Buying a Bank Is in Line With Growth

Credit unions looking to build market share generally have had two options: build from scratch in a geographic area with growth potential or merge in other institutions.

Building from scratch, also known as going de novo, is capital-intensive and offers no guarantees of achieving targeted market penetration and financial returns. Mergers may be more promising in terms of building market share, especially if credit unions expand their merger concepts to include the possibility of acquiring a community bank or bank branch and the new members that often come with such a transaction.

As with any merger or acquisition, buying a bank is a complicated endeavor. But interestingly, some aspects of buying a bank or acquiring a bank branch may actually be more straightforward than negotiating a merger with another credit union. This may be a reason why interest in bank acquisition among credit unions has been accelerating over the last 12 to 18 months.

Completed bank acquisitions have gone from about one a year to two to three a year, and more credit unions are looking to buy banks. The size of banks that credit unions might consider acquiring also has been rising.

Why Buy a Bank?

Merger negotiations with other credit unions can be complicated by emotion. Executives and directors of a merging institution may be protective of their organizations’ identity, culture and history. They want assurances about how their members and employees will fare. Merger talks sometimes break down over differences about how the merging institution will be represented on the continuing organization’s executive team and board.

In contrast, purchase price typically is the most important criterion when evaluating a bank acquisition. When a privately held bank is looking to sell, the owners’ priority is simple: Give us the best price and chances are, you’ll be the winner. This is one reason credit union executives and boards are starting to ask, “If we need to go through that level of effort to negotiate a merger and get through integration, why not consider a bank?”

Acquiring a bank and its customer base can square up nicely with a credit union’s strategic priorities of expanding market share, diversifying through business lending and/or entering new markets. Successfully executed, buying a bank paves the way for growth in a prized community and access to experienced financial professionals who know the market and their jobs. A bank acquisition can tick a lot of items off the wish list for credit unions looking to expand their product offerings and market share.

Scouting New Territory

That’s not to say a bank acquisition will be easy. There are bank regulators to deal with although, generally speaking, when a credit union acquires a bank, the National Credit Union Administration or state agency overseeing credit unions generally takes the lead in reviewing and approving the details of the transaction.

The trickiest questions regulators may pose involve field of membership. The acquiring credit union needs to be comfortable explaining how existing bank customers fit within its existing field of membership. Otherwise, it may need to file for an expanded field of membership to accommodate the acquisition, which opens up a whole new challenge. The acquiring credit union will also need to educate bank customers on what a credit union is and explain that they will not lose services—and may even gain more offerings.

In the limited history of these acquisitions, state-chartered credit unions seem to have had more success in addressing field of membership questions than those with federal charters. Let’s say a credit union has a charter that spans an entire state and the bank it is acquiring serves three counties in the state that are outside of the credit union’s current primary market. No field of membership issues are raised in that case. But a credit union with a charter to serve multiple common bonds, more common under federal charters, will likely encounter regulatory roadblocks. The inability to absorb bank customers into an existing field of membership can be a deal breaker if the credit union has not thought ahead and planned appropriately.

These field of membership requirements pose unique issues, so credit unions considering a bank acquisition need to work with legal experts with specific experience navigating these negotiations and regulatory reviews. Even credit unions that have been through multiple mergers may not be prepared for the special challenges that will arise when they are purchasing a bank.

Post-approval mechanics also require special handling. In both a credit union merger and a bank acquisition, the parties need to get through two major milestones: (1) “legal day one,” when the two financial institutions formally become a single entity, and (2) systems conversion.

In a credit union merger, these are usually two separate dates, with system conversion happening sometimes months after legal day one. In the interim, the continuing credit union may elect to avoid member confusion by continuing to operate under two separate brands until the system conversion is complete.

This is more limited in a bank acquisition. As of legal day one, the continuing credit union can no longer call any part of its organization a “bank.” It needs to eliminate that word in all communications. Former bank customers are now members whose deposits are insured by the National Credit Union Share Insurance Fund, not the Federal Deposit Insurance Corp. The need to change disclosures and potentially other processes at legal day one (vs. the conversion date) is one of many nuances that require the guidance of an experienced merger and acquisition team.

Calculating the Price Tag

In a bank acquisition, the acquiring credit union writes a check to the bank owners to complete the deal. Only credit unions with adequate liquidity to cover the upfront price tag and a capital position that can absorb the dilutive impact of new intangible assets are able to do so.

