WASHINGTON - In the 1970s there were nearly 24,000 credit unions in the United States. Today, that number has dropped to a little over 8,300.
Many of the credit unions lost were those organizations under $20 million in assets merging with larger organizations. Since 2000, credit unions have merged at about the rate of about 300 annually; 2007 had 246 mergers, the smallest number of mergers since 2002, as the chart below, left illustrates.
In this issue Credit Union Journal takes an indepth look at mergers. Contrary to popular thinking, the number of credit unions merging has actually decreased in recent years. The drivers of those mergers are many, and this report examines the assumptions behind mergers, and the realities–including whether the sought-after efficiencies of scale are achieved. This report further examines whether there are alternatives to mergers to gain efficiencies, and looks into the experiences of credit unions that have found ways to share costs without mergers.
A Decline In Credit Union Mergers
“The credit union press headlines give an impression of a lot of mergers, but the number of mergers in 2007 actually declined by 24% from 2006 levels,” said Jay Johnson, EVP of Callahan & Associates in Washington (see chart, below left).
NAFCU Chief Economist Tun Wai predicts that merger activity will continue in the range of 250 to 275 annually for 2008 and 2009. As with most interviewed for this report, Wai doesn’t foresee an end in credit union mergers in the foreseeable future.
For the past several years, credit union mergers have followed a similar journey. Typically, a smaller credit union merges into a larger credit union. The reasons are often similar, in particular, the CEO retires, there’s no succession plan and the board is faced with hiring a replacement.
“Often the board gets sticker shock; it is very expensive to replace a CEO or a senior management team,” said Wai. “They feel they can’t afford to keep the institution afloat anymore.” For the larger institution, it may be a matter of membership expansion, said Wai.
The second reason is regulatory driven. The cost of regulations is increasing for small credit unions, according to Gordon Dames, CEO of the $2.75-billion Mountain America Credit Union in West Jordan, Utah. “The regulatory burden on credit unions less than $100 million in assets is enormous; the government keeps pouring on regulations.”
The current political climate makes regulatory relief unlikely in the near future. There is a feeling in Congress and among the public that the financial services industry needs more, not less, regulatory oversight. The sins of a few bad actors–Bear Stearns, dishonest mortgage brokers, hedge funds hustlers–has killed the appetite for regulatory reform.
“The circumstances that led to our economic issues with lack of oversight with Bear Stearns and the current sentiment are a lack of regulatory oversight,” said Fred Becker, CEO of NAFCU. “While we need relief, the politics make it difficult for regulatory relief. Congress can only deal with so much.
“The regulatory burden has never been higher for banks and credit unions,” continued Becker. “The agency has been moving toward more regulation not less; there is a lack of recognition of the regulatory burden on credit unions.”
So, regulatory relief may have to wait for a new president and new administration? “That may be case, but we will still get CURIA,” predicted Becker, referring to the Credit Union Regulatory Improvement Act currently before Congress.
Beyond the retirement of a long-time manager, other drivers for credit union mergers include a credit union being financially troubled or performing at a mediocre level. Or it may be performing at an adequate level, but the members want more services, access and convenience that the organization is unable to provide given the resources it can muster.
Credit union mergers tend not to be market-driven, while bank mergers are, according to Jay Johnson. The numbers are fairly comparable, banks and credit unions are each experiencing around 300 to 350 mergers annually, he said.
“Banks are more market-driven and tend be more complementary and look for more synergies,” he said. “Last year credit unions merged about one half percent of their assets, while banks merged 3.5% of their assets.”
Small Credit Unions, Big Effect
The drivers of mergers are those credit unions under $20 million in assets, said Johnson. “The large credit unions that merge are the exception to the rule, TRW and Western credit unions, for example, and State Farm credit unions where nine credit unions merged to form State Farm Great Lakes.”
The chart below, right, shows the dollar amount of mergers from 1999 to 2007, indicating that small credit unions have dominated mergers.
Economies of scale have been also been driving mergers, according to Jim Likens, economics professor at Pomona College, Claremont, Calif., and chairman of the board at the $355-million First City Credit Union in Los Angeles.
“It is easier to be successful if you have more assets; it’s not universal, but on average it’s true.” he said. “The expense ratio falls with size. Productivity measures are improved. All this enhances performance. In 2007, credit unions with assets of $500 million or more had loan growth of more than 10%, credit unions with assets between $100 million and $200 million had loan growth of about 4%, and those under $10 million in assets had shrinking loan growth.”
