Stock Sales Reveal The Real Story In CU Conversions

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We're doing it because we need the capital! That's the reason du jour as to why it is necessary to convert from a credit union to a mutual savings bank. At first blush, it has an air of veracity. Yeah, the credit union has failed to raise capital the old-fashioned way by earning it. We need help.

Should these credit union management officials and directors be rewarded for their failure? Shouldn't someone ask, Why couldn't you increase capital (undivided earnings) to avoid concerns of Prompt Corrective Action? If the reason is growth outstripping earnings, shouldn't management do a better job of managing growth? If the reason is excessive losses and/or underperforming assets, shouldn't we ask management where they were when all this was going on?

No! Let's reward these folks! Let's give them rights to buy stock and take advantage of those undivided earnings sitting on the table (and as a consequence of such have the price of the stock explode upward on its initial trading day). Let's give the management employee stock ownership and stock option plans.

Oh, and those credit union members whose devotion to the credit union has built up those undivided earnings? Well they really have no rights to those undivided earnings, and by the way, they can buy stock in the savings bank just like directors and employees. Sure they can! All those members have a borrowing source in the wings waiting to lend them money to fully subscribe to all the stock they can purchase. Sure they do!

The capital, the capital, we're doing it because we need THE CAPITAL! OK, let's take a closer look at the lady and see if she doth protest too much.

A relatively recent conversion serves as a good example. The credit union claimed that its regulatory demands for increased capital necessitated the conversion to a bank. Before the stock issuance the credit union converted to a mutual savings bank, which, at the time of the stock issuance had assets of about $530 million and equity (undivided earnings) of about $43 million. Approximately eight-million shares were sold and, after expenses, approximately $77.5 million of proceeds was collected.

Within less than 18 months from the initial stock offering (the first repurchase was about nine months after the offering), the newly converted bank repurchased about 18% of the stock it previously sold at an average price of 70% above what it received at issuance (helping to support the increased stock price for those directors and officials that purchased stock at the offering price). In dollar terms, the bank repurchased the stock using 33% of the capital it raised (but it only received 18% of its stock back). What's wrong with this picture?

Before a mutual savings bank can convert to a stock institution, it must prepare a business plan to be approved by the regulator that sets forth, among other things, the use of the proceeds from the sale of stock.

Did things change so drastically in this short period of time? Was the business plan flawed? If the business plan was flawed, what does that say about management?

Perhaps there's another reason. If less stock were initially sold, say five-million shares, the proceeds would be $50 million (this is about the amount of proceeds remaining after the repurchases).

However, with the $43 million of undivided earnings on the table, the immediate increase in the price of the stock on its first day of sale (and thereafter) would be significantly greater and may have raised some eyebrows as to what was going on.

Needless to say, the directors and officials of this converted credit union, as has been previously reported in this publication, have reaped millions of dollars in stock benefits.

Me thinks, the lady doth protest too much! What do you think?

Steve Bisker is a Washington-based attorney specializing in credit unions. Mr. Bisker is also authoring a column in The Credit Union Journal responding to reader questions on legal matters. For info: bisker erols.com.

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