What Does the Future Hold for Credit Union Mergers?

Although credit unions continue to leverage mergers to achieve scale and stay competitive in the marketplace, that strategy may be changing as more of them are turning to other options, such as purchasing a community bank or forming a partnership with a fintech for growth opportunities.

What’s more, a comprehensive analysis and review of the industry’s consolidations from 1979 to 2017 conducted by Filene Research Institute offered an in-depth look into whether mergers create value for credit union members. And one of the report’s surprising findings may alarm credit union executives who are looking to create marketplace scale through a “merger of equals” to strengthen their competitive position.

The Chicago, Ill.-based business consultancy West Monroe Partners conducted an online survey of 100 credit union leaders whose organizations are actively pursuing merger and acquisition transactions. Although the number of executives who responded to the survey is small, it may nevertheless provide some slivers of insight as to the top-of-mind considerations among credit union leaders who are considering mergers and acquisition partners.

A little less than half, 46%, of respondents to West Monroe’s poll said they are looking to merge with another credit union. However, the survey found 54% of credit union executives are considering a bank merger or fintech partnership/acquisition. Thirty-two percent of the credit union respondents said they plan to merge with banks and 22% said they are considering fintech organizations.

Though credit union mergers are expected to continue to dominate the M&A field, negative perceptions about the industry’s consolidations persist today.

“Mergers are often seen as an indication of failure on the part of the credit union target, and there are lingering questions about whether a merger is beneficial or detrimental to members of the target and/or the acquiring institution,” William E. Jackson III, a business professor at the University of Alabama, wrote in the Filene research paper released earlier this year.

The report, “Do Credit Union Mergers Create Value for Credit Union Members? An Analysis and Review of the Empirical Evidence,” includes the results of an in-depth analysis of the industry’s consolidation over the last three decades.

When small credit unions of $100 million or less in assets, and midsize credit unions of more than $100 million to $1 billion in assets, consolidated with large credit unions of more than $1 billion in assets, the consolidations did create value for members through loan and deposit benefits, according to Jackson’s research.

However, when midsize credit unions merged with other midsize credit unions, otherwise known as “mergers of equals,” the loan and deposit benefits were significantly lower while the noninterest expenses actually increased, according to Jackson.

He reviewed previous research on credit union mergers from 1984 to 2009 by Filene Economist Luis Dopico and Filene Fellow and University of California, Berkley, Professor Jim Wilcox. Jackson and his research team updated that previous work by analyzing data from the NCUA on credit union consolidations from 2010 to 2017.

For the mergers that occurred from 2010 to 2017, Jackson’s research team developed metrics based on an index of the rates credit unions offered on different loan and deposit products. To determine the benefits of these credit union products, they were compared to the national average rates of loan and deposit products offered by commercial banks. Positive metrics implied that credit union loan rates were lower than commercial bank loan rates and that credit union deposit rates were higher than the deposit rates at commercial banks.

The research also reviewed noninterest expense ratios to measure operating efficiency. A decline in the noninterest expenses ratio meant that the credit union became more efficient post-merger and was passing these efficiency savings to members.

From 2010 to 2017, there were 54 midsize-to-midsize credit union consolidations versus 30 midsize credit unions that merged with large credit unions.

The loan benefits from midsize-to-midsize credit union mergers were significantly lower than from the midsize-to-large credit union consolidations, 0.09 vs. 0.38; for deposit benefits the comparison was 0.12 to 0.38; while the noninterest expenses ratio actually increased to 0.06 for midsize-to-midsize credit union mergers and substantially declined to -1.60 for midsize-to-large consolidations, according to Jackson’s research.

Jackson’s metrics also showed that small credit unions see the most benefits from merging with large credit unions versus merging with other small credit unions. For example, loan benefits were seven times larger (0.70 vs. 0.09), deposit benefits were five times larger (0.25 vs. 0.05) and reductions in noninterest expenses were more than three times larger (-1.30 vs. -0.35).

“We stress that these are averages,” Jackson wrote. “There are some large credit unions with much higher than average noninterest expense ratios or much lower than average loan benefits and deposit benefits. Similarly, there are some small- and medium-sized credit unions that outperform their asset size categories across these measures.”

He said that small or midsize credit unions seeking to merge with a large credit union must be diligent and investigate the individual metrics – for both current and historical performance – of their prospective large credit union merger partner.

For credit union executives who may have some second thoughts about merging with another credit union, the emerging trends of credit union acquisitions of banks and credit union-fintech partnerships provide additional strategic options for growth.

John Stockamp, the Seattle, Wash.-based director of the financial services practice at West Monroe Partners, said his company’s online survey of credit union executives showed 32% of them are planning to merge with banks and 22% said they are considering fintech organizations.

“Their primary reasons for wanting bank/fintech mergers are twofold. The first is technology-based. Credit union leaders feel that a bank or fintech partnership will facilitate access to technology that wouldn’t be available otherwise,” he said. “The second reason is growth. Leaders feel these mergers will, in the words of one respondent, ‘make our business more viable in the long run.’”