Then there is the changing labor force. “The jobs created today are by companies that employ less than 500 people; credit unions need to figure out a way to serve these companies,” he said.
Four Types of Mergers
There are four types of credit union mergers evolving in the marketplace today, according to Ron Nice, president/CEO of Nice Enterprises, Kremmling, Colorado:
Type I: Regulatory. This is the most common, which is caused by bad loans and poor management. The regulator has stepped in and the credit union has no say in the matter.
Type II: Acquisition. The acquiring credit union is generally stronger and much larger than the one that is being acquired. For example, a $200-million credit union acquires a $7-million credit union. The smaller credit union brings little market value, but there is a net benefit for the members for the smaller credit union.
Type III: Perceived Merger of Equals. For example, a $200-million credit union merges with a $400-million asset credit union and each brings something of value to the table in branches, staff or board members. They are able to leverage each other’s strengths to create greater member value than they could separately.
Type IV: Real Merger of Equals. This is a true merger of equals, whereby two like-sized credit unions combine together to form a new, stronger organization through merger. Or two institutions decide to merge that have capital in excess of 10%. They both bring multiple benefits to the table for employees, members and the organizations.
Although Type IV mergers have been rare in the past, Nice said that there will more of these types of mergers in the future. In both Type III and Type IV mergers, members benefit significantly with better rates and fees and enhanced electronic capabilities and branch convenience as well as improved services.
“In financial services, with everything else being equal, size always trumps and provides economies of scale and gives you greater capability for membership growth,” said Nice. “You become doubly competitive and with new members you get new loans and you’ll increase profits, thereby increasing ROA and competitive strength.”
“Mergers are occurring for credit unions that are growing on their own, not just for those in trouble,” he continued. “Credit unions are looking one to five years down the road and considering mergers.”
Of course, not all would agree with Nice’s assessment that size “always” trumps. It does trump in most cases, though. The cost differential gap between small and large credit unions has grown significantly in recent years, making it difficult for the small institutions to survive, bringing more pressure for mergers. For a detailed study of this argument, please see “Will Only the Big Dogs Survive?” CU Journal July 16, 2007, available to subscribers at www.cujournal.com.
Do Mergers Increase Efficiencies?
From examining mergers and research, it is evident that mergers can and do bring efficiencies, but this is not always the case. It would be a mistake to assume that a merger automatically increases efficiencies and economies of scale. Often mergers bring better services, convenience and more access points to members.
In fact, most credit union mergers in the past decade haven’t brought a great deal of efficiencies, according to Jay Johnson. “The smaller credit unions are merging into larger and usually the smaller credit union has a minimal impact on the larger credit union; it tends not to have scale on the large credit union,” he said.
“But for the acquired credit union members’ perspective they bring more convenience, more branches, more services and more access points,” said Johnson. “For the acquiring credit union it brings an untapped member base, more branches, more members and employees and more resources.
There has been a good deal of research on mergers. Filene Research Institute’s landmark study in 1999, “How Credit Union Mergers Affect Service to Members,” studied 1,624 credit unions prior to merger and their performance for three years after a merger. Here’s what the researchers found:
* Acquiring credit unions served their members well prior to a merger, while target credit unions served their members less well.
* Acquiring credit unions on average were capable of improving their member service rating relative to best practice standards by just 14% prior to a merger; target credit unions were capable of improving their member service levels by 25%.
* In 80% of the mergers studied members of target credit unions benefited significantly from a merger. The benefits are immediate and persist during the three-year study period.
Members of the acquiring credit unions do not benefit significantly from the merger during the same period. However, their benefit levels do not decline, either. The study doesn’t assess strategic benefits, but one can assume that benefits are substantial in many cases.
As mergers in credit unions and banks continue to merge at about the same annual rate–roughly 300 annually–it could be assumed that both would start to realize increased efficiencies in operations expense. With mergers, one would assume that there would be a decline in non-interest expense for the industry, but that hasn’t been the case.
In 2003, the non-interest expense as a percentage of total assets was nearly identical for credit unions and banks. However, banks continued to reduce the non-interest expense ratio over the past four years, while the non-interest expense ratio for credit unions continued to increase during the same time period, as shown below
An example of the benefits accruing to the members of a small credit merging with a much larger credit union is the merger of the $2.75-billion Mountain America CU with the $25-million SP Sparks Credit Union, both of Utah. The reason cited for the merger was that members were demanding services–business lending, home banking–that SP Sparks CU lacked the resources to provide. The merger took place in 2006.
