Bank - Credit Union Merger

Credit Union-Bank Merger Considerations

2017 saw a total of 7 credit union-buying-bank deals announced, with one being terminated. As of March 22, 2018, there have already been four deals of the same nature announced. More and more of the smaller community bank sellers are now including credit unions in the bidding pool and this is expected to keep growing as larger acquirers lose interest, opening the door for other institutions. There are a few considerations that credit unions should keep in mind when acquiring a bank that wouldn’t have an effect in a traditional credit union transaction.

Member Retention

One of the first things to consider when a credit union merges with a bank is member retention. Anytime two financial institutions merge, there is a risk customers change banking relationships. This can especially be true when customers are transitioning from a bank that is more convenient, usually in the form of technology, than the acquirer.

Banks, as a whole, have invested significantly in technology compared to credit unions. Technology such as mobile banking platforms, are not easy to transition into a new system. The tax-exempt status of credit unions can give the opportunity to provide slightly higher deposit rate. An institution must determine whether the difference in deposit rates mitigate the potential inconvenience of having to change mobile deposit or online banking platforms.

Furthermore, will the target institution’s customers qualify for membership of the acquiring credit union? Credit union membership restrictions could require the member to live or work in a certain county or state while the acquisition target may have multiple branches outside of the credit union’s footprint. The credit union can put in a request to change its membership requirements, but this may be declined and can take time to accomplish. An alternative option would be to negotiate the sale of branches that don’t fall under the acquiring credit unions membership requirements to an additional party before the merger transaction closes.

Balance Sheet Composition

Balance sheet composition is another important aspect to consider when looking to merge with a bank. For example, credit unions have restrictions regarding the member business lending (MBL) by limiting their single borrower’s policy limit of 25% net worth. Depending on the size of the acquiring credit union, this restriction can take many targets out of consideration.

However, if the credit union can acquire the MBL portfolio without exceeding the limit, there can be tremendous upside to gaining employees with underwriting expertise and proper qualifications in the commercial real estate (CRE) and small business administration (SBA) loans field. For example, CRE loans usually require a sound business plan and must provide financials frequently. If there is a guarantor, they will also be required to provide personal and business information. This could cause commercial servicing cost to increase significantly compared to residential mortgage lending or general consumer lending. CRE is an extremely competitive and relationship-based sector with rates being negotiated based on a number of factors such as borrower deposit size or potential for referrals.

SBA lenders can also be particularly valuable due to the rigorous barriers to entry and regulations within the sector. However, there are a few ways to bring commercial lending assets that do not impact the credit unions cap on net worth. First is by partaking in non-member commercial loans. The NCUA revised rule 723.8 in 2016 to exclude any non-member commercial loan or non-member participation loan from the federal credit unions MBL cap. For SBA lending, the government-guaranteed portion of the loan are not counted towards the cap, but as stated earlier are far more complex in nature. Many credit unions are hesitant to venture into this market without the proper staff. Lastly, credit unions that have the low-income designation may apply to remove the MBL cap altogether.

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Investments

Many banks hold municipal investments for, above all else, the tax benefits. Credit unions being tax exempt do not have as much need for such investments. Municipal bonds require due diligence on bond structure and the projected performance of the subject municipality which may increase the effort of managing such investments beyond what is profitable for the acquiring credit union. Also, the target bank may hold other investments the acquiring credit union does not want or need on their balance sheet. The acquiring institution should consider the appropriate disposition of such investments prior to completing the transaction.

Deposits

It is common practice for banks to receive municipal and brokered deposits as a source of funding. Acquiring credit unions should review whether such deposits are permissible given policy architecture and determine appropriate means of remediation. Such deposits could present a volatile and costly source of funding for the institution. The permissibility of municipal deposits varies based on charter and state laws.

Special Considerations

A few special considerations when a credit union is acquiring a bank is when the bank has Community Reinvestment Act (CRA) tax credits or Home Affordable Modification Program (HAMP) loans on the balance sheet. The CRA applies to Federal Deposit Insurance Corporation (FDIC) insured institutions such as banks and excludes credit unions insured by the National Credit Union Share Insurance Fund (NCUSIF) and other non-banks. In these instances, the target bank sells the specific CRA designated loans at a premium. Since all FDIC insured institutions are required to meet certain levels of CRA lending, the CRA designated loans will fetch a premium on the open market from institutions that haven’t met their quota. The HAMP program allows borrowers who are at risk of foreclosure due to financial hardship to reduce their monthly payment for a select period of time. This can pose a problem in a merger when the acquirer does not have the appropriate authorization to service such mortgages. To resolve this issue, the acquirer can either set up subservicing arrangements with another party or let the target institution sell the loans prior to the merge. However, institutions need to be mindful about potential duplication of vendors and whether there are termination fees in their servicer contracts. If a target has a termination fee, that would immediately reduce the value of the merger.

With the surge of credit union-buying-bank transactions, it is important to know the complexities of merging the two types of institutions and the things to consider beforehand.

Kevin Kirksey, ALM First Financial Advisors (Guest Author)
Principal, Strategic Solutions Group at | + posts

Kevin Kirksey is a Principal at ALM First Financial Advisors, joining the firm in 2011. Mr. Kirksey oversees the Strategic Solutions Group, which conducts merger valuations, capital planning and stress testing, ALM and CPST model validations, CECL analysis, MSR analysis, and fosters many hedging strategy relationships.  Additionally, Mr. Kirksey serves as the Chief Compliance Officer for the firm while overseeing Operations, Quality Assurance, and Technology departments.