As Congress considers legislation to reform U.S. tax policy, the credit union tax exemption is a frequent topic of debate and a point of contention during tax reform discussions and the reconciliation process that requires finding “pay-fors” to help balance the budget, with credit union taxation being strongly considered as a source of new revenue. Lawmakers could tax all credit unions on par with banks or establish an asset threshold beyond which credit unions could be taxed, such as $1 billion in assets as recently proposed by bank lobbyists.

With the looming threat of taxation, along with calls to consolidate the NCUA with other bank regulators to streamline government bureaucracy, credit unions are asking themselves if without the benefit of the tax exemption, why be subject to the limitations of the credit union charter?

Consequently, several credit unions are now considering the once inconceivable – a mutual bank conversion – to prepare for possibly losing their tax-exempt status and the elimination of the NCUA as an independent regulator.

Before delving into the mutual bank conversion process, it is important to understand the motivations for doing so and certain considerations. Like credit unions, mutual banks are “member-owned” with no stockholders. The bank’s member voting process can be one vote per one deposit account so that membership control is not diluted.

Many mutual banks offer the “credit union way” to their customers – a community-oriented institution focused on charitable endeavors and high-touch customer service, with profits, albeit taxable, earned for the benefit of members and not stockholders – without field of membership and the member business lending restrictions.

A mutual bank can also be reorganized into the mutual holding company (MHC) structure. In doing so, members fully “own” the MHC, which in turn owns 100% of the stock issued to the MHC by the subsidiary bank as part of the reorganization. The MHC can acquire another bank or credit union and hold it as a separate sub of the MHC, which may facilitate a partnership with an institution that desires to retain its charter and full board and management. Further, MHCs can raise subordinated debt, the proceeds of which can be transferred to its subsidiary bank as Tier 1 capital.

Unlike mutual banks that fully convert to stock form by selling their entire fair value to members and the public, banks in the MHC structure can sell less than 50% of their value and raise equity capital, while remaining a majority “member-owned” institution. This allows the best of both worlds – a member-controlled institution that can raise capital through the issuance of stock.

A credit union must receive prior approval from the OCC or applicable state chartering agency to convert to a mutual bank. The application process is significant – the credit union must prepare pro-forma financial statements and capital levels as a bank, a detailed business plan, including plans to meet the Community Reinvestment Act, revised lending, ALCO, and BSA/AML policies and an analysis of how its operations will comply with applicable bank regulations and policies. The relevant banking experience of the credit union’s board and senior management will also be scrutinized.

Although the NCUA has no approval authority of a conversion to a mutual bank, it has authority to administer the member voting process of the conversion proposal. Because of this, the NCUA has created what critics argue is a complicated and inefficient process designed to discourage mutual bank conversions. For example, before the requisite board and member votes approving the conversion, credit union members must receive four separate member notices – a member notice prior to the board vote and three member notices at intervals of ninety, sixty and thirty days prior to the member vote – which is wasteful for the credit union and aggravating to members.

Moreover, the notices require “clear and conspicuous” disclosures about the possible loss of membership control and potential compensation payable to directors and executives associated with a hypothetical conversion to a stock institution, which must be boxed in a particular way and appear at a certain font size. These requirements – designed to ensure clear disclosures are made – also appear devised to influence members to vote no without considering the merits of the mutual bank charter.

Lastly, following member approval of the mutual bank conversion, the member vote methods and related voting procedures must be approved by the NCUA. As such, even if members vote in favor of the conversion, the NCUA may still contest the vote.

Be ready – it is critical for credit unions to educate themselves on the opportunities available should fundamental changes occur that upend the credit union industry. Any credit union considering a mutual bank conversion should be prepared for a methodical and painstaking process, particularly if the NCUA behaves as a captive regulator. Advance preparation and careful planning are paramount to successfully navigating the regulatory and member voting process. With change on the horizon, it’s likely that more credit unions will evaluate whether a conversion to a mutual bank is prudent and in the best interests of members and other stakeholders.

Jeff Cardone is a partner at Luse Gorman, a law firm specializing in representing credit unions and community banks related to mergers and acquisitions, stock and debt offerings, regulatory compliance and credit union charter conversions, including to mutual banks.

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