Monterey Credit Union in California is aiming to become the first credit union in more than year to convert to a state-chartered mutual savings association.

The $210 million-asset Monterey applied for deposit insurance with the Federal Deposit Insurance Corp. on Sept 2. The credit union, which plans to change its name to Community Savings Bank of Monterey, has also applied for a bank charter with California's Department of Business Oversight. Spokesmen for the FDIC and the state banking agency confirmed that the applications are under review.

The regulators have not asked Monterey for additional information, said J. Stewart Fuller, the credit union's chief executive. "I'm taking the view that's a positive sign," he said, adding that the credit union is in a "holding pattern" until its conversion is approved.

Monterey's board concluded that a bank charter would provide greater operational flexibility, Fuller said, including the option of lending more to businesses and greater access to capital.

About 20% of Monterey's roughly 19,500 members are connected to small business in some way, Fuller said. But Monterey is effectively locked out of that business due to rules that cap the size of credit unions' small business lending portfolios at 12.25% of total assets.

"To get into commercial lending and do it properly from a safety and soundness standpoint costs a lot of money, and just about the time you break even you hit the cap," Fuller said.

Fuller said he does not expect to lose many customers as a result of converting. "Credit unions are known for providing good service, but so are community banks," he said.

If Monterey's paperwork is approved, it would mark the first credit union-to-bank conversion since the $2 billion-asset HarborOne Bank in Brockton, Mass., became a state-chartered co-operative bank in July 2013.At least 36 credit unions have become banks since 1995, according to CU Financial Services, a Portland, Maine, consulting firm that advises credit unions interested in converting.

Conversions experienced a bit of a surge between 2004 and 2007, before tailing off during the financial crisis. HarborOne was the first credit union to convert since July 2009, when Coastway Credit Union in Cranston, R.I., became Coastway Community Bank.

In fact, Monterey, which began to consider converting in 2005, put its plans had to be put on hold due to the financial crisis, Fuller said.

Monterey's planned conversion is "interesting" because it would be the first California credit union to convert since 2000, said Alan Theriault, CU Financial's president, though he cautioned that the switch is unlikely to trigger a new surge in conversion activity.

"It's not like 2005, 2006 and 2007, when we had credit unions lined up seeking to convert," Theriault said.

Peter Duffy, a managing director at Sandler O'Neill, agreed that a "rush to the exit" by credit unions is unlikely. "As long as they can deliver value, grow organically and by acquisition and meet new regulatory requirements," most credit unions will keep their charters, he said.

"The natural DNA of credit unions is that they prefer to remain credit unions but many understand they must keep their options open given the changes in the business and the growing need for secondary capital," Duffy added.

Still, it is possible that a few more credit unions could look to convert next year.

Richard S. Garabedian, a lawyer at Luse Gorman Pomerenk & Schick, said he is advising "a couple" credit unions considering conversions. Like Duffy and Theriault, Garabedian said he does not foresee a significant upsurge. He said the number of conversions would probably be determined by the circumstances of individual credit unions looking to fuel growth or escape membership limits.

The conversion pace could quicken somewhat as the economy improves, Garabedian said. "As to exact numbers, it's hard to tell," he said.

The issue of risk-based capital could determine if another wave of conversions could take place. The National Credit Union Administration is expected to unveil revisions to its proposed risk-based capital regulation in mid-January.

Under the proposal, which would have applied to credit unions with more than $50 million of assets, institutions would need capital equal to 10.5% of risk-weighted assets to be well-capitalized. The proposal would have also allowed the NCUA to impose higher ratios on a case-by-case basis "where specific supervisory concerns arise regarding the institution's condition."

The rule currently defines a credit union as well-capitalized if its net worth equals 7% of assets.

The NCUA received more than 2,000 comment letters in response to the original risk-based capital draft, which it made public last January. A number of respondents expressed concerns that requiring credit unions to hold more capital would make them less competitive.

Risk-based capital "has instigated a lot of discussion and analysis among large credit unions," Duffy said. "They are taking a very deliberative, comprehensive and careful look" at the issue.

The NCUA has been working for several months on a revised plan, but regulators have been unable to craft a scheme that satisfies credit unions. So it is hardly far-fetched to speculate that some institutions — especially larger ones — might take a closer look at converting.

"NCUA is in an enormously difficult pickle" because it is writing regulations and supervising an industry where the institutions have become very different from each other, Duffy said.

Credit unions with more than $250 million are "materially different from smaller credit unions and substantially similar to community banks," Duffy added. The NCUA is "trying very hard to strike a balance but, at the end of the day, what large credit unions tell me is that the only thing all 6,200 credit unions have in common is their appreciation of the federal tax exemption."

John Reosti is a community bank reporter at American Banker.

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