This article originally appeared in the February 2006 Callahan Report.
The leadership of another large credit union DFCU Financial ($1.8B in Dearborn, MI) is attempting to convert away from its credit union charter. Although many in our industry passionately oppose such a conversion on moral grounds, we oppose it because a strong business case can be made that the credit union charter is the charter of choice.
Credit unions serve three constituencies: members, the institution itself, and employees. Members are the focus of a credit union. For a conversion to make sense, all members must be able to enjoy material long-term gains in service or pricing. This must occur at the same time the institution improves its financial position. If both these conditions exist, the employees would also benefit over the long haul.
Additionally, in considering a conversion, the board of directors must take into account a fourth constituency: stockholders. This group would bring capital stock to the institution and expect to be rewarded for doing so.
Examining the Financials
It’s illusory to believe that an institution can be taxed and add a fourth stakeholder for free. A margin analysis of well-run banks such as Wells Fargo, Bank of America and USAA clearly shows that earnings must increase if all of the constituencies are to be satisfied. The cost of taxation for all of these banks is roughly 80 basis points in pre-tax earnings. That money, plus the return to the new stockholders, must come from increased loan rates, decreased deposit rates, higher non-interest income (fees), or some combination of the whole.
Equally important is that in a stock model the stockholders receive the highest prioritization in terms of value creation. This transference of rights makes it incumbent upon the Board of a credit union considering conversion to show in financial terms what members would gain for giving up their member-focused charter.
We believe that members need to know in financial terms what their long-term benefit would be as a result of a charter change. This means that the boards of directors quantify the value proposition they are presently providing relative to what would be provided under the taxed entity. Full transparency demands this level of full disclosure.
We’ve Looked and There’s No Better Model
Pentagon Federal Credit Union ($8B in Alexandira, VA) delivers consistently better rates and fees in the tax-free model than our banking competitors can deliver. It is not that we are better managed. It is that there is no free lunch. In our discussions with Wall Street we have yet to be shown a long-term business model that returns more to the member than the credit union charter.
It is incumbent upon us as an industry to define in concrete financial terms our value proposition to the members. In doing so we will, in part, answer the question posed by the Congressional House Ways and Means Committee. And we will also have the opportunity to place a higher standard of disclosure and transparency on the management and boards of directors that are considering converting their charter.
We do not believe that the comparison numbers revealed by a higher standard would find favor among members of credit unions choosing to convert.
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