A bank acquisition generates a lot of “goodwill,” the difference between the purchase price and the bank’s book value. Goodwill is classified as an intangible asset that doesn’t count against risk-based capital. A credit union with 12 percent capital may get diluted down to 11 percent because goodwill is excluded from the risk-based capital calculation. While a credit union merger will also create goodwill, the effect is more minor compared to a bank acquisition, because the calculation of goodwill is based on the calculated value of the merged credit union vs. the purchase price, which is often higher than the “intrinsic” value of the institution based on such valuation approaches as discounted cash flow. Continuing our previous example, the risk-based capital might only be reduced from 12 percent to 11.8 percent. As a result, credit unions considering a bank acquisition should have a strong capital cushion, well above regulatory limits.

As an alternative, buying a bank branch is less capital-diluting than purchasing a bank. The credit union will still need to cut a check to complete the transaction, but it may cost less in the long run than building, staffing and marketing a new credit union branch—and it could bring with it the deposits and loans of branch customers, depending on how the purchase is negotiated.

In other words, buying an operating bank branch is typically not just a real estate deal, though a new physical location is the most visible part of the transaction. Often when branches are sold, the customer relationships—including their deposits and loans—are part of the negotiations.

Bank branch acquisitions may involve community banks or large national institutions. For example, Bank of America may have a branch in a rural county, 200 miles from its next nearest facility. If the bank decides to take that “orphan branch” off its books, it can close the facility and leave its customers to find a new financial institution, or it can look for a buyer.

When customer deposits are transferred in such a sale along with the building title, the bank typically negotiates a fee, called a “deposit premium.” The credit union pays a price to assume those accounts, but that price will likely be lower than the costs of recruiting new members and their deposits and loans. Loans are typically sold at the fair market value.

Selling the Brand and Model

Once the bank or branch acquisition is completed, the acquiring CU still has its work cut out for it—to maintain and build on those new member relationships and to make the finances work. If the previous owners of the bank or branch weren’t satisfied with their financial returns, what makes a CU team think it can make this venture work?

First and foremost, credit unions don’t have the pressure that banks do to generate a return for shareholders. As long as they can cover operating costs and meet their capital requirements, credit unions with an effective, efficient financial model can make a go of serving their new members.

Committing to the purchase of a bank or branch that its current owners don’t consider profitable enough requires that the credit union is confident that it can successfully “export” its business model to this new market.

Then comes the challenge of winning over new members, many of whom likely have questions about why their bank is now a credit union—and maybe even what a CU is.

A suitor credit union must come to the table ready to answer questions about how bank customers and staff will thrive in their new environment. And, as their financial services provider, the credit union should be prepared to offer its new members products and pricing that make it worthwhile for them to stick around. It may well be that the credit union can provide a wider range of products and services—more mortgage, home equity and consumer loan options—and better rates than the community bank that previously held their accounts, especially for consumer customers.

Community bank customer bases (loans and deposits) tend to be more commercially oriented than those of credit unions, which can offer an acquiring credit union a firm base on which to build business lending or enhance an existing program.

The acquiring CU may also be able to rely on business lenders and branch staff as they transition from bank employees to credit union ambassadors.

A final adjustment that an acquiring credit union must address is the difference in organizational culture and business norms. For example, at many community banks, commercial loan officers are paid well for building business, to the point that their annual pay with incentives may equal or surpass the credit union CEO’s compensation. Is the credit union comfortable with this practice as a condition to holding on to high-performing business lenders?

Also, can the acquiring credit union align the titles of its bankers-turned-credit union executives in a way that keeps them enthusiastically on board in the new organization? The key to success is ensuring early engagement with bank loan officers and branch managers (that is, within 60 days of the acquisition announcement) since they are the face of the credit union post-merger in those markets.

Seekers of Scale

Consolidation in both the credit union and community bank sectors will likely continue for some time, as financially healthy organizations seek to achieve a long-term sustainable scale. The banks that would be most attractive to credit unions in this environment would be privately held, community-based institutions with family ownership.

These institutions’ values and commitment to community are typically much more aligned with credit unions than those of larger banks—resulting in smaller cultural gaps that need to be bridged. The shareholders want the best price, but may have other concerns. They want to do right by their customers, employees and community. That commonality may give credit unions a leg up in negotiations—if they are prepared and open to handling the challenges that accompany this growth opportunity.  

Vincent Hui is a senior director with CUES supplier member and strategic partner Cornerstone Advisors. He specializes in strategic planning and leads the firm’s merger & acquisition and risk management practices.