To be sure, more credit unions are considering the possibility of establishing a partnership or acquisition of fintechs. In September, for example, Florida’s second largest credit union, VyStar Credit Union in Jacksonville, announced it created a $10 million fund to invest exclusively in fintech companies and the R&D CUSO, MEMBERS Development Company, is also establishing a company that will manage a credit union ventures fund to invest in fintechs.

In the credit union bank acquisition arena, there have been 37 credit union bank purchase deals since 2012. Twelve of those new acquisitions were announced from January to September of this year, compared to 11 new acquisition deals in 2018, three in 2017 and 2016, and two each year from 2012 to 2015. A few cooperatives have bought two or three banks.

Andrew P. Meyer, a senior economist for the Federal Reserve Bank in St. Louis, Mo., noted one reason that may keep enticing credit unions to make bank acquisitions is that it may be the fastest way to expand into new business lines that are more closely associated with banks.

“The average ratio of business loans to total loans for the acquiring credit unions in the quarter before the transaction was 8.6%, whereas the average for the acquired banks was 33.8%,” Meyer wrote for the FRB’s Regional Economist. “The acquisitions of the commercial banks raised the business loans to total loans ratio in the credit unions to 10.9%.”

Indeed, several credit unions that have announced bank acquisitions have acknowledged this strategy of expanding and diversifying their business banking offerings, which will serve to strengthen their overall loan portfolio.

Cheryl DeBoer, president/CEO of the $2 billion Advia Credit Union in Parchment, Mich., said the acquisition of the $149 million Golden Eagle Community Bank in Woodstock, Ill., announced last year, is expected to grow the credit union’s commercial-focused financial solutions, including commercial lending and deposit services.

Meyer also pointed out that if a bank has profitability challenges only because of its small size, then a larger pool of financial institutions would likely pursue the acquisition of that bank. However, if the bank’s challenges are more complicated than its ability to grow, a credit union may be willing to pay a higher price for the bank – and all of it in cash – because of the credit union’s favorable tax treatment.

In addition, there’s the relative convenience of integrating with a bank or fintech partner compared to merging with another credit union, Stockamp noted.

For example, in a transaction between two credit unions, both organizations have a responsibility to both entities’ members and board directors, while those concerns are apparently abated with a bank or fintech transaction.

“This rang true in our [survey] finding,” Stockamp said. “Forty-three percent of credit unions that had been seeking a merger and acquisition with another credit union for more than 12 months cited member alignment as a reason for the prolonged time frame, compared with 25% of those looking for a bank partner.”

Credit union-bank acquisitions are also gaining traction as a national industry trend because experts agree it’s actually easier to buy a bank than to merge with another credit union, in part, because the acquisition process from start to finish may take just several months or up to a year, and the ROI is typically in five years or less.

Among credit union executives who responded to the West Monroe Partners online survey, 88% pointed to regulations as an issue when exploring a fintech acquisition.

“Those seeking bank and fintech agreements are facing down an educational or buy-in requirement around topics like lending limits, products on offer and even regulators themselves,” Stockamp said. “While regulations have loosened in recent years, these mergers still aren’t a simple shift for any credit union.”

Jeff Kline, president/CEO of the R&D CUSO, MEMBERS Development Company, acknowledged there are regulatory restrictions for credit unions and CUSOs to invest in fintechs, and he hopes to work with the NCUA to modernize those regulations.

In the meantime, MDC is laying the groundwork for the credit union ventures fund and has already established a plan to form a company to run the fund under the guidance of professional investment fund managers.

Kline said all of the approximately 70 large credit unions that are co-owners of MDC want to form collaborative partnerships with promising fintechs, and fintechs want to explore similar partnerships with credit unions.

“Fintechs need a partner to help them understand the landscape, the lingo and the member base. They are looking for our members,” he said. “We can bring a lot of value to them. The partnership could look more like a traditional customer/vendor relationship, and there is a lot more of that going on.”

One challenge, however, is that many fintechs lack awareness of the credit union industry.

“I have probably talked to 50 to 70 fintechs,” Kline said. “Many of the ones I have talked to are very intrigued by credit unions. They love our focus on our members, but they don’t know very much about us.”

To change that, Kline said the industry needs to proactively engage fintechs that have something to offer credit unions and their members, so they become not just options but sought-after partners to fintechs looking to change the world for the better.

“Our approach to this was to create our own fintech-centric event, MDC’s FinTech Expo. With help from eight of our owners, we identified dozens of fintechs with something to offer the credit union industry,” he explained. “After evaluating 30 of them more closely, we invited a final 15 to present at our inaugural event this past August after our Summer Owner Meeting in Chicago. We will repeat the expo again in August 2020, with the goal of sharing the best fintechs have to offer the credit union industry and inviting any credit unions that wish to engage in this work with us.”