The Evolution in Chartering

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BIRMINGHAM, Ala.-Community chartered credit unions have been the primary driver of the industry's growth since since HR 1151 removed legal obstacles to community charters for federally insured credit unions.

But not all CU leaders interviewed for this special report on chartering agree that this is entirely a good thing for members, yet given the realities of the U.S. economy, it's hard to argue that the industry can thrive without community charters.

In the decade following HR 1151, 1999 to 2008, community chartered credit unions grew from 997 to 1,967, while the total number of credit unions dropped 26%, due in part to mergers of SEG-based CUs with larger community CUs. During that same period, assets increased 98% for all credit unions, fueled mainly by a six-fold increase in community CU assets.

Conversions to community charters have leveled off since the recession began in 2008, and community CUs now comprise 28% of all CUs, with 38% of all CU members and 36% of the industry's assets, according to NCUA statistics. The pace of conversions will increase again soon, says former NCUA Chairman Dennis Dollar of Dollar Associates, Birmingham, Ala.

Part of Dollar's consulting work since leaving the NCUA, where he oversaw expansion via community charter, has been guiding CUs through the community charter application process. In late May, he said, inquiries from credit unions about community charters increased significantly for the first time since the economic downturn, although not to the level he was seeing in 2005 and 2006.

NCUA Makes It Easier

In June 2010, the NCUA issued amendments to its community charter policies to streamline the application process.

The biggest change for most FCUs seeking a community charter is that they no longer need to expend the effort and resources they once did to define the community they wish to serve, Dollar said. The amendments include using "objective and quantifiable criteria" to determine the existence of a local community, according to the NCUA's published rule.

For example, the NCUA now uses the U.S. Office of Management and Budget's definition of a Metropolitan Statistical Area (MSA) to define most urban FOMs for a federal community charter. An MSA is basically an urban hub of at least 50,000 residents and the outlying counties tied to the hub by commuting patterns. Rural FOMs now have similarly narrow parameters.

The NCUA's amendment does allow FCUs to apply for community charter fields of membership that had already existed, whether or not the FOMs would be granted under the new rules.

Dollar said the rules are more restrictive, but should speed the community charter process. The NCUA used to spend most of the application process evaluating whether the CU's chosen community was legitimate FOM, he added, and now it focuses on whether the business and marketing plan will serve all of the proposed field.

"It's gone from a six-inch-thick application-of which four inches is the community documentation-to a three-inch-thick application, almost all of which is the business and marketing plan," said Dollar.

A Different Animal

A marketing plan to serve a community is a different animal for credit unions built on their relationships with employers. Rather than abandoning these relationships and focusing solely on mass-media advertising, however, credit unions should use the SEG relationships as tentacles to reach into the larger community, Dollar suggested.

"Most decisions consumers make about financial services are not a result of the media, they're made as the result of a relationship," he said. "You can still work with the same people at SEGs that you did before: HR people, management, etc. Because those existing members are your best entre to their neighbors who always wanted to belong to the CU."

In addition to a new marketing approach, some long-time SEG-based CUs have difficulty adjusting their internal culture to a more competitive marketplace, Dollar said.

"We've come a long way in the last 10 years, but we're still in the early stages of defining ourselves as community based financial institutions," Dollar said. "I don't think you'll be able to find many credit unions willing to give up their community charter today." At the same time, he noted, few leaders of community CUs believe they've maximized their community charter. "That takes time, and investment, and patience," he said.

Dollar acknowledges that progress in improving penetration within a community usually requires more capital than the various SEG models require. And maintaining a healthy capital-to-asset ratio continues to be a huge challenge, given NCUA assessments for the failed corporate CUs, recent and upcoming regulations that restrict non-interest income, and the troubled economy's prolonged effect on lending.

A Vital Sign

While the foreboding economic climate has dampened the pace of community charter conversions-and the growth of CUs that have converted-these conditions are exactly what makes community CUs more vital to the financial services industry, said CUNA board member Robert Cashman, CEO of the $812-million Metro FCU in Chelsea, Mass.

Cashman joined CUNA's Community Credit Union Committee in 2011.

"Many of the national banks and international banks have such a poor reputation now, and some were major players in creating the ill effects on the economy," he said. "So credit unions are really leading the way in terms of financial literacy, financial education, better service, better products, and it's really community credit unions that allow us to reach out into the community and do that."

Cashman has extensive experience with the community CU model. Massachusetts' regulations allow state-chartered CUs to be a hybrid of community and SEG-based institutions.

Metro, where Cashman has worked for 28 years and has been CEO since 1998, has been a community CU since it was established in 1926. It also has more than 1,800 SEGs. Cashman noted that community charters have been a lifeline for CUs that don't have Metro's wide-open charter, such as single-sponsor CUs in declining industries.

Mid-Hudson Valley FCU is a good example of a community CU that began with one sponsor, IBM's Kingston, N.Y., plant. The plant closed in 1995.

