Considerations for Credit Unions Contemplating Buying Community Banks
Even with plenty of time left in 2019, credit union (CU) deals for community banks have already exceeded the previous record of nine transactions, set in 2018. What’s driving this record level of activity, and what are some key aspects that credit unions should consider prior to pursuing a bank acquisition?
A Record Level of CU-Bank M&A Activity
A unique aspect of this record-level activity is the confidence in the transaction model the market has gained over the past few years. Since United Federal Credit Union acquired Griffith Savings Bank in 2012, there has been a record number of CU-bank purchases announced nearly every year. This would indicate a spreading confidence in the ability of CUs to pursue this type of transaction and the broadening understanding among community banks that CUs can be strong buyers.
Community banks tend to have strong ties to their communities and a strong desire to care for their valued, long-term employees. In some cases, this ethos can align more closely with the mission and focus of a CU than a larger acquiring bank. In addition, due to industry consolidation, geographic considerations, timing or other factors, there may only be one or two banks with the ability or interest in acquiring a selling bank. Thus, being able to broaden the potential buyer list for a selling bank with the addition of a strong CU may be of significant benefit to the selling shareholders.
As with most financial services merger and acquisition (M&A) transactions, two main drivers for CU-bank transactions are economies of scale and growth acceleration. Across both CUs and banks, research has shown that the larger the institution is, the less it spends on regulatory compliance as a percent of noninterest expense. In addition, while there are organic growth opportunities available in this long economic expansion, many CUs have begun to see M&A as an opportunity to augment organic growth. A CU-bank acquisition can provide for the rapid acquisition of talent, an opportunity to serve new members, the strategic deployment of capital, access to new business lines and immediate expansion of the balance sheet.
Key CU-Bank Acquisition Considerations
Retaining Bank Customers as Credit Union Members
Converting customers to members is vital to a CU-bank acquisition’s success. Assuming technology parity and no field-of-membership issues, strategic communication and a frictionless transition are essential elements to customer conversion in a CU-bank acquisition. Misfires on either front can significantly degrade the value of the transaction to the CU.
Communication throughout the process is key, as failure to timely and comprehensively communicate could lead to losing potential members to competitors. CUs should be prepared to use all available communication channels the banks have made available, including in-person, in-branch, text, email, website and direct mail. The risk that a message isn’t clearly communicated during such a transformative period far outweighs any risk related to over-communication. Potential members want to know how they’re going to be affected—make sure there’s no question in potential members’ minds as to why the combined institution is the right choice for them.
Ensuring the transition is as seamless as possible helps avoid potential member runoff. Most CU-bank acquisitions have seen runoff numbers of less than 5 percent. This is in comparison to bank-bank acquisitions, which often see runoff numbers of 10 percent or greater. However, issues during the transition could create uncertainty about the CU’s products, service or quality, leading to higher runoff rates. Employee training, product integration and technology conversion should all be completed prior to or at closing, allowing the combined institutions to hit the ground running on day one with a nearly frictionless experience for the bank’s customers.
Retaining Business Customers
Personal accounts may be easier to transition by providing education on the value of being a member and immediate assurance that staffing won’t change and existing products will remain. Business accounts may require a high-touch approach, with education and assurance that the acquiring CU has the capacity and desire to serve and retain business accounts.
Special attention may be necessary with business accounts because of systemic differences in how CUs and banks typically are managed. Banks often hire and train business loan officers to network with the community and develop an individual loan portfolio and business relationships. Those business customers are often directly connected to the bank’s individual loan officers with high levels of trust and strong one-on-one relationships. Thus, those business customers may view their relationship with the bank as nearly inseparable from their relationship with the individual loan officer.
The marketing mindset for CUs is generally focused more around developing and marketing desirable products to its field-of-membership. Thus, if a CU is, in part, making the acquisition to expand its business lending activities and services, it also may have to consider some strategic and operational shifts around business accounts to maintain the acquisition’s value. Retaining loan officers will be critical to the CU’s efforts to enter new business lines, especially business lending. Quality loan officers are often the first people to be contacted by competitors when a transaction is announced. CUs should communicate extensively with the bank’s loan officers and have a clear plan to retain key employees prior to any announcement.
