The Charter Choice:Credit Union vs. Bank

Presented By:

Richard S. Garabedian, Esq.Kent M. Krudys, Esq.Luse Gorman Pomerenk & Schick, PC5335 Wisconsin Avenue, NW, Suite 780Washington, DC 20015Phone: (202) 274-2000 Fax: (202) 362-2902www.luselaw.com

CUES Directors Conference

December 8, 2009

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.

3

Charter Conversions Completed By Luse Gorman Pomerenk & Schick

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

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.

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

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

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”

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.

Credit Union

Credit Union Mutual BankMutual Bank

State Chartered

State Chartered

Federally CharteredFederally Chartered

- State - OTS

- FDIC or FRB

Benefits: Increased lending authority

Lower capital requirements

Ability to access capital in the future

Broader customer base

A B

(35)

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

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

Mutual Bank(600)

Mutual Bank(600) Stock BankStock Bank

State Chartered

State Chartered

FederallyChartered

FederallyChartered

Savings BankSavings Bank Commercial BankCommercial Bank Savings Bank

Savings Bank

Mostly small closely-held community

banks (7,000)

Mostly small closely-held community

banks (7,000)

Mega Bank

- BOA- Citi

Mega Bank

- BOA- Citi

(17)

13

Regulatory Comparisons

14

Mutual Bank Charter Overview 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

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

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

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 plus

10% for small business

Auto/equipment leasing 10% of assets

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

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

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

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.

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%)

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

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

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

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

27

Structural Considerations

28

Alternative Corporate Structures

2. MutualHolding

CompanyNo Public

Stock

2. MutualHolding

CompanyNo Public

Stock

4. StockHolding

Company100% Public Stock

4. StockHolding

Company100% Public Stock

3. MutualHolding

Company<50% Public

Stock

3. MutualHolding

Company<50% Public

Stock

1. MutualForm of

Ownership

1. MutualForm of

Ownership

StructureOptions

StructureOptions

29

Form of Ownership

Mutual Form of Ownership

Members

Directors

Mutual Bank

Advantages:

• No pressure from stockholders

• Increased lending authority

• Increased customer base

• Lower capital requirements

30

Form of Ownership“Private” Mutual Holding Company

Members

Directors

Mutual Holding Company

SubsidiaryHolding Company

Bank

100 %

100 %

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)

31

Form of Ownership

“Public” Mutual Holding Company

Members

Directors

Mutual Holding Company

SubsidiaryHolding Company

Bank

Public Stockholders:- Members

- Employees- Management/directors

- Community- Others

45%55 %

100 %

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

Disadvantages:

• Public stockholders

32

Form of OwnershipFully Stock Bank

Public Stockholders- Depositors- Employees

- Management/Directors- Community

- Others

Bank

100%

100%

Advantages:

• Maximize capital raised

Disadvantages:

• Potential loss of control Holding Company

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

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

35

What Lies Ahead

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

37

Dispelling Myths

FDIC is not granting federal deposit insurance

Bank regulators not accepting new charters

Conversions not possible due to recapitalization of NCUSIF

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

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

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

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

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

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

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

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

46

LUSE GORMAN POMERENK & SCHICK

A PROFESSIONAL CORPORATIONATTORNEYS AT LAW

5335 Wisconsin Avenue, N.W., Suite 780Washington, D.C. 20015

TELEPHONE (202) 274-2000FACSIMILE (202) 362-2902

www.luselaw.com