7 minutes
A classic picture of indecision is a person standing on a diving board, trying to decide if she should jump.
Unfortunately, we tend to see this decision—as so many others—as a matter of courage, rather than judgment. We tend to think that of course she should jump!
But before she decides to separate her body and the board, our diver requires information even more than nerve. To start with, is there water in the pool beneath her? Enough water? How high is the board? Is she a good, poor or indifferent swimmer? Are there other people around to help in case she needs aid?
And why jump at all—because she honestly thinks it will be enjoyable and enhance her water skills, or because all her peers are jumping and she assumes she should do it, too?
It’s not so different with credit unions in the world of mergers and acquisitions. Credit unions that are facing some difficulties may see other CUs in their peer group merging and assume that they, too, really should be looking for a partner.
Not necessarily so, say experts.
First, credit unions need to look hard at the financial facts—all the financial facts.
Net Income Over Net Worth
Jim Kasch, founder of Canidae Consulting, sees basic problems in how most smaller CUs determine whether they can remain independent. Too many boards of directors only look at their net worth ratios, says the former credit union CEO, who describes his consultancy as “dedicated to help smaller credit unions remain in control of their own destinies.”
Instead, he says, directors should look first at net income. That can provide a more accurate indication of what’s needed.
“There are ways to artificially increase your net-worth ratio—for instance, by reducing assets—that look good on paper,” says Kasch, who as a CEO went through a merger he says was the best solution for his members. ”But if you’ve been losing money for the last five years, you know you’re in trouble.”
Similarly, Stephen Morrissette, Ph.D., adjunct professor of strategic management at the University of Chicago’s Booth School of Business and co-lead faculty for CUES’ new Mergers & Acquisitions Institute this June, urges credit unions considering merging to start by asking some simple questions.
First is, “Are we under some financial stress?” If the credit union is strong, then ask, “Do we feel we can best serve our members as an independent, or do we need to combine with a larger CU to best serve our members?”
If the CU faces some financial challenges, Morrissette says, then comes, “Can we fix our own problems and keep serving our members well?”
In both scenarios, the key question is, “Which path forward will allow us to serve our members best?”
Credit unions that are facing financial challenges must decide if they can fix their problems by determining whether there are tactics and strategies they can use.
For example, Morrissette says, if the credit union is spending too much on operating expenses, the question is whether costs can be controlled or if it can grow its way out of the problem. If the problem is excessive loan losses, the credit union should consider an external loan review to determine if it can weather the storm as an independent.
The board also has to decide whether there is enough time for remedies to take hold.
“If conditions deteriorate too much, it’s harder to serve members, and you’re less attractive as a merger partner,” Morrissette cautions. Most human beings don’t face problems until the situation becomes a crisis, he says.
Determining the Right Time
So when should the board start asking these questions?
Morrissette suggests there are three signs that act as the proverbial canary in the coal mine.
First and perhaps most important is if your profitability is in the lower third of all credit unions or has been declining for two years. If that is the case, “the lights are flashing yellow,” Morrissette says. “You need to ask the hard questions.”
The second most serious concern is if your membership has been shrinking for a year or two. Third is if the shares-per-member metric has been slipping for the same period of time.
Morrissette points out that some CUs set up a dashboard of the indicators.
Essentially, they’re saying, “We can stay independent if these things are true,” he says.
Morrissette says these really are the basics. “Look at profitability trends, growth trends, number of member trends,” he says. “Are you growing your relationship with your members, or is it stable, or shrinking? What is your expense trend?”
If these are good, he says, a credit union with some problems can maintain itself through growth. But directors have to know the situation in time to do so.
“Have these discussions early on,” Morrissette says. “It’s a matter of ensuring the board is not in denial, not being late to the conversation.”
Moving Ahead to Merge
If the board determines that the credit union can’t stay independent, it needs to know what to look for in a merger partner.
When a CU considers a partner, Morrissette says, it should:
- Be sure the move will help it serve its members in the best way possible.
- Consider the impact on employees.
- Make sure it will be a strong partner.
No. 3 is especially important, Morrissette adds. “Weak plus weak doesn’t necessarily equal strong.”
Kasch is focused on offering credit unions strategic advice about what to emphasize to remain independent as long as they want. He cautions that the board shouldn’t look at any numbers in a vacuum. For instance, net worth ratio, delinquencies and charge-offs may not be a matter of concern if the merging credit union is priced correctly, he advises.
“I keep hearing, ‘Grow or die,’” Kasch says. “Not every credit union needs to be a billion dollar CU. A $100 million to $200 million credit union can survive. You can manage net worth at 9 percent and give back to members.
“A 2 percent charge-off is OK, if you’re charging sufficiently high interest rates,” he points out. He adds that interest income should be 70 percent to 75 percent of income.
Similarly, while the credit union’s net loan interest yield is important, what may seem shaky on the surface may be perfectly acceptable if priced correctly.
The ultimate question, Kasch says, is, “Are we making more money than we’re spending?”
Like Morrissette, Kasch cautions that the credit union can’t let the situation deteriorate if it wants to make a solid merger.
“If the credit union’s market is saturated, if its charter is weak, it’s going to have the least amount of bargaining power,” he points out.
And choices may come to be fewer, too. “If the credit union has a 4 percent to 5 percent loss ratio, or a huge amount of bad loans, then it will need to find a merger partner that’s 10 to 15 times its size,” he adds.
Case in Point
Kasch has been through two mergers himself, most recently as the first CEO of Darden Employees Federal Credit Union, now part of $499 million USF Federal Credit Union, Tampa, Fla.
“In our first four years, we grew the credit union by 600 percent,” Kasch says. “We grew so fast, we determined a merger with a larger organization was the only way we could follow through on our mission of helping as many Darden employees as possible. We needed more everything.
“We brought lots of income, and a well-developed virtual delivery system,” Kasch continues. And even after that substantial growth, the CU was serving only 4 percent of Darden restaurants (including Olive Garden, Longhorn Steakhouse and Bahama Breeze) employees. So there was a huge potential membership. Further, it had a low loan-to-share ratio.
Darden EFCU executives first determined what they wanted the credit union future to be like, then did a lot of research to identify an ideal merger candidate.
While they did not require Darden EFCU to be the surviving CU, they did want to be a separate division of the survivor. “We wanted the name to survive. We wanted to contribute,” Kasch says. They also wanted several seats on the combined CU’s board of directors.
In December 2014, Darden EFCU merged with USF FCU in Tampa, Fla.
“Mergers and acquisitions are an important component to any sound strategic plan,” Kasch says, adding, “I want smaller credit unions to be the ones to decide. We do that by empowering credit unions to translate what they do well into serving next-generation members.”
Charlene Komar Storey is a veteran credit union writer based in New Jersey.