Considerations for Expanding Business Lending
If the CU can navigate restrictions on member business lending (MBL), there’s an opportunity to rapidly acquire employees with business lending expertise and relationships. However, business lending at scale can be challenging and should be carefully and strategically prepared for in advance. As referenced earlier, business lending is often heavily relationship-based and extremely competitive. Rates and terms are often extensively negotiated based on a number of factors, including borrower risk, business/project risk, collateral quality, deposit size and referral potential.
Once the business loan is made, there can be significant ongoing monitoring with business plan updates, updated financials and tax returns, collateral monitoring and changes to legal contracts and agreements. Collectively, these factors can cause business loan servicing costs to run significantly higher compared to the types of residential real estate or consumer lending many CUs normally pursue.
If the target bank does small business administration (SBA) lending, the government-guaranteed portion of the loan isn’t counted toward the MBL cap. However, SBA lending adds another layer of complexity on the already complex world of business lending, with multiple programs such as export-assistance loans, 504 loans, microloans and SBA express loans. One important consideration for a CU acquiring a bank that does SBA lending is that SBA lenders receive a rating from the SBA. If too many SBA loans made by the bank go into default, the bank could be at risk of the SBA discontinuing its participation in the program. If the target bank does SBA lending, a proper understanding of the risks and opportunities afforded by SBA lending is critical to the acquisition’s success.
As most CUs are likely aware, there are additional ways to manage the MBL cap. Loan participations are a strategy many CUs have used to manage MBL limits. The target bank also may be very familiar with this strategy, as banks have used partitions to address similar restrictions on loans or diversify their portfolio. Participating a portion of the MBL loan allows the CU to maintain the member relationship and earn servicing fees while also managing the MBL cap and diversifying the loan portfolio. Like business lending in general, loan participation programs at scale require strategic focus, with an outstanding risk management culture, well-documented policies and procedures and a committed team.
A low-income credit union (LICU) designation may be worth pursuing if a majority of the CU’s field-of-membership is likely to fall within low-income guidelines. If a CU qualifies for LICU, the MBL cap is basically eliminated.
Nonmember business loans also are an opportunity. Rule 723.8 excludes any nonmember business loan from a federal CU’s MBL cap. Nonmember business loans may be especially relevant in a CU-bank acquisition, as the bank may have multiple loans to customers who wouldn’t qualify as CU members and may have additional relationships that could be nurtured into nonmember business loan opportunities.
Finally, a CU may determine that referring the business loan to another lender is the right thing to do. Referring the relationship to another outstanding financial institution could actually strengthen its reputation as a trusted advisor to the business owner, allowing the CU to maintain a portion of the relationship and possibly earn a referral fee.
Transaction Structuring & Regulatory Approval
If all factors point toward an attractive acquisition opportunity for both the CU and the bank, the parties should work together to navigate the transaction structure. This is especially relevant when the CU may not have done a previous transaction and the bank may not have experience with the structure necessary to complete the transaction. The most common structure in a CU-bank transaction involves the acquisition of assets, assumptions of liabilities and the dissolution of the underlying bank charter. While most traditional bank-bank acquisitions involve the statutory transfer of liabilities, the necessary CU-bank transaction structure requires comprehensive identification and documentation of the liabilities to facilitate the assumption.
Since the transaction is structured as a purchase of assets, the bank will recognize gain or loss on its tax return; if the bank is a C corporation, there may be additional tax liability as a result of the gain. Furthermore, the C corp shareholders may recognize gain and incur tax liability as a result of the receipt of any liquidating distributions made by the bank or its holding company. The double taxation may affect pricing for the bank’s sale.
The approving regulatory agencies for CU-bank transactions are the state and federal CU licensing and insuring agencies. Assuming the proposed new members meet the field-of-membership test, the regulatory approval process is likely to go relatively smoothly.
Only time will tell if the number of CU-bank deals will continue to increase over time. Because of the limited number of CUs with the size and capacity to acquire banks, the number of CU-bank transactions may not approach the number of bank-bank transactions each year. However, it’s likely the number of CUs that become comfortable with pursuing a bank acquisition will continue to grow and there may be an increasing number of situations where a CU-bank transaction makes the most sense to the bank’s selling shareholders, thus continuing to support the number of win-win CU-bank transactions into the foreseeable future.
If you’re considering a CU-bank transaction, contact a BKD trusted advisor to discuss possible pitfalls or additional tax considerations.