The Currency of Time
The benefits to the members of the acquired credit union were immediate; they have access to the services of a $2.75-billion asset credit union–investments, home banking, real estate, business lending, trustee and insurance services. The credit union built a second branch in the city.
“Members gained time–time is the currency of the future,” said Gordon Dames, CEO of Mountain America. The credit union belongs to the CO-OP Network which has 25,000 ATMs as well as a shared branching system.
In April 2008, Mountain America also absorbed via a merger the $265-million Salt Lake Credit Union, which has a field of membership of Salt Lake County. Since Mountain American has 20 branches and Salt Lake County has 10, this will give the new credit union a combined total of 30 branches. Mountain America will also have access to a potential membership of 54,000 students and faculty, according to Dames.
Both credit unions have been working together for five years as members in Mountain’s business CUSO and have a compatible culture. Salt Lake CU will convert to Mountain’s data processing system.
Lack of Organic Growth
While Ray Alexander was CEO of the $27-million Technology Groups FCU in Watertown, Conn., the credit union decided to merge with Mutual Security CU, which had $175-million in assets in 2007. Technology had 6,000 members and Mutual had 23,000 members.
At the time Alexander was retiring as CEO and there was no succession plan. The organization wasn’t growing and resources were limited. A merger seemed to be the best option, according to Alexander.
“We weren’t growing organically and we had to ask where our future was going to be,” he said. “We had an aging management team and we would rather merge with a credit union than a bank. We had a decline in members.”
The cultures of both credit unions were similar; they were both from the manufacturing sector. Technology originally served employees of Timex, while Mutual served workers at Pitney Bowes. There were eight employees at Technology and 73 at Mutual. The merger resulted in no layoffs. It was a successful merger, according to Alexander.
“The board realized that it was the best for the future of the credit union and members,” he said. “We were proactive and communicated to the members about every aspect of the merger; for example, the positive benefits they would be getting like online banking.”
Alexander is now a senior VP with Mutual Security CU, which today has $211 million assets and 31,000 members. Previously Technology had one branch, now the members have access to seven branches. Mutual had 15 ATMS, now they have 25.
A Merger of Equals
Ron Nice predicts that the near future will bring more Type III and IV mergers, or “mergers of perceived equals” or “mergers of equals.” In this type of scenario there is a better chance for economies of scale and efficiencies.
An example of a merger of perceived equals was Safeway Rocky Mountain Federal CU and DPS CU in October 2005. Safeway was at $150 million in assets, DPS at $550 million. One year later, the $175-million Gateway Credit Union joined the group and today the three credit unions operate as Westerra CU, which in 2008 was at $920 million in assets and had 75,000 members.
Safeway served the employees and families of the Safeway Corporation. DPS had an education-based public school system field of membership. Gateway served Air Force personnel at the former Lowry Air Force Base, which has closed. The business strategies were similar for all three merged credit unions–a strong desire to serve members and a priority on member convenience–but the cultures were admittedly different, according to Westerra CEO Alan Peppers.
“Safeway Rocky Mountain was much less formal than DPS; DPS was more document-driven,” he said. “Safeway had a single leader with a higher profile. Gateway was a community credit union active with memberships in Rotary and Chamber of Commerce and other community groups.”
“We held employee focus groups. We developed a new mission and a new set of values; we engaged our employees in a new set of values,” continued Peppers. “We redefined and articulated the expectations of the culture at Westerra; the way in which our employees would go about getting work done.”
Most experts agree joining two cultures is the most difficult challenge of a merger. Peppers agrees with that judgment.
“The hardest part of the integration process is cultural alignment and communication, which is the key to ensuring success,” he said. “We had more employee meetings as forums for feedback, additional information in newsletters and a frequent electronic communications. We also spent a lot of time on Q&A. If employees had questions we would share them organizationally, because we figured others had that same question.”
Members, he said, have benefited from the merger in a number of ways. They now had a total of 10 branches and access to a full-service, in-house mortgage lending and commercial mortgage lending program. Westerra also adjusted its pricing model so that the former Gateway members received $500,000 more in dividends in 2006.
As part of our merger strategy there were no employee lay-offs. “We wanted our employees to be advocates for the merger,” said Peppers. They were also opportunities to reduce operating expenses due to better economies of scale. The chart below shows a decrease in operating expenses and operating expense to income since the merger, indicating this merger increased efficiencies.
