A Merger Slowdown
The 230 CU mergers in 2010 represent the second fewest in 30 years.
The 230 credit union mergers in 2010 might seem like a lot of mergers. But it actually represents the second lowest level in the past 30 years—down from 260 mergers in 2009 and 300 in 2008.
The recent recession, new accounting rules, and an ever-increasing compliance burden have slowed merger activity, according to Mike Schenk, CUNA’s vice president of economics and statistics.
But not everyone is backing off mergers. Some credit unions are proceeding with their merger plans in an attempt to accelerate growth, diversify existing fields of membership, or explore completely new fields of membership.
Behind the slowdown
Multiple factors are contributing to the slowdown in credit union merger activity:
- Lower earnings and reserves mean there are less funds available to pay for merger costs.
- The recession increased the potential cost of overlooking risks and liabilities during the due diligence process, causing some credit unions to retreat from potential mergers.
- Declines in capital ratios made some credit unions less willing to consider the potential negative impact of a merger on their capital levels.
- New rules moved merger accounting from the “pooling of interest” method to the “acquisition” method. The acquisition method values assets and liabilities at their “fair value” at the time of the acquisition. This increases the odds that the continuing credit union could experience a “hit” to net worth.
- A wait-and-see approach. Some credit unions could be holding off on mergers in hopes that NCUA will eventually offer higher levels of assistance for mergers with financially distressed credit unions.
Strong credit unions sometimes look for mergers to boost membership growth, pursue market penetration or diversification, and support fixed operating costs, points out Ron Nice, owner of merger and planning consulting firm Nice Enterprises Inc., Kremmling, Colo. This could range from acquiring a smaller credit union to finding a cultural match in a “merger of equals,” where two strong credit unions combine organizations to leverage the strengths
Struggling credit unions are drawn to the bargaining table by economic challenges that put pressure on earnings and reserves, the burden of regulatory compliance, the difficulty of finding high-quality CEOs, or an “unsustainable” business model where the cost of providing products and serving members exceeds the profitability of those products and services.
“If you look at credit unions that are in trouble, you will find that most are overbranched and overstaffed, and are carrying a cost load that isn’t consistent with their asset size,” Nice says. That model is likely to drain credit unions, he adds, particularly those with less than roughly $750 million in assets, with the size varying by local costs and conditions.
Nice says many struggling credit unions have fallen into the trap of trying to be “all things to all members” as their primary financial institution (PFI), rather than focusing on targeted loan and deposit products and using automation to lower operating costs.
In contrast, credit unions with sustainable business models engage in mergers that complement existing operations, whether the merger partner is located across the street or across the country.
“A great merger is a marriage of complementary strengths and like-minded cultures that can do something greater together than remaining two separate organizations,” Nice says.
First Community Federal Credit Union, Parchment, Mich., began its strategy of gradually expanding its territory to encompass a broader region in 2006, when it merged with $15 million asset United Savers Federal Credit Union in Battle Creek, Mich., about 30 miles outside the Kalamazoo area where most branches are located.
First Community built on this strategy in 2010 through a voluntary merger with $60 million asset Education First Credit Union, Southgate, Mich., about 140 miles away, and a purchase-and-assumption merger with $120 million asset First American Credit Union, Beloit, Wis., about 250 miles away. The mergers created combined assets of $623 million.
“You know the saying, ‘It’s not good to have all your eggs in one basket,’” says President/CEO Cheryl A. DeBoer. “To some extent, this could be stated as a benefit of growing into new regions. As one region might be experiencing growth in certain areas, another region might be experiencing downturns. That can provide a balance in terms of growth opportunity.”
Technology such as web conferencing, which is combined with periodic face-to-face meetings, supports the transition to a single organization. That allows opportunity to outweigh distance as a merger consideration, even in a purchase-and-assumption merger.
“First American had undergone some stresses related to the economic condition within their membership,” DeBoer said. “We felt the partnership was a good one as our membership base was very similar, along with the culture within our credit unions.”
DeBoer acknowledges that many smaller credit unions want to continue to run independently. “We are seeing, though, with shrinking margins and increased product line demand along with economic and regulatory issues, that it’s becoming increasingly difficult for some small credit unions to thrive,” DeBoer says.
Economies of scale
Credit unions often cite the opportunity to pursue economies of scale as a motivation for mergers, but those savings can prove difficult to realize. Alliant Credit Union, Chicago,
with $7.5 billion in assets, achieves those economies by eliminating redundant expenses, according to President/CEO David W. Mooney.