"For many IBM employees, this was supposed to be a job for life," said CEO Bill Spearman. "That's how they understood it and that's how it had been historically. And, unfortunately, many of them lived life that way. So when the paychecks stopped, they brought us keys to both their house and their car."

Mid-Hudson Valley applied to the NCUA's Region 1 office for a community charter in 1995, but withdrew the application. The CU was not allowed to sign up SEGs during the application process, Spearman explained, and it appeared that the process would take too long for the CU to be able to survive without finding new avenues of growth.

A Crowded Marketplace

Mid-Hudson Valley began to acquire SEGs, but had to move beyond its home county of Ulster to do so, for the most part. Smaller, local CUs were already serving most of the available SEGs. The area has always had a dense concentration of financial services institutions-Spearman estimates there are still 28 of them in the CU's hometown of Kingston, alone.

Finding SEGs farther south in Westchester and Putnam counties, and even into New York City, worked for Mid-Hudson Valley for a time, Spearman said. But he did not see the strategy working for the long haul.

"It never really felt right for us," he said. "There weren't the kind of boundaries that made it feasible to build a branch network that would conceivably serve members of these different SEGs."

The CU tried again in 2001 to get a community charter, requesting a three-county FOM. The largest CU based in that area, Hudson Valley FCU, applied for the same FOM at about the same time. Both were turned down on 2-1 votes by the NCUA board, with then board member Dennis Dollar the lone affirmative vote.

Other area CUs opposed the multi-county FOMs and formed the group "Twelve Concerned Credit Unions" to lobby the NCUA against creating such large-scale competition among CUs. But as the NCUA board turned over and Dollar became chairman, the political winds were right in 2002 for Mid-Hudson Valley's third attempt at a community charter.

This time, the CU was granted a community charter in Ulster, Orange, and Duchess counties. Others CUs were granted the same FOM in 2002 and 2003, including the now $169-million TEG FCU, the $231-million Hudson Heritage FCU, and the $3.1-billion Hudson Valley FCU.

The Path To Expansion

Mid-Hudson Valley has expanded from two branch offices to 11 since becoming a community CU. In the process, it has grown from about $400 million in assets to $711 million since gaining its community charter. Spearman said Mid-Hudson Valley still isn't a household name in Duchess and Orange counties, but the credit union is steadily strengthening its brand through community service activities.

Without the advertising budget of Hudson Valley FCU, Spearman said sponsoring local events, volunteerism, and other community activities have proved the most effective way to build membership.

As Orange County appears to have the most opportunity for growth, Spearman said he may create a new executive position to oversee that county. It would be an Orange County resident who's well-known and involved in the community.

Meanwhile, Spearman isn't currently planning any new, large branch offices.

Mid-Hudson Valley's FOM would not qualify today for a federal community charter. The Hudson Valley counties lack one central hub with outlying communities clearly tied to it. Instead, it has many mid-size cities surrounded by bedroom communities that feed into several of these cities.

On The Wrong Side of Rule

The Hudson Valley is one of many FOMs that could only be granted under the NCUA's 2010 amendment because a CU has already established it as an FOM. Caught on the wrong side of the rule change was Vantage CU, based in suburban St. Louis. Vantage applied to convert from a state to a federal charter with an interstate FOM.

After a contentious two-year process, the NCUA denied the application in September 2010. Vantage had applied under the pre-amendment rules that allowed a CU to document its proposed FOM as a "well-defined local community (WDLC)," and the NCUA board had already shifted toward a more strict interpretation of WDLC, said Hubert Hoosman, Vantage CEO.

Vantage had been a multi-SEG CU, and became hybrid when Missouri and then Illinois granted it community CU status to serve specific counties. The two Illinois counties, St. Clair and Madison, create a more connected community with the Missouri counties across the Mississippi River than many federally approved FOMs within Missouri, Hoosman contended. But rather than drop the Illinois counties and re-apply for a federal charter, Hoosman said the CU is moving forward with its two state charters.

Hoosman started as a teller and loan officer trainee 29 years ago at what was then Educational Employees CU. Since taking the reins as CEO in 1997, Hoosman has continued to add SEGs, counties, and underserved zip codes to the CU's FOM. The CU has gained significant market share via mergers, he said. In the process, the CU outgrew its name and changed it to Vantage CU in 2002.

"We were becoming less educational and more community based," Hoosman said. "We had to become a community credit union to grow. Our board saw where our growth was coming from and they didn't have a problem (with a community charter)."

'T' Is For Two From Tennessee

Many credit unions that serve entire communities do have a community charter. Orion FCU in Memphis, Tenn., which just recently changed its name from Memphis Area Teachers CU, decided to change its SEG-specific name to coincide with its conversion from a state to a federal charter, said Tara Smith, vice president of retail.

The credit union didn't seek a community charter at the time, in part because it already has so many overlapping SEGs and underserved zip code charters that it covers almost every part of the greater Memphis area, Smith said. Instead, call it a virtual community charter. Orion FCU has become the largest in western Tennessee with $530 million in assets.

