For many years, the commercial banking industry has fought against the unfair advantages enjoyed by credit unions that compete for commercial business. The lack of a level playing field with regard to taxation of earnings, the substantial relaxation of the “field of membership” requirements, and the lack of shareholder accountability, give credit unions a substantial competitive advantage over their commercial bank counterparts when competing for deposits and commercial banking business. These facts continue to be true; however, another area in which credit unions have become tough competitors has come into focus: the M&A market.
Credit unions’ acquisitions of banks began slowly and innocently enough with credit unions generally viewed as a buyer of last resort, typically being considered by smaller banks that had difficulty attracting bids from other commercial banks. However, as the credit union M&A market has matured, credit unions have become a force in the M&A space with the capacity to acquire larger community banks in metropolitan areas and the clear ability to pay the premiums that sellers are expecting in today’s market and, in many cases, outbid other commercial bank competitors.
Credit union acquisitions are picking up steam in Georgia, and look no further than Florida to see where this trend is going. According to research compiled by Rick Childs of Crowe, as of early September, there had been a total of 37 acquisitions of banks by credit unions with the largest bank target in an announced acquisition being $730 million in assets. Of course, there was a recently-announced credit union acquisition of a $250 million bank in Georgia that operates in multiple markets. This article examines some of the drivers of these transactions and the talking points that banks can use to compete more effectively.
Advantages of Credit Unions
- The superficial drivers. Many assume that credit unions are able to compete effectively and pay more in the acquisitions of banks because credit unions do not pay taxes and are not accountable to shareholders. Undoubtedly the tailwind created by preferential tax treatment and the lack of market accountability play into the aggressive pricing offered by credit unions. The lack of normal market forces makes credit unions’ participation in a market process an anomaly but a real one nevertheless.
- Relaxed capital rules. A credit union’s capital requirements are based simply on GAAP capital. This fact means that when a credit union pays a premium for assets acquired in an acquisition, the goodwill created in the purchase price is treated as capital so long as it remains unimpaired on the balance sheet. Unlike credit unions, goodwill on a bank’s balance sheet is deducted from regulatory capital. Therefore, paying more premium than a bank would pay does not adversely affect a credit union’s regulatory capital in the same way that a bank’s regulatory capital would be affected.
- A desire to grow. While not necessarily an advantage vis-à-vis banks, many credit union management teams have a sincere and focused desire to grow their businesses. While some may be motivated by the prestige and potentially higher compensation associated with building a larger business, others seem to be motivated by the economic realities that credit unions face. For example, many experts saw M&A as a strategic move by credit unions to create operating efficiencies in the face of increased deposit competition from money center banks during the run-up on deposit rates prior to 2019.
While certain regulatory restrictions limit credit unions’ ability to acquire commercial business indefinitely, the field of membership rules have been relaxed to the point that they are nearly meaningless. The liberalization of a traditional understanding of those rules causes credit unions to charge forward with nearly any acquisition opportunity.
Advantages of Banks
While the inherent financial advantages are difficult to overcome, all is not lost for banks interested in competing with credit unions for acquisitions. Banks should press the following strategic benefits in building acquisition proposals that can compete with credit unions.
- Stock in Trade. For banks with liquidity in their stock, offering stock in acquisitions is a key strategic advantage. Credit unions are exclusively cash buyers, and while cash is king, offering a continuing interest in a strong franchise on a tax-deferred basis can be compelling to a selling bank’s board. Of course, merger math works best with acquirer stock that trades at a premium to the acquisition price for the target, an increasingly rare feat in today’s market conditions.
- Merger Structure. In most states, including Georgia, banks are not legally permitted to merge with credit unions. As a result, the sales of banks to credit unions must be structured as asset sales. This structure causes the target bank to need to conduct a liquidation of its charter (and then a distribution from its holding company if it has one) in order to pay the transaction consideration to its shareholders. In a typical merger (as would likely be the structure involving a bank buyer), the consideration is paid directly to shareholders which avoids the unwieldy process of a seller winding down its bank. In addition, even in those states that permit credit unions and banks to merge, those states do not permit credit unions to merge with bank holding companies. In those situations, banks are required to take the additional step of, and incur the additional cost associated with, eliminating their bank holding company prior to the bank’s merger with the credit union. Banks should be sure to highlight these structural advantages in a competitive bid process.
- Speed and Certainty of Execution. Many bank buyers are experienced and quite efficient when it comes to due diligence. On the other hand, credit unions tend to be slower, likely because they are less familiar with the types of bank assets on which they are conducting diligence. In addition, the process for gaining regulatory approval for a bank is generally faster than the process for credit unions, typically by a couple of months. Overall, a transaction with a credit union should be expected to take 90-120 days longer than a transaction with a bank. Time is generally the enemy of deals, so sellers should be aware of that risk.
- Go-forward Business. For a true commercial bank serving commercial customers, integration for credit unions will almost certainly create difficulties for customers and employees. Even fast-growing credit unions are generally not accustomed to the level of sophistication utilized by banks in servicing the needs of commercial customers. From commercial loan structures to treasury management, credit unions are less experienced than banks, which generally makes them less responsive. While credit unions might be perfectly capable of continuing the business of a retail-oriented bank with a vanilla product set, a more advanced array of products is likely to be problematic for integrating into a credit union. Finally, credit unions are subject to limitations on member business loans, constraining the growth of the commercial segment of their business.
- Balance sheet management. Even though credit unions “play with house money” in terms of avoiding taxes and lax capital rules, there is a limit to their budgets in that all of their capital is internally generated. Banks with holding companies, particularly those with less than $3 billion in assets that are treated as small bank holding companies by Federal Reserve policy, have the ability to explore more creative financing structures for acquisitions that can boost their ability to pay for prime acquisition targets. Of course, bank management teams must answer to shareholders and should not stretch beyond predetermined pricing parameters, but creativity may be required to do compete effectively with credit unions.
Credit union-bank M&A continues to heat up, receiving almost daily coverage in American Banker and recently in The Wall Street Journal. We do not expect any of the credit unions’ advantages to be taken away from them, nor do we expect credit unions to go away as competitors in community bank M&A. Accordingly, due to the lack of a level playing field, banks should be prepared to leverage all of the advantages listed above to complete more effectively against credit unions in the M&A arena.