Credit Union Mergers: 2020 Trends & 2021 Outlook
Consider how your CU might create new member benefits and more sustainable growth through a proactive M&A strategy in 2021.
After years of experience helping credit unions navigate mergers and acquisitions, we have been struck by a unique trend taking place this year due to ongoing uncertainty in the marketplace. Let’s simply call it the “year 2020 effect.” Just like COVID-19, the upcoming elections, stimulus concerns/deliberations and more have impacted every aspect of our daily lives, they have also significantly impacted the M&A space.
Deals Slow Down Today, Doors Open for the Future
We do still see some mergers happening in the credit union industry this year. However, they are predominately based on opportunities that had been in the works long before COVID-19 entered the scene.
Although credit union mergers have waned in the first few quarters of 2020, we have seen a surge in credit unions open to considering mergers as a part of their forward-looking strategies. This is especially true for those institutions that may have previously shied away from M&A discussions altogether.
This year, we have seen credit unions actively developing their own merger strategies as a way to prepare both proactive and reactive reference documents for mergers as the industry continues to consolidate and economic uncertainty continues to be a mainstay.
Rationale for the Slow Down
We are now all familiar with the phrase “the new normal.” When shut downs across the country first began due to COVID-19, credit unions immediately pulled back to focus on operational effectiveness in serving their current membership via a multitude of new methods from remote channels, appointment-only branch availability and drive-thru services. The challenges of mobilizing a remote workforce in a short period put M&A strategies on hold due to more pressing issues.
In addition, any mergers that were in process were more cautiously pursued due to undefined credit risk, regulatory uncertainly and the challenges posed by a lack of face-to-face meetings due to social distancing protocols. The impact of factors such as these can be seen clearly in the KBW index above (a benchmark banking sector stock index), which shows values rebounding back to early 2019 values, but still 30% off from end-of-year 2019 prices.
Compounding these uncertainties, the credit union industry’s longer term consensus is that 2020 will result in higher loan loss provisions, lower net interest margins and lower earnings. Interestingly, unlike the Great Recession, earnings were considered to be more of a focus since many institutions entered COVID-19 with higher capital levels.
Rationale for Increased Interest in Future Mergers
Although there is still a great amount of uncertainty, the VIX volatility has “moderated” from the heights seen at the start of the COVID-19 pandemic.
Now that many internal operational procedures have been put in place in this “new normal,” many more credit unions are looking at strategic mergers as a viable option for long-term sustainability and relevance.
Is This the Tipping Point?
The credit union industry as a whole had been doing well; however, external factors have sparked new interest as credit union leaders rethink opportunities and consider how M&A could be used to help their cooperatives weather future storms. A renewed focus is being placed on such items as:
- Scale to afford weathering depressed earnings;
- Convenient member distribution channels (both physical and digital);
- Diversified membership;
- Technological infrastructure;
- Human capital (e.g. specialized employees and succession planning); and
- Opportunity before conservatorship.
Macroeconomic factors including COVID-19 uncertainty and continuing net interest margin and volume depression are opening new doors. As digital delivery of products and services has become a central factor in 2020, the potential to increase member benefits by enhancing access and convenience may also drive new merger conversations. This is particularly true for institutions that may be lacking the resources needed to move their digital platforms forward quickly. Increased risk in the loan portfolio may also make the case for greater diversification through a merged institution.
Overall, we believe the potential benefits of M&A will drive more activity in 2021 as credit unions seek new ways to serve their members and strengthen their institutions for the long-term.
How Has COVID-19 Impacted CU Merger Profiles?
We’ve seen five major impacts from COVID-19 related to credit union merger profiles: 1. CEOs are more open to discuss merger possibilities than in past years – COVID-19 is the main driver of this notion. 2. Larger institutions are considering targets they might not have considered pre-COVID, taking opportunities to help struggling credit unions. 3. Financial institutions were very well capitalized leading up to the pandemic. Declines in capital may be a motivation for M&A, but not a primary motivation. 4. Prior to COVID, smaller institutions (less than $200 million in assets) were primarily focused on acquisitions of smaller targets. COVID has caused those institutions to think twice and more are considering mergers of equals. 5. Larger institutions ($1 billion-plus in assets) are considering mergers of equals. In these cases, both credit unions are often better off as a combined organization. Over the last few years, merger of equal transactions have gained traction in the community bank space, and we expect the credit union space to continue to follow suit.
The graphics below show that relatively larger credit unions are merging compared with the smaller mergers that have historically occurred. When you look on a quarterly basis, you can see that volume has slowed dramatically in 2020 year-to-date.
M&A Market Future Outlook
Beyond struggling credit unions being forced into conservatorship, we expect to see the following trends in the credit union merger landscape:
- Credit unions acquiring banks will most likely continue to be stalled until 2021.
- Credit union to credit union transactions will decline from 2019, but proactive discussions will continue to take place and deals will likely be completed in 2021.
- COVID-19 has made some smaller institutions realize that it might make sense to consider merging with a larger credit union.
- Bank to bank transactions will be limited and probably only occur because of financial distress or as a matter of necessity.
- M&A will become even more important for financial institutions once the economy recovers (COVID-19 has emphasized the importance of scale and deeper internal resources, especially in a low-rate environment).
- Deals may increase once there is a better understanding of the credit risks.
While mergers may not be right for every credit union, the current environment has challenged all of us to explore new opportunities and challenge traditional notions. As you plan for 2021 and beyond, consider how your cooperative might be able to create new member benefits and create more sustainable, long-term growth through a proactive M&A strategy.
David Ritter Managing Director ALM First Dallas