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ARLINGTON, Va. – The credit union industry is just now starting to see how pro-conversion consultants and even greed can drive credit unions to give up their cooperative structure, but it’s been happening to cooperatives and mutuals in other industries for years. Thrifts and mutual savings banks, mutually organized insurance companies and utility cooperatives have all seen members convert to stock ownership during the 1980s and 1990s and continuing today. In each of those industries, experts said, consultants lured the leadership of the mutuals or cooperatives by pointing out they could make large sums of money in the switch. “It really was a no-brainer,” said Bert Ely, a well-known bank analyst who has been regarded as an expert on mutual savings banks and their conversion to stock ownership. “You had all this money sitting there without anyone’s name on it.” Ely, who is firmly on the pro-conversion side of the debate, would not call greed the primary motivating factor behind the conversions but said it came in a close second. Capital needs on the parts of the mutual thrifts, particularly as a byproduct of the previous thrift and savings and loans crises, played the major role, Ely said, as did the opportunities retained earnings offered. Pro-conversion consultants are still driving a lot of the conversions, he said. According to his figures, based on call report data, there were 676 mutually organized thrifts in the U.S. as of the end of September 2003, and SNL Financial, a Charlottesville-based firm that advises investors on conversions, reported that 142 thrifts have converted to stock issuing banks in the last five years. Ely would not forecast how many more thrifts or credit unions might convert in the future, but he predicted that the mutual or cooperative approach to organizing capital was likely to fade. He argued that capital organized along mutual lines, without anyone specifically owning it or a portion of it, was often not managed as effectively as capital owned as stock. “Capital in stock issuing banks is used more efficiently because, if it is used inefficiently, there is always the fear of take-over or mergers,” Ely explained. “There is a market discipline to capital use in a stock situation which isn’t present in a mutual organization.” That relative inefficiency, Ely argued, would be what made the mutual approach to organizing capital less successful in the years ahead. There is a Reason Coops Exist But Paul Hazen, CEO of the National Cooperative Business Association countered that Ely and others missed the point of credit unions and other mutually organized cooperative organizations. “His argument makes sense if you are a capitalist and what you are really interested in is how capital can be organized most efficiently,” Hazen said. “But mutual and cooperative firms are organized by consumers who have figured out this type of organization is the best way for them to get products and services at prices that were better than the market could otherwise provide. They aren’t about the capital.” Hazen, whose association represents cooperative businesses across a broad spectrum of industries, said that the NCBA doesn’t take a position for or against conversions, but does favor full and complete disclosures of all the information so that members of the cooperative or mutual firm can make a fully informed decision. “It’s up to the members if their firm could provide them a better choice of products or services as a for-profit, stock issuing firm would,” he said. “But those members deserve as much information as they need to make that decision.” NCBA also favors any conversion vote requiring a high degree of participation from the membership since the decision is going to be so fundamental to the organization’s structure. Hazen said that he had never seen, across the spectrum of cooperatively owned industries that his association represents, an occasion where the membership of a cooperative or mutual organization converted to stock because its members had demanded it. He said it typically happens because a consultant firm or an outside firm had come in and sold the idea to the leadership of the cooperative. “We see this right now,” he said, “advertisements in publications serving rural areas by consultant firms offering to come in and tell you how you can make a whole lot of money by converting your cooperative utility to a stock issuing utility.” Hazen also observed that these generally were the same. The consulting firm would make big promises to the members that they were then unable to fulfill or the members would then lose the cooperative to a merger or buy out from another, larger firm. He further suggested that the loss of the cooperatively organized firms in different industries had a public policy dimension from the point of view of helping consumers and the stability they brought industries. In the wake of the Enron collapse in the energy sector the industry was helped by the number of not-for-profit cooperative utilities in place, Hazen pointed out. These sorts of conversions are attractive to consultants and to some cooperative or mutual leaders because they can provide access to the equity of the cooperative, often built up over many years, essentially for free. For example, suppose a credit union with retained earnings of $30 million decided to become a mutual. That would mean it would have a net worth of $30 million as a mutual. Should it decide to convert further, to a stock issuing institution, an appraiser might value the mutual at $100 million. The former credit union therefore might decide to sell 10 million shares at $10 per share. Before the conversion, each share would be worth $3.00 of equity (i.e., has a book value of $3.00) and one could assume that offering expenses for the company are equal to $5,000,000, or $0.50 per share. In the end, the company nets $95 million from the stock offering. After the offering takes place, the new bank now has a net worth of $125 million, or $12.50 per share. Each investor paid $10 per share of stock they purchased – stock that has a book value of $12.50 per share. So the investor paid 80% of book value for the stock. In effect, the investor got their $10 right back, plus an extra $2.50. But that’s not all. According to market analysts, typical publicly traded thrifts trade at around 1.8 times their book value. In the example that would be about $22.50. The investors just bought a stock for $10 that the market could value at as much as $22.50. And since the approach to such conversions is more or less the same across the different industries, Hazen noted, there can be a lot of draw to converting. Jason Adkins, an attorney with the Boston firm of Adkins, Kelston and Zavez, is an expert in the conversion of mutually owned insurers into ones that issue stock. Adkins founded the Center for Insurance Research, a non-profit organization that has been dedicated to protecting consumers’ rights in these sorts of conversions. He now serves as the organization’s outside counsel, and said that he had thought credit unions might soon face the same sorts of offers and pressures that mutual insurance firms had faced. “Years ago, I had wondered if credit unions might be next,” Adkins said, “once I saw what was going on among thrifts and insurance companies.” Adkins called the process among mutual insurers “100% consultant driven” and noted that there is a difference between demutualization, in which a firm’s retained earnings or surplus is returned to the policy holder or credit union member prior to an initial stock offering, usually as cash or stock, and a conversion. In a conversion the initial public offering includes the equity or retained earnings that a mutual or cooperative might already have. In a demutualization, the policy holders or members get the value of the equity or retained earnings back on an equal basis, Adkins argued, noting that it was already their money and ownership. In a conversion, the company is seeking to sell back to the policy holder or cooperative member the equity that they already own. “If a mutual insurance company is going to go to a stock basis, demutualization is the only way that can happen in a way that is fair to all the policyholders,” Adkins said. Hazen added as well that one reason as many mutual insurance firms have converted as they have has been because many of them had ceased really being governed as a mutual long ago. “It doesn’t have to be a high degree of member participation,” he said, “but there has to be some degree of participation from members in the governance of the institutions,” he said. -

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