The most important factor that can help a credit union decide whether to buy a bank is within its loan portfolio.

The $377 million Five Star Credit Union in Dothan, Ala., is the only cooperative in the nation to have completed two bank acquisitions in recent years.

In May 2014, Five Star completed its first bank purchase of the $21 million Flint River National Bank in Camilla, Ga., and in November 2015, the credit union completed a purchase of its second bank, the $47 million Farmers State Bank in Lumpkin, Ga.

"The biggest portion of determining fair value is driven from the bank's loan portfolio because that is where we make our money," Five Star President/CEO Bob Steensma said. "Ninety percent of our due diligence we do on these deals is in the loan portfolio. We look at how the bank's portfolio fit into our existing portfolio. What does it do to the number of church loans we have or the number of single-family rental units we have on the books, and what does that do within the parameters in our guidelines and policies? We also look for a concentration of any type of credit that is outstanding, high-risk loans, delinquencies and other issues."

After performing the painstaking work of cleaning out the bank's outdated, inaccurate or incorrect data in its portfolio, Five Star spent most of its due diligence time reviewing, analyzing and stress-testing the bank's loan portfolio.

"Regulators want those loans run through your ALM model, and they do want those loans stress-tested," Five Star SVP and COO Tyler Beck said. "The NCUA wants to protect the share insurance fund, so they want to know that when you look at the loan portfolio you understand all the risks, including the maturity of the loans, the interest rates, the resets, the pricing and other factors."

Stephen Morrissette, managing director for Providence Advisors Inc. in Joliet, Ill., and an adjunct associate professor of strategic management for the University of Chicago, recommended credit unions review a good cross section of every loan type and pay extra attention to the portfolio's big loans.

With big commercial loans, Morrissette said credit unions review all of the legal documents to make sure they have been maintained and updated. He also suggested that credit unions re-underwrite those loans using their own commercial loan documents.

"With my own institution's commercial loan documents to collect all of the information, you find things when you redo the work that you don't find when you review somebody else's work," he explained. "The analogy would be that if you read someone else's loan documents you see things from the perspective of being a passenger in a car and you are not going to see things as well when you are in the driver's seat."

It's also important to make sure all of the legal documents, including the collateral files, on commercial loans are correct and updated because some banks are better at that than others, he said. Not confirming the accuracy of the legal documents could put the financial institution at risk.

Another way to determine the value of investing in a bank purchase is to compare it to the cost of investing in a de novo branch and new employees, Bell said.

Using financial models, he helps credit unions compare and evaluate the costs and ROI of purchasing a targeted bank versus building a new branch or branches.

"If we are writing a big check for a bank purchase, people could get nervous about that, but if we were to invest in a de novo branch, we also know what that will cost, and I think that's a strong comparison for the credit union and the regulator," Bell said.

Other important factors to negotiate include the bank's contracts and the fair market price of the bank.

"Contracts are very expensive and if you assume those, they could have a detrimental impact on your financials, so we don't bring over contracts," Steensma explained. "We make sure that as part of the purchase price they have to liquidate their contracts out, which is written in the purchase and assumption agreement."

Steensma also recommended credit unions not agree to a fixed price for the bank because if the bank continues to lose money before the purchase date, the credit union will essentially share in those losses as well. That was a lesson Steensma learned from his first bank deal.

In his second bank deal, the credit union negotiated a variable price, which meant if the bank kept losing money, the purchase price would drop dollar for dollar. The purchase price would increase, of course, if the bank made money.

"What we did to figure out that purchase price was look at where our comfort zone was with how much goodwill we would bring on the books." Beck said. "We figured out what that number was and gave them that price, and it varied depending on how much money they made or lost. And so, we knew we weren't going bring on any more goodwill because of the way it was structured and priced."

Some of the big items credit unions need to watch for when determining fair value are the credit adjustment on their loans, the yield adjustment on their loans and the bank's investment portfolio.

