Navigating Risk

"You’ll always miss 100 percent of the shots you don’t take." – Wayne Gretzky

Joining forces can be effective for credit unions that want to stay viable long term. To give a merger their best shot, leaders need to recognize and respond to the risks that arise from initial discussions through implementation.

Even before the executive team and board begin to consider potential merger partners, they should have a clear shared understanding of how this endeavor might fit into the overall strategy and what risks must be addressed to optimize outcomes. Of all the risks the National Credit Union Administration has identified as inherent in the mission to serve members’ financial needs, two in particular come into focus in exploring whether a merger would support that mission: strategic risk and compliance risk.

In evaluating the strategic risk posed by a prospective merger, consider these questions: Can your credit union continue to compete as a stand-alone financial institution? How would you rate its competitive position in the field of membership it currently serves? To what degree is that existing market saturated? Is the credit union already serving its likely share of that market, or is there room to grow?

On another front, are there any critical products and services that your credit union needs to provide to compete effectively but can’t do so cost effectively on its own? Do you have the resources to invest in any new technology needed to keep pace with the market and member expectations? Answering these questions aids in an objective assessment of the strategic challenges your credit union may face.  

The burden of managing compliance risk can be daunting, especially for smaller CUs. Measuring the scope of the regulatory burden includes considering both employees whose jobs relate directly to regulatory issues and member-facing staff, such as mortgage officers and branch staff, whose responsibilities are made increasingly complex with added disclosure requirements. The burden of compliance is unlikely to lighten, with new regulations arising regularly on the federal and state levels. If the CU decides that the burden is too high and it cannot continue to meet member expectations, a merger needs to be a viable option.

According to NCUA statistics on why credit unions merge, many of the most-often cited reasons relate to strategic and compliance risks: a desire to grow membership and asset size and expand the field of membership; the need to introduce new products and services to meet members’ evolving expectations; and concerns about the rising costs of regulatory requirements.

The board and management need to carefully evaluate those two prime elements of risk and weigh the credit union’s ability to meet those challenges on its own. If you conclude that those risks are too great, searching for a merger partner or partners may be a viable game plan.

Keeping Scale in Perspective

"Life’s greatest dangers are often found in apparently small risks." – James Lendall Basford

Besides addressing strategic and compliance risks, another common goal for a merger is pursuit of economy of scale. Scale addresses some aspects of the risks that turn credit unions toward consolidation in the first place, but it also creates new risks.
Gaining scale by itself is not a good enough reason for credit unions to merge, however; achieving economy of scale should be viewed as a means to an end. It might be for banks, with the aim of increasing return to shareholders. But credit unions have a different mission. Executives and directors should study and agree on how best to use the increased resources of the continuing credit union to further that mission after the merger.

Is the long-term vision to apply the cost savings and/or additional revenue to larger investments in the community or in member services? Has the board identified a need to “bank” those savings and grow capital or to reinvest those funds by expanding capabilities? The return on realizing economies of scale might be about the pace of progress: Maybe new services that were on the roadmap for two years out could instead be introduced next year.

Taking up these issues before the agreement is signed assures the leaders of the merging credit unions that their members’ interests will be served by consolidation and provides a beacon to guide both organizations through implementation. Failure to explicitly address the issue of scale early on could have the effect of diminished results for the combined credit union.

Merger discussions can get emotional over questions about who will lead the continuing financial institution, how many directors the new board will have and how the legacies of the merging organizations will be recognized. These are important questions, but boards and management teams must not lose sight of the longer-term issue of how the credit union will operate once those pieces are in place. I’ve seen deals fall apart—luckily before they got to the altar—because the leaders of the two credit unions couldn’t agree on how they were going to operate as a combined organization and where they were going to utilize the additional resources expected to result from the merger.  

"Integration and Execution Risks Predicting rain doesn’t count. Building arks does." – Warren Buffett

As implementation of the merger begins, the risk management focus shifts to integration and execution. Integration risk gets a lot of attention, rightfully so: How do you bring two organizations together culturally, operationally and technologically? Two credit unions need to become one as quickly and efficiently as possible.

The second challenge, which could be referred to as operating model or execution risk, is equally crucial but may get short shrift. Once you’ve worked through all the major integration points, it’s time to step back and consider: If your major goal was to expand your market or reduce compliance risk, have you accomplished that aim? Has your executive team and board reassessed the credit union’s business model? For example, if a key objective of the merger was to dilute an over-concentration of indirect vehicle lending by expanding mortgage volume, what does your loan portfolio look like now, and do you know how to manage that diversification?

Everybody can be so focused on getting the deal done that addressing both the big picture and the details of operating as a combined credit union is not done so purposefully. Integrating staffs, systems and infrastructure is just the outer layer of the merger. You have to keep peeling the onion and asking: Is this working out for members as we expected it would? Post-integration execution is an aspect that can be overlooked or not undertaken with sufficient vigor. In the worst case, you end up with a lot of infighting among management or on the board about how to execute and where to spend the money gained from economies of scale.

Cornerstone is currently working on a couple of mergers in which the credit unions have complementary products and branch networks. Management teams are moving forward on plans to improve online banking and mobile access. These considerations are all good and necessary, but we are encouraging the merger partners to peel back the onion a bit more to consider: What’s your business plan for the next three years?

The value proposition of the merger is different from the business plan underlying the merger. The value proposition is what you want to achieve to build value for members. The business plan and strategy are the how. Insufficient attention to the hows is the definition of execution risk.

With respect to Mr. Buffett, the ark of a merger is the conveyance that carries the continuing credit union across the high waters of implementation through the many details of integration. When those waters recede, how will your credit union operate, and how will you monitor outcomes to assess that the hows of the business plan deliver on the value proposition?

Driving Value, Managing Risk

"Living at risk is jumping off the cliff and building your wings on the way down." – Ray Bradbury

Sci-fi writers may be able to leap before they look, but credit unions need to take more care in evaluating the risks inherent in mergers before committing to that course. As your leadership team evaluates merger opportunities, be sure that your planning incorporates the need to assess levels of integration and execution risk going forward. If you agree on a plan to manage those risks and enter a merger agreement, both credit unions need to put in place the planning, analysis, ownership and accountability to effectively manage those risks throughout the process.

The board has a responsibility to ensure that those risks are being addressed on a timely basis. One challenge is that, unlike public bank boards that have a more formal fiduciary responsibility, the duty of care is less explicit for credit union boards. Directors must rely on their internal governance frameworks and policies in finding the right balance between driving value and managing risk in merger discussions.

The level of risk varies based on the relative size of credit unions involved in the agreement. If a smaller credit union is merging with a financial cooperative 10 times its size, for example, the integration and execution risk profile will not be as great because the merging credit union will be adopting the continuing credit union’s operating model.

On the other hand, in a merger of near-equals, where the size of the non-surviving credit union is at least 50 percent of the size of the surviving organization, the risks are greater. When a $500 million credit union is merging with a $1 billion credit union, the potential for operating model risks increases. For 12 to 18 months following the official merger date, the board and leadership of the continuing credit union must stay vigilant in managing execution of the agreed-upon operating model.

Vincent Hui specializes in strategic planning and leads the Merger and Acquisition and Risk Management practices for Cornerstone Advisors, Scottsdale, Arizona.