BIRMINGHAM, Ala. — Will the risk-based capital rule increase the pace of credit-union-to-bank conversions?
Only time — and the final rule — will tell.
But most industry insiders and experts say it's unlikely that a significant number of credit unions will be rushing to make the switch.
Most agree that NCUA will significantly improve the final rule and that attrition, and typical reaction to any major reg, will be the reasons for CUs that do change teams in the next few years.
Industry insiders emphasize, however, that credit unions are now closely examining their business model and the viability of the CU charter.
One analyst also cautions that those CUs changing sides must be ready to tackle commercial lending effectively or potentially face failure.
"The average is less than two successful [credit-union-to-bank] conversions per year, and there has only been one announced in 2014," said Dennis Dollar, former NCUA chairman and principal at Dollar Associates. "I don't see anything, short of credit union taxation, that would turn that fairly insignificant number into a possible trend."
Michael Bell, attorney and counselor with Royal Oak, Mich.-based Howard & Howard, who has worked on a number of CU purchases of banks, does not see a wave of credit unions converting.
"We will see some switch to a bank, certainly, just like when any new, significant regulation comes out, like the MBL cap," said Bell. "But I think the credit union charter, for the great majority, makes the most sense."
Richard Garabedian, partner with the Washington firm of Luse Gorman Pomerenk & Schick, which works with banks and CUs on mergers and conversions, said he is assisting two credit unions that plan to change to a bank charter—but not because of the RBC rule.
"I don't see a trend here outside of what normally occurs over the years," said Garabedian, referring to the attempt by California-based Monterey CU to switch to a bank. "Yes, there has been talk of the risk-based capital rule pushing some credit unions to a bank charter, but I don't think that portends any wave of CU conversions."
According to Peter Duffy, what is happening inside credit union board rooms as a result of RBC are discussions that place every option on the table to protect the business and move it forward. The managing director at Sandler O'Neill, New York, said his firm has talked with more than 100 credit unions—many over $1 billion in assets—since the risk-based capital rule was proposed.
CU business decisions coming out of the final risk-based capital rule will be mixed, insisted Duffy.
"Some credit unions will reduce the value they offer members. Some will rotate their investment portfolio strategy and accept less income. Others will slow mortgage originations — and I think you could eventually see a pickup in credit-union-to-bank charter conversions, but those may take some time," offered Duffy. "I think you will see everything. CUs are modeling what it is they can do to meet this proposed rule and still be as much of themselves as possible."
Duffy reminded that in addition to RBC, credit unions face reduced fee income due to legislation, margins shrinking and first mortgages slowing.
Duffy pointed out, too, how growth through merger will be much more challenging if the final rule does not include goodwill. Many experts believe goodwill will remain excluded from capital in the final rule, since bank capital guidelines do not include it.
"This, obviously, is shining a stronger light on the need for equity capital, and credit unions know this is something that is way out on the horizon for them, with a low probability of ever happening," said Duffy. "Even if the final rule is more accommodating to the ways credit unions have been growing their businesses, that does not replace the growing desire for equity capital."
While NCUA Chairman Debbie Matz has said significant changes to the rule are coming, Duffy contends that the proposal forces some credit unions, in an effort to meet the new risk-based ratio, to move into lower-paying assets and therefore sacrifice net income and capital (see related story).
"CUs are discussing and modeling whether they can continue their investment portfolios as currently structured, market for mortgages in the same manner and continue to ramp up small business lending," said Duffy. "These are real issues."
Duffy said that is generating discussions about the ability to carry staff at existing levels, as well as low-performing branches and marketing budgets.
Garabedian believes all the feedback from credit unions — a record 2,000-plus comment letters — and Congress weighing in at what many say is a
"Yes, there has been talk of more credit unions converting to a bank charter. But with all the pushback, especially from Capitol Hill, my hunch is significant changes to the proposal are on the way."
Duffy pointed out that the proposal's risk weights are more restrictive than new bank capital guidelines, and that many CUs know they can take their balance sheets "as is," place them under the bank rules and be well capitalized.
Dollar believes NCUA is going to "substantively respond" to "legitimate" CU concerns and finalize a much more balanced risk-based capital rule.
"If they do, I think they'll take the steam out of the bank conversion consultants that are actively out there right now in credit union land claiming the sky is falling with RBC and that credit unions need to convert to become a bank under Basel before it's too late," said Dollar. "If NCUA doesn't get RBC right, yes, that could perhaps provide some impetus for some larger credit unions to re-evaluate the [conversion] question."
But Dollar is not betting that will happen.
"I think NCUA knows this is a legacy issue for the agency with great congressional interest, as well as stakeholder concern," he said. "Under their original proposal, a credit union would be better capitalized as a community bank under Basel than under the proposed NCUA RBC rule."
For the value of the credit union charter, NCUA cannot allow that to stand, asserted Dollar.
"I believe they'll make substantive changes to both the risk weights and the 10.5% excessively high threshold to be well capitalized," he said. "If they do, and I expect that they will, RBC will not — within itself — be a reason for a credit-union-to-bank conversion."
At NAFCU's annual meeting last month, Matz said that NCUA recognizes that all risk weights must be reviewed and some lowered,
Garabedian noted that NCUA's proposed rule on associational common bond requirements will
"I have a number of clients that have NCUA revisiting their associational membership groups," said Garabedian, who added that more flexibility to do mergers and acquisitions under the bank rules and no MBL cap turn CU eyes toward the bank side, as well.
Losing the tax exemption is certainly a reason against becoming a bank, but should not be one that stops the credit union that has a solid plan for growth, said Garabedian. "With clients I have worked with, if you are able to grow you can overcome the loss of the tax exemption."
Garabedian emphasized, however, that any CU converting to a bank will have to be strong and well run. "Bank regulators have toughened up the entry standards. If you are a mediocre credit union you are not likely to get a bank charter."
What is a problem, according to William Drevant, CEO of WRD Consulting in Antioch, Ill., are credit unions switching to a bank charter without the commercial lending expertise needed to compete with banks.
About 25 years ago, Drevant, as head of First Chicago's financial correspondent group, worked with a number of thrifts during a period in which many in that industry converted to banks. He said thrifts' lack of commercial lending expertise, and senior management not understanding commercial lending, led to profitability problems, internal difficulties and even failure.
Drevant warned that credit unions often don't have the commercial lending skill needed to compete with banks.
"And it is not always easy to hire the people you need because the talented commercial lending experts are only going to move for more money—and, you are going to need more than one person," he said.
Borrowers, as well, won't move their commercial loans unless they get better rates and terms, said Drevant. He warned that current low rates and money costs are heading up soon, and that FIs can't afford to offer lower, more competitive rates.
"There is a strong chance that in a few years you will lose money on the loans you make now. So if the credit union is thinking about switching to a bank charter because of lending reasons, those are poor reasons now."
The last credit union to convert to a bank was Brockton, Mass.-based HarborOne, which
"You look back on the last three to four years and you get maybe one to two conversions a year," said Garabedian, who acknowledged there are more regulatory and economic pressures now on credit unions to examine which charter is best to help them survive.
Duffy says time will tell and that there simply is a lot of discussion among CUs about a bank charter.
"I know of no credit unions that are lining up to convert to a bank," said Duffy. "I am talking to a lot of big credit unions, and no one has said, 'All right, we have to get out of here.'"
What credit unions are doing, said Duffy, "In a very deliberate and careful manner they are looking at all the things they need to do to become comfortable with the risk-based capital regime and are determining if they can live with the outcome or make other changes."
