Pre-Merger Considerations For Credit Unions

The number of mergers and acquisitions between credit unions has been steadily growing for several years, with the majority involving credit unions under the $100 million range.   That being said, there are a few considerations that credit unions should keep in mind when acquiring another institution.

Member Retention

One of the first things to consider when acquiring another institution is member retention. Anytime two financial institutions merge, there will be a risk of depositor attrition. This can especially be true when customers are transitioning from an institution that is more convenient, usually in the form of technology, than the acquirer. One of the first items to consider is alignment of charters between institutions. For example, a credit union membership requirement could need the member to live or work in a certain county or state while the acquisition target has multiple branches, some being out of the membership area. The credit union can put in a request to change its membership requirements, but it can be a lengthy process and the request can be declined. 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.

Culture Fit

One aspect of the merger process that might be overlooked is the culture fit. Organizations develop long-standing values, beliefs, and processes that become ingrained and trying to merge two very different cultures can prove difficult and costly. This especially important in credit union sector because a high percentage of institutions have a very resilient culture with employees and customers ardently believing in the institution’s mission statement. While it is difficult to quantify the impact of poor culture convergence, its effect can be directly felt by members and possibly effect the credit unions growth or profitability. There are a few ways to ensure a smooth transition. First is to identify a target institution’s culture early in the process. As stated previously, culture can be a difficult thing to quantify, but it is imperative to find similarities between the acquirer and the target institution. Moreover, informing critical employees of the impending merger can be crucial. Valuable employees may feel disenchanted if they are informed of a potential merger late in the process. Management needs to inform employees what exactly their roles will consist of and what benefits, if any, they will receive.

Federal and State Regulations

With the number of credit union mergers growing every year, a common consideration is that of regulations. Some states have very clear merger rules and requirements, while other states do not. Furthermore, the National Credit Union Administration (NCUA) must approve the transaction given the following criteria:

• The merger/acquisition is in the best interest of the member
• Is in line with the requirements of the Federal Credit Union Act, the NCUA’s Rules and Regulations, and IRPS 03-1
• Minimizes risk to the NCUSIF

In some instances, the NCUA can go as far as seizing an institution and let the acquiring credit union purchase only the assets and liabilities it needs. The NCUA can also provide cash or agree to remit the acquiring credit union in transactions they would not or could not do without the assistance, known as an assisted transaction. Assisted transactions require additional diligence on the part of the acquirer to determine whether the assistance provided will be sufficient to cover expected losses.

Member Voting

Another consideration in the approval process is the member voting. As a cooperatively owned institution, members have the right to vote on any proposed merger or acquisition via the annual meeting or by mail. The institution is also required to give its members an advanced notice about the meeting, information about the merger, and information on the members rights to vote. A straightforward approach to estimating member acceptance is through discussions with the Board which represents the membership base.

Investments

The investment portfolio of a target institution also needs to be considered pre-merger due to policy restrictions which may require modifications to the target’s balance sheet. Many target institutions will have investments the acquirer simply does not want on their balance sheet. In these instances, the target institution usually sells any impermissible or undesired investments pre-merger and the acquirer accepts cash. In some cases, the credit union can seek a policy limit change from the board of directors to include specific investment types. This approach can take time and has the possibility of seeming imprudent. Another important factor is the percentage of investments to total assets. Higher percentages of investments to total assets means the acquiring credit union is getting less of a member base but paying full price. Fewer loans on a balance sheet limits the acquiring institution’s ability to cross-sell products. There may be minimal benefit to a merger if a significant portion of the target institution’s balance sheet can be purchased separately without incurring merger-related expenses.

Deposits

When analyzing a target credit unions deposits, the acquiring institution should also consider how many of those depositors also have loans with the institution, debit card use, and the percentage of members that utilize direct deposit. These factors are good predictor of a primary banking relationship. When an institution has low percentages in these specific categories, it may indicate a less stable source of funding. The indication of a primary banking relationship would improve the likelihood the acquiring institution can improve member engagement and cross sell other banking products and services.

Allowance for Loan Losses

In an acquisition, the projected loan losses from the target institution’s loan portfolio are recasted into the acquiring institution’s credit loss account. Prior to the merger, the acquired institution should be encouraged to increase the allowance, within accordance with GAAP, to decrease goodwill. As part of due diligence, the acquiring institution should review the target’s recovery practices and ensure they are in alignment. Management of the cost to recover can help adjust the credit loss projections.

Goodwill

Goodwill arises in a merger when the overall value of the acquired credit union is greater than the fair value of the assets, liabilities, and intangible assets. The goodwill must be amortized over a maximum 10-year period or be subject to annual impairment testing. A decrease to goodwill, usually by increasing the allowance for loan losses prior to the merger, will in turn decrease the 10-year annual expense or possibly remove the need for the annual impairment testing. Once the amortization period is selected, the credit union cannot reverse this decision. In cases where negative goodwill exists, the institution will see an immediate increase in capital as negative goodwill is recorded as an increase in earnings.

Mergers and acquisitions can be a healthy strategy for credit unions to increase member base, penetrate new markets and acquire new products and technology. However, this might not be right for all institutions. It is important to consider the pros and cons of every aspect of a transaction before proceeding.

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