I often get calls from credit unions that are considering merging into a larger credit union. Unfortunately, many of these credit unions wait too long before considering the merger option. Their deteriorating financials limit the choices they have to find a partner that offers the greatest benefit to members, staff, and community.
If a merger is a possibility in your credit union’s future it is wise to begin thinking about how to position your credit union as an attractive merger candidate so that you can be more selective in your merger partners and negotiate a better deal.
Size – Increasingly larger credit unions will only consider a merger partner if they exceed a certain threshold of assets or members. Over time the minimum threshold has been increasing. Whereas ten years ago many credit unions would consider a $20 million asset credit union as a good partner, now many will say a target credit union must have assets in excess of $50 million to justify the transaction. Smaller size credit unions have a more limited pool of potential acquirers, but they may still have strategic value to potential acquirers.
Net Worth Ratio – Next to size, the net worth ratio is a key consideration for in many mergers. Acquirers are often hesitant to acquire a credit union if the consolidation will dilute the net worth ratio of the combined organization. Strategic acquirers will generally look for targets with net worth ratios in excess of 10%. The higher the ratio the more flexibility the acquirers have in negotiating terms that are favorable for all the stakeholders, including employment protections for staff and donations to charitable causes in the community.
Earnings — An acquirer wants to be confident that the investment in a merger will be a positive contributor to the bottom line in the long run. A credit union with negative earning may have less value. In order to generate profits post-merger the acquirer may be more reluctant to provide employment guarantees and other concessions. Long term earnings challenges also deplete net worth. Thus, a credit union in wise to act quickly to rectify earnings or consider merger.
Contracts – Long term contracts are detrimental in merger negotiations. The breakup fees associated with the contracts are often so substantial that the economics of many mergers do not make sense or it compromises the targets ability to negotiate more favorable terms. Small credit unions in particular should think twice about entering into 10 year contracts, especially if a merger is even a remote possibility. In several of my recent mergers the CEO has wisely kept the contracts on a year-to-year basis, which has provided them with more merger options.
Field of Membership – For strategic acquirers the field of membership is a key consideration in evaluating merger partners. Credit unions serving larger growing SEG groups or an expanding community with strong demographics have great value to many acquiring credit unions providing the target with more options in selecting a partner. To improve the attractiveness of your credit union, consider applying for an expanded FOM. I have had clients in the past make FOM expansion in advance of merger a condition of the merger.
Branch Locations – While the role of branches has shifted in recent years, they still play an important role in serving members and are an important element of mergers. Credit unions with strong locations and well-maintained branches are more valuable merger targets. Credit union acquirers do not want facilities that will dilute their brand. If you’re in a branch with poor location keep leases short or consider selling and moving to more advantageous location. Occasionally, new branch locations are negotiated by the targets as part of the merger agreement to provide members with better access in better locations. A strategically valuable credit union has more opportunity to negotiate these terms.
Asset Quality – Acquiring credit unions are hesitant to merge in a credit union with a troubled loan portfolio. Ensure that you maintain strong underwriting and collections. Some credit unions with earning problems have migrated into riskier lending practices in order to generate more income. We have been fortunate that the employment trends have been positive for a long time. With the coming changes in the economic cycle, many of these credit unions will be more significantly impacted. Credit unions with riskier portfolios that may be challenged in more difficult times would be wise to consider a merger while they are still doing well economically.
When assessing its future credit union directors must be realistic in their assessments. Is the risk-reward of member funds to generate sustainable growth worth the risk, or are the members better served through merger?