Smith said the switch to a federal charter may help Orion add SEGs or communities eventually. For now, Orion's branding campaign is focused on using its new name to change perceptions about who may join.

"When you have something that exclusive ("Teachers") in your name, many people will think they have to be teachers to become members, because many credit unions still do have limited FOMs," Smith said.

Orion's board may consider converting to a community charter in the future, she added, "But we want to go through our branding campaign first and continue to make a difference in the community to help establish the Orion name."

Across the state in east Tennessee, UTFCU is also rebranding itself, but chose to retain its name's connection to its original sponsor, the University of Tennessee. The "UT" identity is simply too strong and positive to replace in the Knoxville area, said CEO Debbie Jones. In contrast to Orion, UT needed a community charter to grow, Jones said.

Eastern Tennessee is home to several large, community chartered CUs that have been aggressively expanding their branch networks in the Knoxville area. For example, three Oak Ridge-based CUs share UTFCU's five counties, and then some, and all have more than UTFCU's $248 million in assets: ORNL FCU (12 counties; $1.3 billion in assets), Y-12 FCU (seven counties; $575 million), and Enrichment FCU (eight counties; $328 million).

Jones, a CPA who had been UTFCU's CFO and had audited CUs as part of an accounting firm, found in analyzing her credit union's market in 2006 that UTFCU was the largest, non-community-chartered CU in the area. She concluded that market share would continue to slip as the community CUs expanded their branch networks.

UTFCU was granted a community charter in December 2007-not an auspicious time to begin building new branches, as it turned out. The CU has built three of its planned five new branches so far.

The expense of adding branches in a dire economy strained UTFCU's capital, and the last two branches are on hold for now, said Jones. She adds that UTFCU did not lay off staff or cut its generous benefit plan and merit pay increases during this period.

Instead, the credit union analyzed its transaction flows to determine where employees could be reassigned as needed to create more efficiency, among other cost-saving measures.

The Cost of Being Community

Maintaining adequate capital is generally more difficult for community CUs. According to a 2010 CUNA white paper, "Best Practices in Credit Union Efficiency," from 2004 to 2008 community credit unions spent almost 50% more on a relative basis than non-community credit unions to attract/retain members.

During that period, the average operating expense-to-assts ratio for community CUs was 3.68%, compared with 3.14% for non-community CUs. (The report didn't include these statistics for 2009 or 2010 because NCUA assessments skewed the results.)

Jones acknowledges that a community CU's branches may not achieve the efficiency of non-community CU or banks, and further noted credit unions are also less likely to close branches and lay off employees, because they are committed to personal service, she said.

"We haven't seen (branch) closings yet, but I think it is going to happen to some credit unions, because each one now has to look at profitability in a different light-from a business standpoint, not from an emotional standpoint," Jones said. "Going into a branch, I think you always need an exit strategy, and I don't think credit unions have ever thought about that," she said.

Jones isn't convinced that community charters and aggressive branch expansion is the best thing for the industry or for members. But she is convinced that UTFCU had no choice but to convert and compete.

"Life's not fair," she said. "Credit unions have to be thinking differently now-it's never going to be the same again. So, we've invested in the future. We're entrenched."

Community chartered credit unions competing with one another is necessary for the industry to grow, said Joe Melbourne, CEO of CFE FCU, Lake Mary, Fla. "Even though you're competing with other credit unions and other financial institutions in your area, I think the community charter is healthy, because it keeps everybody sharp. If you don't grow, you don't survive," he said.

CFE FCU had already achieved significant growth as a multi-SEG CU, increasing from $200 million in assets when Melbourne joined the CU in 1993 to more than $1 billion when it converted to a community charter in 2006.

Controlled Growth

CFE is now $1.2 billion in assets with a capital ratio that has stayed between 11% and 12% throughout the recession and its aftermath.

Controlled growth has been Melbourne's mantra. CFE's community charter includes four counties surrounding the Orlando hub. The credit union maintained 10 branches before converting, and has added six more in its five years as a community CU.

"It costs more for us to operate those additional branches, but we're more convenient for our membership today. No, we're never going to be as convenient as Bank of America or Sun Trust Bank, so our niche has to be service," said Melbourne. "Why else would somebody drive past 20 branches to deal with you? Either you have great service, lower rates, or something else."

Melbourne cited the personal service CFE FCU provided for members who have struggled to avoid foreclosures on mortgage and consumer loans since 2008. CFE's staff reached out to 1,700 members to work out flexible repayment terms rather than foreclose.

Expanding just to expand and make more money is not the credit union way, Melbourne said. Instead, he said, a credit union's purpose in expanding is to stay economically viable enough to provide better service and financial education.

Melbourne counsels credit unions considering a community charter conversion not to expect new members to flock to their doors. A series of recent focus groups sponsored by CFE showed that consumers tend to stay with large banks even when they're unhappy with the experience.

"The end results for growth are probably going to be less than you thought they'd be (after converting to a community charter)," Melbourne said. "It takes a certain amount of inertia to move people away from their current financial institution. It takes time."

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