Motivation Behind Mergers

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Glenn Christensen, managing director of CEO Advisory Group here, spends his time in search of partners for credit unions seeking a merger.

"We give assistance so that they can find the most compatible credit union for a merger, one with a complementary branch structure without much overlap," he said.

Those credit unions looking to merge may have "capital or growth issues" or just need to respond to a request for a merger.

That there are people making careers out of mergers indicates just how the consolidation trend has grown. From a high of more than 23,000 in the 1970s, today there are fewer than 9,000 credit unions. While some were liquidated, most disappeared in mergers. In many cases, credit unions report they were seeking "efficiencies of scale" in merging.

The mergers among the $500-million-plus credit unions get the headlines, but most merging credit unions are small, with an average size of $9.3 million during 2004, according to data from Callahan & Associates.

"If you look at the margin between the large and small CUs, typically larger CUs have greater ability to return more to the members," Christensen said.

Some small credit unions may have difficulty getting new deposits and new shares. There is low membership growth and poor financial performance, he said.

Yet credit unions looking for a merger may be healthy, wanting to be stronger. "We are seeing larger credit unions merge for strategic reasons. Not so much that they need to, but for strategy," he said. "Many credit unions feel constrained in their abilities. They may want to put in place high quality mortgage services, investment services."

Another trend that has contributed to mergers, noted Christensen, are boards opting for a merger rather than going through the process of replacing a retiring CEO. In many cases, long-time managers and CEOs retire without any successor in place, and the salary that's available has little appeal given the long hours involved.

But what about those "efficiencies" that are so often cited? When two credit unions merge do their expense ratios in fact decline? When banks merge, layoffs usually follow. But that's a strategy that's often anathema to credit unions, which often pledge to retain staff.

The type of merger determines the type of savings, according to Christensen, who said it can take a year or more before savings from a merger show up on the balance sheet.

In fact, in the short term, he noted that costs due to the merger usually increase. Specifically, costs due to combining technology platforms and marketing expenses related to communicating the merger are among those that increase in the short-term. In the case of technology costs "a lot" depends on the length of a contract with a data-processing company and whether there was an early-out clause.

Allowing everyone to keep their jobs may carry a cost, but it addresses one of the greatest problems related to mergers. "There is always fear among management and on the staff that is being merged," Christensen said. "Most boards want the staff retained. It may be a bit different if merger is due to financial strain."

Some staff may be asked to accept early retirement. In other cases staff may leave if they feel they don't care for the new work environment, as mergers can bring visible "changes in culture" in one of the organizations.

Savings Coming from Strategic Mergers

In 1998, two large Kansas credit unions merged: Community Credit Union and Members America. Jeff Kline, president and chief operating officer at CUSO One, a subsidiary of what is now CommunityAmerica Credit Union in Lenexa, said that combined expenses following a 1998 merger with Members America rose initially, but benefits have now offset all merger costs.

"Members America was the legal surviving entity (though it operates under the CommunityAmerica name). Its expense ratio went up from about 2.1% as a separate entity to 2.9% combined, but if you look at the combined credit union the year before the merger, we would have been 2.7%," he said. "Of course we broadened our product line, had no layoffs, and a much higher loan-to-share ratio (55% to 70%)."

Rising costs are inevitable if loans are also increasing, he said. "Anytime loan-to-share ratio goes up, expenses go up. A credit union with $1 billion in savings is not the same as one with $1 billion in savings and $1 billion in loans, too," Kline observed.

Kline's comments came after a merger discussion at an webinar hosted by Callahan & Associates. During the webinar, Kline said that benefits of a successful merger go way beyond savings.

"In almost every merger one credit union has a stronger product line or more delivery channels, which you can now offer to more people," he said, adding that those greater efficiencies can be translated into "higher deposit rates, lower loan rates or more capital."

For example the 1998 strategic merger "gave Community America an opportunity to grow faster into a new and promising market area."

Members America in 1998 was a $640-million credit union with a lagging 40% loan-to-share ratio. CommunityAmerica was a $160-million credit union with a more robust 90% loan-to-share ratio.

The 16-branch combined credit union now has $1.5 billion in assets and 110,000 members. Three more mergers with other credit unions since 1998 have accounted for $110 million worth of asset increases, with the rest the result of faster growth.

Kline, who was involved in the negotiations, said that in the case of strategic mergers done to expand services there can be costs to get managers of a merged credit union to give up the reins.

"I remember telling a CEO: for 5 years of (annual salary) compensation, I'll flip this and I'll leave. But that's where we landed: around a five-year contract," he said.

Savings When Merging With Distressed CU

Since 1991 Jack Braswell has served as CEO of the $180-million, 14-branch Members Credit Union in Winston-Salem, N.C. He first joined the credit union in1979 as treasurer, and over that time he has seen many mergers.

"We have merged 23 credit unions into ours since October 1984. We had a lot of those mergers with credit unions that were in trouble," he said.

The biggest merger came in the mid-1980s with a credit union of the Pilot Freight trucking company, which was struggling financially. At the time it was his credit union's seventh merger, he said.