The credit union used secret shopper surveys in 2006 and 2007, scoring 94% in both years; and 93.4% in 2008.
Prior to the merger, the three credit unions also each had their own core data processing systems. “We decided to go with the Safeway core system. We moved off the other two systems and converted. It was cost efficient, since we already owned the system,” said Peppers.
The downsides to the merger were costs the credit union didn’t plan, according to Peppers. Those unplanned costs included market valuation of fixed assets, and provision expenses for nonperforming loans. For example, a $1.4-million impairment charge was taken in 2007 for the corporate headquarters of one credit union that had to be liquidated.
The Driver Behind A New $785-Million CU
Scale economies will be a major reason for an increase in the number of mergers of equals in the near future, according to those interviewed for this report. The following example is perhaps a glimpse into the near future.
The $355-million First City Credit Union in Los Angeles, and the $430-million SCE FCU in Irwindale, Calif. announced on May 30 their intention to merge.
“It will be a merger of equals driven by scale economies,” said First City’s Chairman Jim Likens. “Both credit unions are well-capitalized and strong financially. The fields of memberships are complementary–a diverse mix of SEGs, income groups and community credit unions.”
The new combined credit union will have 80,000 members, $785 million in assets and 13 branches in greater Los Angeles and parts of San Bernardino County.
“With a combined deposit and capital base and economies of scale, the new credit union believes it will be able to add member value by offering more competitive rates, new products and enhanced service,” said Likens. “It will also be able to provide more career and training opportunities to staff as well as greater access to new technologies.”
For mergers to be effective, Likens suggests credit unions try to locate in a fairly concentrated geographical area. “The market for consumer financial services tends to be local. In urban areas, in particular, members like having a branch within five miles of where they live or work. So it makes sense for branch networks to be concentrated locally.”
Likens also recommends that credit unions that are contemplating a merger look for complementary fields of membership. “It helps to have people of all ages. And a credit union benefits from a mix of savers, borrowers and transaction-users,” he said. “These factors taken together will also make it easier for larger merged credit unions to take advantage of economies of scale and scope in advertising. These factors can also help it conduct target marketing to specific demographic groups.”
A Corporate Merger: WesCorp & PacCorp
Corporate credit union mergers have similarities with natural-person credit unions. Hawaii-based PacCorp, had $500 million in assets, and San Dimas, Calif.-based WesCorp had $25 billion assets at the time of their merger in December 2003. PacCorp served credit unions in Hawaii and Guam, while WesCorp, the largest corporate in the United States, serves credit unions in much of the mainland.
The cultures and business strategies of both organizations were similar, according to Rand Yamasaki, SVP of Pacific Operation for WesCorp.
“What made the merger immediately successful was a similar member-centric focus and culture between the two organizations,” said Yamasaki. “The business strategy was based on providing value to the member-owner credit unions without compromising the safety and soundness of the funds.”
Twelve employees, all of the PacCorp staff, were retained by WesCorp to run their new Pacific Operations staff office in Honolulu. Today, the staff has been downsized with attrition to 10. One board member had an interim board appointment to the WesCorp board, and has since been re-elected to a new three-year term, while the other four PacCorp board members were appointed to a Pacific Advisory committee by the WesCorp board.
The biggest challenge was convincing the PacCorp staff that the proposed merger would be in the best interests of the member-owner credit unions, as long as all employees could adjust to our re-defined roles and responsibilities and deal with a mainland based head office, said Yamasaki.
“The most challenging and time-consuming part of the merger was developing replacement items and ATM card processing solutions for our Hawaii and Guam credit unions and leading them through a conversion,” he said.
The member credit unions approved the merger with assurance that the local office staff would be kept intact, according to Yamasaki. The key was that WesCorp’s CEO, Bob Siravo, and the executive staff provided frequent and in-person communication with the Hawaiians, he said.
The major difference between a corporate and a natural person merger is the regulatory oversight. “Regulatory oversight on corporates is far tougher and extensive than on natural-person credit unions and the same degree of scrutiny applies to mergers of corporates,” said Yamasaki.
Four years after the merger, 99% of Hawaii and Guam credit unions are members of WesCorp, according to Yamasaki. Satisfaction levels among the membership remain high, “because of the optimal solution of better rates, lower fees, local presence and expertise provided by WesCorp,” he said. (c) 2008 The Credit Union Journal and SourceMedia, Inc. All Rights Reserved. http://www.cujournal.com http://www.sourcemedia.com