For example, in Five Star's second bank deal, there were many long-term callable bonds with price volatility. The credit union knew if the interest rates increased, the value of the bonds would drop. While the interest rates did not increase, the credit union negotiated with the bank to liquidate the bonds seven days before the purchase closing date, which resulted in a $600,000 loss for the bank and reduced its purchase price.

Credit unions should also watch for the bank's tax-deferred assets and make sure they are written down appropriately before the acquisition is finalized. That's because those assets bring no value to the credit union.

It's also important for credit unions to include a statement in the purchase and assumption agreement that the bank maintain its books with generally accepted accounting principles – and be prepared to enforce it.

Beck once found that a bank was not writing down its other real estate owned assets to realistic market values, according to GAAP guidelines.

"Enforcing the PNA means you have to have difficult conversations with the bank's board," he said. "Once they realized they were going to lose another $100,000 to $200,000, they admitted that they knew a long time ago that they should have written down the OREOs but didn't because that would have meant more losses on their books."

While 80% of credit union bank acquisitions are cash transactions, 20% of the deals involved the credit union assuming the bank's liabilities because of its poor financial condition.

Bell said there are hundreds of banks in the $10 million to $50 million asset range that can be potential acquisition targets for credit unions with solid capital positions, as long as the management team feels comfortable evaluating and implementing these deals.

He also noted buying a bank is not exclusive to billion-dollar cooperatives, pointing out Five Star had about $258 million in assets when it made its first bank deal.

Five Star said it approaches bank deals as a picky buyer.

"We have definitely turned more deals down by a factor or two or three," Steensma said. "And that probably is the proper equation for credit unions. You've got to be a picky buyer. The money is made at the buy, not the sell. Most people make it at the sell, but we are not going to sell this asset. For us to do well, we've got to make the money at the buy. That is sort of the mentality you have to have."

List of Credit Union Bank Acquisitions

• The $1.7 billion Royal Credit Union in Eau Clare, Wis., will acquire the $35 million Capital Bank in St. Paul, Minn., in the second half of 2016.

• The $1.1 billion Advia Credit Union in Parchment, Mich., will buy the $83.3 million Mid America Bank in Janesville, Wis., in the second or third quarter of 2016.

• The $645 million Avadian Credit Union in Birmingham, Ala., bought the $112 million American Bank in Huntsville, Ala., in 2016.

• The $377 million Five Star Credit Union in Dothan, Ala., acquired the $47 million Farmers State Bank in Lumpkin, Ga., in 2015.

• The $1.4 billion Achieva Credit Union in Dunedin, Fla., purchased the $165 million Calusa Bank in Punta Gorda, Fla., in 2015.

• The $377 million Five Star Credit Union in Dothan, Ala., acquired the $21 million Flint River National Bank in Camilla, Ga., in 2014.

• The $637 million Self-Help Federal Credit Union in Durham, N.C., purchased the failed Second Federal Savings and Loan Association in Chicago in 2013.

• The $3 billion Landmark Credit Union in New Berlin, Wis., purchased the $190 million Hartford Savings Bank in 2013.

• The $1.1 billion Municipal Employees Credit Union in Baltimore acquired the $62 million Advance Mutual Savings Bank in Baltimore in 2013.

• The $2 billion United Federal Credit Union in St. Joseph, Mich., purchased Griffith Savings Bank in Griffith, Ind., in 2012.

• The $465 million GFA Federal Credit Union in Gardner, Mass., bought Monadnock Community Bank in Peterborough, N.H., in 2012.

Note: In December 2014, the $496 First Commerce Credit Union in Tallahassee, Fla., withdrew its application to purchase the $89 million First National Bank of Crestview in Crestview, Fla. The credit union and bank did not comment publicly about why the deal fell through, but FDIC data showed the bank had substantial financial problems, including a capitalization level of only 2.91%. The credit unions' assets on this list were updated to reflect their current asset levels.