Members Credit Union, formerly the McLean Trucking Co. Credit Union, had experience dealing with distress. The savings from that merger and from 16 more since then helped it survive, he said.

The Mc Lean Trucking Co. credit union had 12,000 members who at one time were nearly all drawn from the sponsor company. The trucking company went bankrupt in 1986.

"We got down to 0% net capital. At that time we had branches in eight states. We changed our name to Members Credit Union in 1986 because members were having trouble cashing credit union checks," he recalled.

"We saw that through mergers we could expand our membership and rebuild our capital," he said.

Savings from the Pilot Freight merger in 1989 were important, he said. At the time, the "six- or seven-branch" Members CU had $50 million in assets and the one-branch Pilot Freight had $7.3 million. Savings came from cuts in payroll, branch operating costs and technology, among others, he said.

"Several employees decided they wouldn't continue with us. We discontinued their location located beside the company that was closing," Braswell said.

In 1988 Members Credit Union's net capital had plunged to 0% when many of the truckers and other members declared personal bankruptcy after being out of work. In some cases the drivers were being re-employed elsewhere but taking big pay cuts "after being paid above market in comfortable jobs" he recalled. Not surprisingly, loan delinquencies rose sharply.

The state-chartered credit union, which had forecast such a situation years earlier with the deregulation of the trucking industry around 1980, had a business plan to face the emergency.

After deregulation, established truck companies couldn't compete on price with newcomers that didn't have heavy cost structures built-up. Around the time of the McLean bankruptcy, it was time for Braswell to show the plan to regulators.

"We forecasted our ratios, expenses and write-offs. We kept NCUA apprised of what we thought was going to happen. Our state regulator gave us enough room and allowed us to carry out the plans that were laid out," he recalled.

The credit union hired additional collection staff and cut as much on expenses as it could.

A couple of years later, as Members Credit Union was still in the process of rebuilding capital, it learned of Pilot Freight's credit union's problems.

That credit union was struggling with profitability, but it also had a healthy capital-to-assets ratio of 15%. Calling that ratio "a white elephant," Braswell said he knew what had to be done.

"We worked through their delinquency ratio, which by the time of merger was already up to 30%. Reducing employees and eliminating their facility cut expenses," he said.

Many employees of the merged credit union left on their own even as they were offered jobs.

"The manager didn't want to take a lesser-feeling job. We were offering a marketing director position. The lady who ran their computer system didn't want to become an accounting clerk and so on," he said.

As in the Pilot Freight merger case, all 23 of the mergers have led to some small cost reductions that have added up to bigger savings.

Over time, expenses related to "technology, administrative costs, marketing costs, supplies costs" were either eliminated, halved or reduced through greater volume. Auditing and examining costs for 23 institutions," were gone, Braswell said.

More savings were the result of economies of scale as "they all had loans and shares." The efficiencies resulting from a bigger portfolio are immediate, Braswell said.

Yet mergers also carry costs and losses.

"You have a lot of double-expenses in the short run. You may need to change the name of the branch if you are retaining it or it may take a month or so to unwind an operation," he said.

Some of the merging credit union's assets can be worthless to the new combined company. "We never used their old hardware. They became boat anchors, " he said.

Mergers "allowed us to remain in business," he said. Members Credit Union now runs a weighted 7.98% net worth ratio, calculated for PCA purposes.

The first seven mergers, up to the one with Pilot Freight, brought $16 million in assets to Members Credit Union. The following 16 mergers brought in an additional $24 million in assets, he said.

Braswell said he wouldn't mind more mergers. "If a credit union feels like they can't sustain their own operation, we'll step in and fill the void," he said.

More Mergers Will Come

David Hilton, founder of credit union consulting company D. Hilton Associates in The Woodlands, Texas, estimates he has been involved in discussions related to 14 mergers over the past two years, including those that were completed and some that were just "exploratory." The largest created a credit union with a combined $2 billion in assets, he said.

At first glance, Hilton acknowledged that many mergers among credit unions give the impression that there are little cost savings or efficiencies to be had, especially with no changes to staffing. But down the road, even in mergers that aren't entered into with a plan to reduce costs but instead to increase services, savings would be the end result, he said.

"Credit union mergers aren't done to let go of employees. Most get done so members can access more services," he said.

Initially expenses would rise, particularly in marketing. "There is marketing signage. Most must have that redone. There is marketing for new services. There are information costs to let members know what is going on and then there are the costs associated with technology," he said.

But over the long haul, costs drop.

"Over the span of two to five years you are going to see some reductions, especially with larger credit unions," he said. That is because some costs remain the same "no matter how much an organization expands," he added.

For example, "the call center may have more capacity than you are using. And if the size of a credit union increases, you don't need more accounting staff to do the same job as what it would be handling just larger numbers."

Hilton said it would be impossible to develop a formula or ratio on savings that can be expected from any credit union merger, as each is unique. A lot depends on the merger size, he pointed out.

