3 Key Considerations for Credit Unions Considering Bank Purchases

While it would be easy to fill an entire volume of textbooks with specific items that need to be discovered, assessed and agreed upon prior to exploring a bank acquisition, the most common issues for credit unions seeking this type of growth opportunity tend to fall within three main areas: Why a bank and not a credit union, the financial structure of the transaction and regulatory concerns. Here, we’ll address some of the most common questions the ALM First team receives.

1. Why a Bank and Not a Credit Union?

We often hear credit unions say that they can make a business decision to buy a bank and realize synergies immediately. However true this may be in some cases, the motivations and goals of both parties need to be examined. Yes, you may be able to buy out a bank’s board of directors, but what are you buying exactly? Is it the physical location, the commercial lending expertise, the business services, technology, other products and services, or is it financially motivated in terms of liquidity or something else?

We recommend that institutions conduct an in-depth assessment, including careful consideration of the positives and negatives of both a credit union merger and a bank acquisition, early in their strategic process. Credit union mergers have a number of positives, including no transfer of consideration (typically cash) required, existing members and staff already familiar with the credit union difference, and a history of overwhelmingly favorable responses from members, employees and communities to “collaborative” mergers. The downsides of credit union mergers include the drive by both parties to be the “surviving” institution and the more humanistic ties volunteers and leaders may have to their cooperative, which can result in a longer process than buying a bank.

Bank acquisitions do tend to be perceived as more of a business decision than the “collaborations” required in credit union mergers. Ideally, this means a deal can potentially be done faster and credit unions can purchase expertise they are lacking. On the negative side, the credit union buyer cuts a check to the bank shareholders, which will result in a decrease to the net worth post-bank acquisition. There is also the potential for double taxation based on the bank’s structure, less certainty about retaining customers as members, and more regulatory bodies involved. All of these aspects complicate the transaction and may mean that the synergies sought may not come to fruition as quickly as anticipated.

2. How Does the Financial Structure of the Bank Impact a Transaction?

The structure of the bank may have an impact on the purchase price. Banks can be structured as S corporations or C corporations. The S corporation is generally the same as the C corporation; however, S corporations, upon their inception, make a special election to be taxed differently by the IRS. S corporations do not pay tax on earnings. Instead, the earnings flow through to the shareholders to be reported on personal tax returns. Whereas C corporations are taxed and their shareholders are taxed. Shareholders must pay tax on the receipt of assets from the distribution or liquidation of the company following an asset sale, resulting in double taxation.

Banks may be sold via two different taxable methods, an asset sale or a stock sale. In an asset sale, the corporation sells most of its assets to the buyer, but ownership does not change. The gain from sale is calculated at the company level and taxed to the company (for a C corporation), or passed through and taxed to the individual shareholders (for an S corporation). After the proceeds of the sale are distributed to the shareholders of a C corporation, their shareholders are then taxed again (both instances of income taxation occur at both the federal and state level).

In a stock sale, the shareholders sell shares to the buyer directly. There is no transfer of assets, only transfer of ownership. Stock sales are treated similarly for both S corporation and C corporation targets. The individual shareholders are the sellers. Therefore, each shareholder reports the sale as a capital gain. Since there is no gain transaction for the target corporation, the stock transaction eliminates the double taxation impact of an asset sale of a C corporation.

However, credit union bank acquisitions must be structured as a purchase of assets & assumption of liabilities (P&A). Federal law and most state laws do not allow for direct mergers of a bank into a credit union, or for a credit union to purchase stock and hold the bank as a subsidiary. If the target bank is a C corporation, there is virtually no way to avoid double taxation on the sale of its assets

A simplified example of taxation on the sale of assets of a C corporation and S corporation is shown below. Double taxation occurs for the C corporation, resulting in an effective tax rate of 56.57% versus 38.10% for an S corporation. It’s important to be aware of how double taxation can affect the bid of a credit union on a C corporation bank; whereas a bank can structure the acquisition as a purchase of stock, the credit union may be required to increase the purchase price for the “net” amount to shareholders to be equal (if bidding against a bank).

David Ritter is Managing Director for financial advisory services firm ALM First headquartered in Dallas, Texas.