And When It’s Over: Credit Union Normalization in a Post-COVID-19 World
A sale leaseback strategy can generate financial and accounting benefits that absorb up to 100% or more of your CU's COVID-related costs.
The new normal business environment facing credit unions is taking shape. For the moment, senior management remains focused on business continuity, protecting staff, community support and maximizing member service delivery in a difficult environment. But the dialogue in the boardroom soon will shift away from COVID-19 operational response to adjusting to new strategic realities and financial challenges unimaginable just a few months ago.
A credit union’s core mission is to improve the financial well-being of its members, and that includes helping them through temporary quarantine and income interruption. To accomplish that mission, credit unions must be financially secure themselves. Charting the right look-forward strategy means growing new business on the margin and making adroit moves in operating efficiencies now. Waiting for a fully post-COVID economic environment to take shape is not a viable alternative.
The financial elephant in the room is credit risk. Regulators have issued all manner of statements supporting financial accommodation to borrowers. That is a temporary state of affairs framed by the reality that many families and small businesses simply do not have the resources to endure more than a few months of income and business interruption. Credit unions therefore must confront the thorny business of estimated loan loss provisions for at least 2020 and 2021.
One perhaps not obvious element of a successful look-forward strategy may be tapping non-lending sources of liquidity, earnings and capital through the sale and leaseback of operating real estate, as illustrated below. It is a simple, tested and powerful strategy to enhance your credit union’s financial condition in an operationally seamless manner. While the logic of sale-leasebacks was always compelling, the new reality of unexpected and substantial loan loss provision expenses makes this strategy look better than ever.
The chart below presents three hypothetical scenarios facing credit unions with assets of $1 billion, $3 billion and $5 billion in assets. Faced with substantial unexpected incremental loan loss provision expenses, each is able to offset all or a substantial portion of those costs with a sale-leaseback of its main office, while retaining full, uninterrupted use of the facilities and harvesting a substantial, immediate, tax-free gain otherwise trapped on its balance sheet.
The basic value proposition is simple and time-tested. Many credit unions have operating facilities on their books at steadily depreciating carrying values while those facilities in reality enjoy steadily increasing market values. Thanks to recent changes in accounting rules, by selling a facility the credit union could recognize an immediate tax-free gain, offset onerous unexpected loan loss provision expense, generate fresh liquidity to lend out and rebuild interest income, and likely provide a boost to capital. By leasing back the facility, the credit union would maintain uninterrupted operations for a lease term negotiated to suit its long-term occupancy preferences (typically 20 or more years).
From a tactical standpoint, a sale leaseback could be done as a single transaction, for example involving a main office or operations center and perhaps some larger branches. Or, it could be done through a series of multi-location transactions phased over several years in order to have a predictable, annuity-like impact on financial performance.
The efficiency of a sale leaseback transaction is synergistic. The credit union unlocks financial resources that are otherwise trapped on its books. It deploys those resources to benefit members and communities that are in need like never before. Ownership of the underlying real estate is placed in the hands of an investor that can utilize recently enhanced tax benefits from real estate ownership (including expanded depreciation write-offs and lower effective tax rates) that the non-taxable credit union cannot enjoy.
There are accounting, legal and regulatory issues that require the credit union’s attention, but sale and leaseback transactions are a time tested, easily understood, but often overlooked tool for enhancing credit union finances.
The challenge of unanticipated loan loss provision expenses in the next few years could put a major dent in your capital reserves. A well-designed and executed sale leaseback strategy can generate financial and accounting benefits that absorb up to 100% or more of those COVID-related costs and strengthen your foundation moving forward.
Steven Eimert is Of Counsel for Business Law and Credit Union Groups at Sherin and Lodgen LLP in Boston.
Edward Lopes is CEO of CU Real Estate Solutions, LLC in Boston.