Mergers and Credit Unions

Doreen Burton
June 18, 2008 | COMMENTS

Flip to the business page in any paper across the country. It's a story a day about a merger. It's part of one company's business plans, and another company's greatest fear. Smart organizations have a discussion about it every year at strategic planning time.

Credit unions represent all of those organizations—the planners, the fearful, and the aware but not yet doing it. That's because mergers are no longer strange to the financial services sector. Banks have been doing it with fanfare for years, and credit unions are now doing it more quietly and more often.

Here's the evidence: In 1970, there were more than 23,000 credit unions. By 1992, there were 12,595. This year, there are fewer than 8,600. Some of this decline is from mergers. In fact, for the past several years, 300 credit union mergers have occurred each year. CEOs interviewed for an upcoming merger panel discussion at CUNA Mutual Group Discovery Conference in Hollywood, Florida, reported that they believe the number of credit unions will continue to shrink, estimating that there will be about 6,000 in 2011, down about a third from today's 8,600!

A Growing Trend

Mergers used to be something murmured in hushed tones! But merger certainly doesn't mean failure or death of the commitment to a community, company or cherished members. Mergers can be a growth strategy that guarantees success through economies of scale and membership growth. It can be a competitive strike against another financial services provider. It can be a survival tactic that means a name change, but preserves the essence of a long-standing and trusted financial institution. Other reasons to merge include:

• Increased operational efficiency
• Allows more competitive pricing
• More effectively leverage credit union's capital and underserved membership
• offer more products and service

Given these drivers, it's logical that more and more credit unions entertain a merger—from desire or fear. To articulate your own credit union's perspective on merger, whether to initiate or respond, take a look at your leadership, loan growth, and membership stats in light of these national trends.

Twenty four percent of credit union CEOs will retire in the next five years. In the smallest credit unions—those with less than $2 million in assets, one-third of CEOs will retire. Even the large credit unions—$1 billion in assets—will see 17 percent of their CEOs leave. Only those credit unions with a succession plan in place and outstanding professional opportunities will attract great leaders from a small pool. No succession plan? No leadership prospects? A merger might be in your future.

Another telling stat is that while assets are growing, overall membership numbers are flat. Credit unions are helping their members grow their financial assets, but they aren't as successful at growing their own assets—members. Even loyal members are starting to fall off because they are aging—and dying. They are not being replaced with younger people who will stay and grow with the credit union. In 1985, credit union members in that desirable 25 to 44 age group comprised 55 percent of membership. Today, it's 38 percent.

The majority of credit unions are worth more than $100 million. The numbers of small, single SEG credit unions are dwindling. Is it because they struggle to survive?

Credit unions are a mixed category of success stories. Four thousand one hundred had positive asset growth, but 4500 had negative asset growth.

The larger the credit union, the better the member benefits. These benefits happen behind the scenes and up front, but each one leads to better value for the customer. The larger the credit union, the greater the ability to pass lower loan rates and higher dividend rates for the benefit of the membership. The larger the credit union, the lower net operating expense load due to economies of scale. The larger the credit union, the greater the ROA, and thus the ability to deliver long-term value to members.

New types of competitors are entering the credit union arena, and credit unions only represent 3 percent of the total deposit share in the U.S. Beyond banks, check cashing shops, insurance companies, and alumni credit cards, there are also Online Savings players who offer outstanding interest rates ranging from 5.3 percent to 6.00 percent. Consider how you'll compete with them, especially to the younger, wired worker.

Growth Plans

Are you thinking about a growth plan now? Merger is one option, as is internal growth or even a combination of both. If merger is a possibility, it can happen in one of three ways:

• Voluntary, perhaps when a smaller credit union seeks or is approached by a mid-sized or larger credit union
• Involuntary, such as regulator-driven when one credit union is troubled
• A partnership of equals in a strategic move between two full-service, healthy credit unions

A thorough analysis of your attractive assets and possible flaws will help you decide which path to pursue.