According to figures provided by Joe James, analyst from Callahan & Associates Inc., credit union mergers have steadily increased from 233 mergers in 2001 to 331 mergers last year.

Mergers may continue to rise to somewhere around the peak of 344 mergers in 1999 if the year-on-year rise from January figures are any indication. James said that there were 23 mergers approved in January of 2005, up from 18 approved in January of 2004.

Between 1999 and last year there were a total of 1,734 credit union mergers, James said.

David Hilton agrees that mergers may rise in the short term. "I do think we will see many more mergers," Hilton said.

Merger Among Corporates

The merger activity hasn't been limited to natural-person credit unions. In Honolulu, Hawaii, Rand Yamasaki, former CEO of the $550-million Pacific Corporate FCU, says his experience and that of Pacific Corporate shows savings can be achieved.

Yamasaki was CEO of Pacific Corporate, the former corporate CU for Hawaii and Guam that in December 2003 merged with the $25-billion, San Dimas, Calif.-based Western Corporate (WesCorp). He is now the Honolulu-based senior vice president for Pacific Operations of the combined WesCorp.

"There are definitely economies of scale achieved and fixed overhead can be spread over more operational cost centers," he explained. "There is an elimination of duplication in back -office processes and systems."

He doesn't regret accepting the merger that was initiated by WesCorp. "Ultimately the member credit unions have benefited by obtaining better rates on their deposits, lower fees on services, and a wider range of expertise and resources from the combined corporate entity," he said.

That isn't to say there weren't some difficulties.

"There is a period of acclimation to the new organization's policies and systems," he acknowledged, adding the corporate culture clashes were not significant.

"The importance of family, 'ohana' in Hawaiian, in our operating philosophies were similar and served as the foundation of our new partnership," he said.

Mergers Ease Expansions

Gesa Credit Union was founded in the Southeastern Washington area known as Tri-Cities more than 50 years ago and named after its original sponsor, the General Electric Supervisors Association. Last year it went through a merger with the 2,600-member Apple Valley Credit Union.

The merger allowed it to expand north into Wenatchee, Wash., in the center of the state.

In 2000 Gesa CU had already merged with WA-Two credit union, which also helped the Richland-based credit union grow some 50 miles westward to the city of Walla Walla.

Roger Fishback, general manager and president of GCU, said the mergers have helped his credit union expand at a low cost.

In the case of Apple Valley "it gave us an opportunity to move to an area 130 miles from our main location," said Fishback, whose credit union now has $600 million in assets and 75,216 members. That is an increase over the $275 million in assets at the time of the Walla Walla merger five years ago, and up from $68 million when he started running Gesa in 1983.

Expenses such as league dues and other such costs can add up and hit hard at small credit unions that lack "economies of scale," he said.

But once those cost savings begin to be realized, credit unions can offer the rates needed for faster growth.

For example, its operations in Walla Walla have been able to expand "five times its size" since the merger, he said.

In addition, the mergers have helped Gesa Credit Union have "the lowest expense ratio of the top 25 credit unions in the state of Washington," Fishback said. This improvement came even as the credit union, unlike other organizations, didn't cut benefits and still pays 100% of health insurance for employees and their dependents, he said.

"The credit unions, while marginal, at least provided enough to support the expenses that they had and, of course, we improved that," he said.

The improvements came as the merged credit unions "saved on examination costs, processing for share drafts and in all the process of individual regulation," he said. Also, "no costs related to their management's annual meetings are incurred," he added.

Savings on payroll and building insurance were also possible, he said.

"All the property still has to have insurance but a larger credit union gets better rates," he said.

As in other cases, while the credit union offered to keep all staff, not everyone stayed.

"At Walla Walla the management wanted to retire. In the second case the manager also wanted to retire, though we kept her for six months."

The Apple Valley branch, formerly home to the $10-million credit union, had strong brand recognition and the name, next to Gesa, continues in the signage at the branch, located in the 50,000-population town.

As a result of the mergers, members of the former Walla Walla and Apple Valley credit unions are earning more interest on their shares, currently at about 1.6%. "At Walla Walla it probably wasn't much more than 0.75% to 1% on a regular share," Fishback noted.

A Merging CU Expects Savings

Howard Dunn, president of University Credit Union in Maine, which is merging this year with smaller Bansco Credit Union, said that he is anticipating cost savings will be achieved when the merger is completed. Even now, he said, members of the merged credit union have already reaped a benefit.

"The credit union that merged with us was a smaller credit union and they were charging members a fee on their checking accounts," he said.

As has often been the case, the smaller credit union had use for a partner with a stronger capital position. Bansco had a net worth ratio of about 6% compared with University CU's 9%.

"They were at a point in which they weren't able to grow because their capital was limited," he said.

Dunn said he approached Bansco about the merger because "we both serve educational fields membership," he said.

The merger is resulting in a $152-million, 20,000-member credit union that will become Maine's third biggest CU.

While Dunn is currently facing higher costs, particularly for "converting their computer systems into our computer," he is convinced that the savings will come.

"Overall, it will be worth it in the long run," he said.

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