit unions paid 35 basis points on their insured deposits, while banks paid 9 basis points or less.

Banks have spent decades locked in battle with credit unions, trying to prevent them from loosening regulations, expanding their service areas and otherwise becoming more competitive.

The most frequent complaint is of the level-playing-field variety: bankers insist that credit unions' tax-exempt status is an unfair advantage.

But Freedman says the discrepancy in insurance assessments alone is almost enough to justify a change in charter for credit unions.

In addition, credit unions must hold 40 percent more capital than a bank of comparable size, which, like the extra expense of deposit insurance, financially offsets the benefit of not paying taxes, according to Theriault. "If you factor in the higher capital requirements and the higher deposit insurance costs, your tax advantage has gone away," Theriault says.

The possibility of even higher insurance assessments isn't the only specter haunting the credit union industry, says Peter Duffy, a managing director at Sandler O'Neill & Partners in New York.

He says that while bankers tend to focus on credit unions' advantages, there are quite a few regulatory restrictions on credit unions that, while not necessarily major impediments in the past, have become more so in recent years. Chief among these is their statutory inability to raise capital in the markets. If a credit union wants-or needs-to grow, it must do so through retained earnings.