Credit unions that have achieved a successful merger indicate that it's essential for the board and credit union management to agree that mergers are part of the overall growth/strategic plan. This can be an emotional topic, so be sure to probe feelings and don't be surprised at the vehemence of reactions. Mergers can feel like a loss of identity or a huge responsibility, or even a diversion from founding principles. These should be heartfelt subjects.

During this discussion time frame, aggressively explore the reasons for the merger. Credit unions are all about their members. Ask again and again: Is this strategy in the best interest of our members? Are we clear that the interests of the credit union and the members come before the personal or professional interests of any board member or manager?

Next, it's time to think about the “life partner.” What are the criteria you'll use to identify potential merger candidates? Remember, you're looking for a match and more. Look at:

• Demographics
• Geography
• Philosophy/personality
• Asset size
• Operations
• Financials

CEOs of credit unions that recent underwent mergers offer these tips:

• Look at over-capitalized credit unions
• Look for credit unions that are not growing
• Look for credit unions with earning problems
• Look for credit unions whose CEO is close to retirement
• Establish a referrals network of regulators or league regional managers
• Make your own credit union known
• Explore complimenting cultures

Once agreement is reached on the field of candidates, as with any other strategic initiative, it's useful to create a team of savvy and committed staff to own this project. The merger team is responsible for:

• Determining and articulating the need for the merger
• Crafting the wish list
• Identifying the deal points
• Creating the CEO/management packages
• Creating the merger package

Once you find a prospective partner, take time for an unemotional, analytical period. Check these elements of your prospective partner and encourage them to do the same on you!

• Have clear picture of credit union's history
• Understand the financial condition of credit union
• Understand financial impact, performance, liquidity of future value

Your due diligence checklist should include:

• Financial analysis
• Field of membership, demographic and service usage
• Loan portfolio analysis
• Lending program
• Delinquency/allowance for loan losses
• Investments
• Leases/contracts
• Pending litigation
• Human resources
• Information services including hardware, software, and data processing contracts
• Central services, including ATMs and item processing
• CUSOs
• Sponsor relations
• Member relations

Getting It Done

Once convinced that the other's house is in order, focus on back of house (your staff) by evaluating the ability to integrate merging credit union's employees and members into the surviving credit union. This exercise can be painful, but it's necessary to gain the full benefit of the merger and ease the staffs through what will be a period of intense learning and adjusting. Business statistics note that 80 percent of mergers fail because of culture clash. Common challenges include fitting cultures together, making decisions on staffing and office locations, consolidating operations, and negotiating the number of board seats.

As with all highly regulated industries, there are critical legal steps. Recognize you will have state and federal rules and it's crucial to have a legal consultant who knows your state's laws. And, that there is a difference between mergers of state-to-state, and state-to-federal and federal-to-federal mergers. NCUA chartering or FOM policies do not apply to a federal credit union merging into a state credit. But, NCUA approval is still required, as the federally chartered will be terminated upon merger completion.

Once you've made the deal, celebrate and get ready for more hard work. But in the words of those who've made the merger, look for signs of success. They are real and they deserve to be recognized, along with everyone who contributed to this success for members and staff. What are the tangible benefits? Look at this impressive list:

• Impact on ROA and margin
• Growth
• New SEG development
• Expansion into new communities
• New perspectives, loyalty, and relationships with members
• Attract staff that has a wealth of experience
• Serve members from more branches

Lastly, just to give you the urge to merge sooner, consider that right now the Financial Accounting Standards Board (FASB) is changing to valuation of credit unions post-merger by eliminating the pooling method of accounting and requiring the acquisition method instead by January 2009. In a merger, this will require that net assets on a fair value basis of the merging credit union as a whole, rather than retained earnings, be carried over as “acquired equity.” This results in a reduction of the post-merger net worth and could discourage voluntary mergers.

Doreen Burton is a strategic consultant to the credit union industry. Contact her at 608-838-8275 or visit www.burtoncuconsulting.com.