That philosophy was reflected in mergers in 2008 with $96 million asset Kaiperm Federal Credit Union, Oakland, Calif., which served health-care employees, and in 2010 with
$170 million asset Continental Federal Credit Union, Tempe, Ariz., which served employees of Continental Airlines and U.S. Airways.
Alliant was founded to serve United Airlines employees and now counts more than 150 select employee groups (SEGs) in its membership base.
“In the case of Continental, the credit union’s airline heritage made it attractive,” Mooney says. “The other aspect was that we saw an opportunity to create financial value for our members through merger and integration and elimination of redundant expense.”
Alliant announced the Continental merger in September 2010 and completed integrating operations in January 2011, retaining five branches and the related staff and some call center positions.
That enabled Alliant to eliminate approximately 80% of Continental’s operating expenses, or about $8 million annually. Mooney says conservative estimates put the merger payback at about 16 months to recover “integration expenses, write-downs to exit leases and contracts, and market value adjustments.”
Mooney says it’s painful to eliminate jobs in a tough economic environment, but it’s essential to capture economies of scale.
“I’m a believer that credit unions need to be a little bit more disciplined about eliminating the redundant expense in mergers,” Mooney says. “Otherwise, the question I would have is, ‘Why bother?’ What’s the advantage of being bigger if you’re not going to capture the economies of scale? It’s imperative if you’re going to serve your members’ interests.”
Continental members gained high deposit rates and below-market loan rates along with strong online and mobile banking services. But Continental members also had to accept the Alliant branch model, which eliminates cash withdrawals and deposits in teller lines, relying on ATMs to supply cash.
“That certainly was unpopular with some of Continental’s members whose primary needs or preferences were cash from a teller,” Mooney says. “But fundamentally that was nonnegotiable because our model is cashless and that’s a big part of why our rates are as good as they are.”
This “thin branch” approach helps Alliant avoid what Mooney describes as an “arms race” to build the most branches. Instead, Alliant targets SEGs that allow the credit union to take advantage of both the affinity with the company and the sponsoring company’s endorsement.
Finding ‘franchise value’
Western Federal Credit Union, Manhattan Beach, Calif., takes a different approach. The $1.6 billion credit union examines potential merger partners to find untapped opportunities within their fields of membership and add diversity to its SEG base.
“We almost never try to maximize savings in the short term,” although Western Federal still seeks long-term efficiencies, President/CEO John Bommarito says. “We try to find the franchise value in the opportunity and incorporate it into our existing business model.”
A 2009 merger with $20 million asset Channel Islands Federal Credit Union, Oxnard, Calif., formerly known as Oxnard Municipal Employees Credit Union, highlighted the value of serving municipal employees.
“Channel Islands turned out to have a very stable membership that was growing even in a troubled economy,” Bommarito says. So Western Federal began looking for additional municipal credit union mergers, completing a purchase-and-assumption merger with
$88 million asset Oakland (Calif.) Municipal Credit Union in February 2011.
Serving diverse employee groups enables Western Federal to target services to specific markets across branch operations in 10 states. For example, Western Federal hopes to expand business lending in California’s Ventura County while offering loan and deposit products that will attract members who work for three major manufacturers in Siloam Springs, Ark.
“Growth through mergers hasn’t been our primary objective; we like how our balance sheet stacks up with enough capital to take on risk when the time is right to do so,” Bommarito says. While composite cost savings are appealing, Bommarito places a higher value on finding market opportunities that can be integrated into Western Federal’s list of “priority markets” where it can compete and succeed.
“Meantime, our already diversified book of business—a key element of our business model that we crafted during the industry’s flight to community charters—grows incrementally,” Bommarito says. This model helps protect the credit union from a downturn in any single industry or geographic region. By avoiding a “runaway balance sheet,” it can supply those markets with capital and expense load and watch them grow, steadily and methodically, he says.
Bommarito predicts that even a small improvement in the economic outlook could cause an additional drop in merger activity because it will give hope to struggling credit unions.
An economic rebound is likely to benefit credit unions with a sound business plan,
but experts say it will only delay the inevitable for credit unions with unsustainable business models.
“Even after the pressures of the recession and the financial crisis begin to fade, we’ll probably still see continued consolidations because the economics just favor it,” Mooney adds.
SMALL CUs SEEK MERGER ALTERNATIVES
Small credit unions can thrive by seeking merger alternatives, according to Frank Michael, president/CEO of $18 million asset Allied Credit Union, Stockton, Calif., and chairman of CUNA’s Small Credit Union Committee.
Michael says small credit unions can: