Martin Luther King’s Eternal Question

The legacy of Martin Luther King, Jr. covers many areas of public and democratic life. Based on a philosophy of non-violent protest, he transformed the civil rights movement into a national priority. Before he was killed, he had also spoken out against the Vietnam War in Vietnam and organized the Poor People’s March on Washington. The march’s goal has been transformed today into a growing concern with income inequality as the American economy celebrates a full decade of positive growth.

But as important and unfinished as these concerns are, I think King’s legacy for an individual may be more vital than a specific issue on one’s social/political agenda.

A Call for Self-Reflection and Awareness

In his I Have a Dream speech on the steps of the Lincoln monument, he prefaced his dreams with the following:

“We have also come to this hallowed spot to remind America of the fierce urgency of now. This is no time to engage in the luxury of cooling off or to take the tranquilizing drug of gradualism.”

The Urgency of Now. That is the never ending question that each person answers in their everyday actions and priorities. It has both personal and professional or civic dimensions.

As credit union leaders, what is the most urgent priority motivating your leadership? Yes, circumstances can reorder priorities. But when do these become challenged? At a time when the cooperative system has record levels of reserves, members and assets, is better financial performance the most urgent issue?

A holiday from work is a time to step back, catch up, run errands or even honor the underlying reason for the day off. King’s holiday reminds us that what we do every day, the Now, matters. What is the urgency that causes you to get out of bed in the morning? What should it be?

Mistakes and the Beauty of Music

One of my hobbies is choral singing. Both in church choirs and at adult singing vacations in summer.

A choir director whom I follow tells the following about how professional muscians handle mistakes.

“The Baroque trumpet is really just a piece of bent tubing with a bell on one end and a mouthpiece on the other.

On a modern trumpet there are valves to change the effective length of the instrument, and thus to make notes more playable.

On the Baroque trumpet it’s all done with tiny and precise pressure adjustments of the lips with the difference between the notes shrinking as the range rises.

It makes the instrument famously difficult to play.

Historically, trumpet players have had big, bold personalities, something akin to fighter pilots. He or she must be confident in their abilities with even a touch of well-earned swagger.

A player hits a lot of notes, and makes them sound beautiful, but sometimes, a note will just fail to sound, or worse, come out in a loud and rather atonal squeak.

“What do you do when that happens in public?” I asked of a player who is a frequent soloist in the Messiah movement, The Trumpet Shall Sound, “like when you’re standing at the high pulpit playing out over the cathedral packed with 3,000 people?”

“How do you keep from having your confidence shaken for the notes that are yet to come after something goes wrong?”

I was speaking from experience. As an organist with many notes to play, some of them quite obvious if they go wrong, I’ve felt my confidence shaken after a mistake. Voices within berating me for many measures that follow. A wry smile came across his highly trained lips.

“I don’t even think about my mistakes,” he said. “I’m focused on the beauty of the musical line I’m playing.””

Investing in a 10 Year Rising Stock Market

It is hard not to feel very smart or lucky if you have made investments in the stock market during its 10 year bull run. Virtually all asset classes in 2019 increased in the high teens to more than 20% for broad market indexes. These are great returns especially when compared to risk-free CDs, which have earned 2% or less annually during the same period.

Most forecasts for 2020 support continuation of the current 2% GDP growth trends and a rising stock market. No recession or market retreat is foreseen. What could possibly go wrong?

Looking at Some Details

To the extent stock prices reflect the present value of anticipated future earnings, there seems to be a growing disconnect between stock prices and projected earnings. Especially for smaller companies. A cautionary analysis of 2019’s soaring market was written by James Mackintosh in the WSJ last Friday. He points out that the percentage of all listed companies reporting losses in the last 12 months is close to 40%. The highest level since the late 1990’s, outside recessionary periods.

Moreover, he cites another analyst who calculates that the proportion of US-listed companies losing money for three years also reached its highest point last year. The caveat in this second observation is that these are small companies which in total represent less than 5% of the market’s overall value.

Two thoughts. Almost all credit union member business lending is to small companies. And secondly, one of the eternal verities about market returns is “reversion to the mean.” That is average returns will revert to long term “normalized”values over time. Could 2020 be such a year?

Maya Angelou-Reflects on Why We Collaborate

This is a poem that deals with togetherness. It was published in 1975 in her book Oh Pray My Wings Are Gonna Fit Me Well.

Alone

Lying, thinking
Last night
How to find my soul a home
Where water is not thirsty
And bread loaf is not stone
I came up with one thing
And I don’t believe I’m wrong
That nobody,
But nobody
Can make it out here alone.

Alone, all alone
Nobody, but nobody
Can make it out here alone.

There are some millionaires
With money they can’t use
Their wives run round like banshees
Their children sing the blues
They’ve got expensive doctors
To cure their hearts of stone.
But nobody
No, nobody
Can make it out here alone.

Alone, all alone
Nobody, but nobody
Can make it out here alone.

Now if you listen closely
I’ll tell you what I know
Storm clouds are gathering
The wind is gonna blow
The race of man is suffering
And I can hear the moan,
‘Cause nobody,
But nobody
Can make it out here alone.

Alone, all alone
Nobody, but nobody
Can make it out here alone.

What is the Value of a Member Account?

This week my wife received a mail promotion from BB&T bank inviting her to open a checking account.

If she chose their Elite Gold product with either a $35,000 deposit or direct deposits totaling at least $3,000 per month, than they will pay a bonus of $600 into the account.

The only time limit is she must leave the deposit for 75 days or have the direct deposit(s) established in the same time frame.

Acquisition Cost and Future Value

Paying cash to incentivize new account relationships is not a new strategy. USAA regularly solicits my credit card business with a $200 cash offer.

But the amount of $600 seemed to be unusually high. Why?

I don’t know the answer. Is there a new awareness of the value of a consumer’s payment account in a low interest environment? Or is this an effort to preempt Fintech deposit acquisitions? Does the amount reflect a targeted marketing strategy for a specific demographic, such as retirees? Or is it just paying the present value of a long term customer relationship for the bank? Is the $600 based on documented acquisition costs from other marketing efforts, which it will now amortize over the estimated life of the relationship?

The Value of Members

What the offer should remind credit unions is the value of their checking account relationships, especially those with direct deposit. There is unrecorded but real value, from those members whose loyalty often goes back decades. These core deposit relationships underwrite much of the rest of the credit union’s activity.

If you have a 10,000 member credit union half of whom have checking accounts with direct deposit, according to BB&T that is $300,000 of real value to the market. Or to be more analytical, what is the prospect of BB&T’s ability to earn more than 1.7% ($600/$35,000) if the average relationship from this marketing remains with the bank for at least one year?

Even more fundamental, should credit unions still require a membership fee?

Scale and the Law of Diminishing Returns

The most common rationale for credit union growth is to achieve new scale. Larger size is meant to bring more efficiency, productivity and market clout. And hopefully member value.

In a situation where everything or everyone else stays constant, growing larger might produce this outcome. But even in the most hospitable circumstances, the law of diminishing returns sets in.

Learning From Another Industry Serving Consumers

In a recent plane flight I sat next to a mining engineer from Houston, Texas. We talked about the largest and deepest mines in the world including a mile-deep open pit copper mine run by Kennecott in Utah.

Productivity is measured by the ounces of ore (1-3 oz) per ton of rock extracted. The constant challenge for geological engineers is to try to find veins so mining is still economically feasible. But, sooner or later, ore recovery is not worth the additional cost.

Our discussion then turned to Houston’s recent floods in part exacerbated by the city’s paving over much of its surface area by concrete. As an example he mentioned that Houston had the widest highway system anywhere in the world.

I returned home and found this was no Texas exaggeration. The Katy Freeway covers 26 lanes of freeways, toll lanes, frontage and emergency roads. At Beltway 8 it is in fact the largest according to the Houston Chronicle.

The Result of Becoming the Biggest Highway

So did this investment from 2008 help traffic flow faster? At first, for a short time, it did. But now, traffic engineers call it a Monument to Futility.

For as capacity is increased, so does “induced demand.” In fact, the same journey now takes longer on this highway mammoth than before the expansion.

My flight companion told me one result of this new congestion is that companies the highway has meant to serve are now moving to less crowded areas of the Houston metroplex. Not just the head office, but also tens of thousands of employees jobs are relocating for more open spaces.

The moral is that scale changes things, some unanticipated or even unintended. Consumers’ loyalty to is rarely based on size or scale-“the biggest”. Rather satisfaction comes from service and personal responsiveness.

Many factors cause each credit union to be the size it is today. Understanding that legacy may be more valuable than yearning for bigger scale wherein existing comparative and competitive advantages are significantly lessened in exchange for unproven future benefits.

Part II: The Half-Billion Dollar Wealth Transfer in the SchoolsFirst FCU Merger

Why Should Credit Unions Care?

Read Part 1 here.

Mergers of sound well run credit unions are a fact of life in the cooperative system.  So why should the $2.1 billion mega-merger of Schools Financial and the $16.1 billion SchoolsFirst be an issue?

I believe the circumstances and specifics of this merger highlight in ways that smaller combinations do not, the threat these transactions represent to an independent system of cooperative financial institutions in the American economy.

Credit unions have a federal and many  state income tax exemptions because they are supposed to be creating an alternative to the purely for-profit practices of other consumer options. Cooperatives are designed around certain premises including self-help, self-finance and self-governance.  Member-owners are loyal, over and above the economic benefits, because the institution belongs to them and  future member-owners.

Once these fundamental facts are debased by agents who pay lip service to principles but act from personal and institutional self-interest, then the boundary lines between for-profit and coops is blurred, if not lost.

Factual Basis Missing From Merger Process

While not entirely unique, the size of the SchoolsFirst merger dramatizes the failures of the current merger process to disclose and to protect members interests.  A few of the critical omissions are:

  • The failure to mention any aspect of the approximate $540 million wealth transfer;
  • The absence of any description of the significant losses to the community in terms of business relationships, the setting of local lending and investment priorities and the consequent reduction in civic leadership;
  • The complete lack of any specific product, service or fee comparisons and changes that would be coming-whether gains and losses;
  • The conflicts with the senior management and the board negotiating their own ongoing roles and compensation versus the absence of any commitments for continuing or new services, programs and products from which the members would benefit;
  • The lack of any disclosure of alternatives considered and, if evaluated, why this merger was the option chosen.

These significant information gaps and subsequent post-merger announcements suggest a pattern of deception.

Given the public record and limited details provided, it is hard not to conclude that this combination is motivated more by the personal ambitions of two CEO’s and their boards, not from promoting the best interests of School Financials’ members.

Members Given 49 Days to Decide a Charter Cancellation

Today a new charter takes years, volumes of paperwork, financial  projections, organizers’ resumes,  and millions of donated capital to open the doors of a de novo credit union.  It seems contradictory, even absurd, that a CEO and board should ask members to give up a charter in less than 60 days from the public notice of October 23 to the December 12 final vote.  The timing prohibits any meaningful discussion.  Surely the process to surrender a charter granted and successfully managed since 1933 should warrant greater member dialogue and public scrutiny.

Lessons Learned

As other CEO’s and boards read about mergers similar to SchoolsFirst, these examples incentivizes behavior that contradicts both faithful stewardship and the priority of members’ wellbeing. Consultants now openly solicit engagements to show how CEO’s can enhance their benefits from mergers. Credit unions market their willingness to bargain with CEO’s where “like seeks like” to facilitate the sale of their leadership responsibilities.

Boards begin to feel  they must play the same game to protect their options or to preempt competitive intrusions in their markets.

The consequence is that instead of creating a cadre of cooperative leaders driving innovation for member benefit, the system is spawning a capitalistic, robber-baron CEO style that elevates institutional growth over member value.

These self-serving mergers  promote a stunted view of what cooperative leadership and collaboration looks like.  They adopt a simplistic view of success and a Neanderthal’s approach to change.

Cooperative growth opportunities are not being enhanced.   Rather myriad options for future innovation are shut down and the industry becomes more heavily concentrated in a small percentage of large institutions.  Industry risk becomes more concentrated.

The system does not grow its reach through mergers; it only reduces the diversity of credit union institutional models.  During the past decade the number of credit unions declined by 2,400 (virtually all by mergers) and shares grew at only  5.7%, an annual rate characteristic of a mature, if not stagnant, system.

The moral capital that the cooperative system created over the past century is being squandered by short term behaviors from executives unwilling to pursue long term member value creation.

The Arguments Back

  1. Everybody does it. Wrong, not everybody.  And if that were true, we should have had a much more public and active bidding process for not only this merger, but all mergers.  Instead CEO’s selectively seek  the best option for themselves, privately discuss the potential, and then negotiate in secret with the board’s blessing or indifference.
  2. The regulator approved this. Therefore, it must be all right.   Correct, NCUA and state regulators routinely sign off on actions even when shown that they violate any objective test of member benefit or due process.   The fact that the regulator can be, and often is incorrect or unknowing in its actions, does not mean an action is proper.

As in its financial management of credit union’s cooperative resources, the NCUA board’s oversight of mergers is squandering an inheritance that it does not value nor understand.

Instead of honoring the unique member-owner design and being the architects of a cooperative system, the NCUA board sees itself as just another banking regulator.

The NCUA’s merger process undermines any meaningful democratic choice for member owners; in fact, it promotes corruption by endorsing the self-interest of the initiators of these transactions.

Member voting is nothing more than a sham. A merger proposal has never been turned down by members.   This democratic fig leaf can no longer hide the naked ambition that animates these events.

The NCUA board lacks any respect for the member-owner cooperative system.  It does not grasp how credit unions differ from other financial institutions.   Even when given detailed examples of improper and self-serving mergers, the agency at the highest levels is unable to see the mistakes of its own making.

In sum, two wrongs do not make a right.

  1. I agree but these mergers are just the “way the world works.” This argument  reminds me a line from the play, Just Call me God.  In it the character observes, “The one thing I know about power is that the good never seek it.”

But the reality of the cooperative model is that one is not asked to stand alone.  The whole model depends on the realization that each credit union member, board and CEO is part of a whole.   That together, we uniquely contribute to a greater good.

We succeed not by acquiring but by collaborating, learning and then helping each other.

Similarly, this distortion of the cooperative system, will be ended when leaders say enough is enough.   Just as happened in the conversion from coops to mutuals and then to for-profit charters in the 1990’s.

Next Steps:

This SchoolsFirst merger is a prime example of how the community’s future is jeopardized when an individual’s ambitions or a credit union’s claim of superior capability is given priority over cooperative value and design.

It poses the question whether the cooperative system can correct its own excesses.  Will the future evolution just be a relentless pattern of bigger buying out the smaller?

This merger exposes multiple institutional failures within the cooperative system including: individual credit unions with leaders converting cooperative design to commercial ends; regulators who grasp neither purpose nor practice when faced with challenges; and,  fellow travelers trying to earn a living seeking the next big wave to take them to shore.

These factors suggest that  change may have to come from outside the system should credit unions be unable to learn from their own experience.   The fourth estate is always looking for aberrant behaviors; competitors seek examples of cooperative hypocrisy; and congress protects the public interest by highlighting the other party’s administrative failures.

The Action Called For

However, this charade of mergers ends or is transformed so members actually received the benefit they created, this is an important moment for those aspiring to future cooperative leadership.

A participant once caught in a similar historical dilemma commented: “I didn’t do anything wrong; But I didn’t do anything right.”   The difference is courage. Do believers in the specialness of cooperatives still exist?

 

Part I: The Half-Billion Dollar Wealth Transfer in the SchoolsFirst FCU Merger

Note: As background for this article, please see previous posts: How Can This Merger in the Members’ Best interests and What Credit Unions Can Learn from Bank Purchases

Largest Ever “Special Credit Union Dividend” of $540 Million Paid to Members on January 1, 2020

In a December 26 release to the credit union press, Schools Financial CU announced it was paying its members a special pre-merger dividend of $4 million before it completed combining with SchoolsFirst FCU on January 1, 2020.

What the announcement omitted was that the January 1, 2020 merger will also transfer over $540 million of the reserves and net worth of Schools Financial members to the Board and members of SchoolsFirst FCU.

Each Financial Schools member’s pro rata share of this transfer is  $3,420 versus the token $26 they were given upon approval of the merger.

This is the largest wealth transfer by the members of one credit union to another credit union’s control. The use and disposition of over a half billion dollars of common wealth created by the former member-owners of Schools Financial CU since 1933 is no longer theirs to determine.

How the $540 Million Wealth Transfer Occurs

In this merger of two sound, well-run credit unions, the terms called for the entire equity of Schools Financial CU to be transferred at par. The estimated year-end net worth based on the credit union’s announced 2019 ROA of 1.73% is $270 million. This becomes “equity acquired in a merger” and is added directly to the net worth of SchoolsFirst FCU.

In addition, under the accounting standards codification for “business combinations,” Schools Financials’ merged assets and liabilities assumed by SchoolsFirst are recorded at their fair values. To simplify the numerous calculations, prior year end audits certify that the assets of Schools Financial when “fairly presented” exceed the liabilities by the amount of the net worth, which would be the estimated $270 million reserves at December 31, 2019.

This excess of assets over liabilities acquired is recognized as income on the books of SchoolsFirst FCU. It is called a “bargain purchase gain” or “negative goodwill.”

The merger of two stable credit unions creates a wealth transfer similar to a credit union which makes a “whole bank purchase.” Unlike a bank purchase however, none of the shareholders’ equity is paid to the member-owners whose loyalty and patronage created the wealth. Nor is there any additional amount, that is a “premium” over book value, offered as would be expected in a purchase of a sound bank.

The Duties of Credit Union Directors

The fiduciary duties of credit union directors, established by NCUA rule and standard legal practice, are summarized in the following article:

https://cusomag.com/2019/12/05/board-member-liability-in-an-age-of-litigation-part-1-duties-and-case-studies/

The five key legal concepts relating to director responsibility and liability are excerpted in part below:

    1. Business Judgment Rule

The business judgment rule dictates that a court must presume a director based his or her decision on an informed and honest belief that the decision was in the best interests of the institution and members… To receive the business judgment rule’s presumptive protection, directors must inform themselves of all material information and then act with care.

    1. Duty of Care

Fiduciary duty of due care requires directors to use that amount of care which ordinarily careful and prudent persons would use in similar circumstances and consider all material information reasonably available when making business decisions.

    1. Duty of Loyalty

This duty forbids corporate directors from using their position of trust to further their own private interest (i.e. “self-dealing”)… Additionally, directors are required to act in an “adversarial and arms-length manner” when negotiating transactions between the corporation and the director.

    1. Duty of Good Faith

Breach of the duty of good faith occurs if the directors consciously and intentionally disregard their responsibilities, adopting a “we don’t care about the risks” attitude concerning a material decision. Moreover, deliberate indifference and inaction in the face of a duty to act epitomizes bad faith.

    1. Waste

Waste is defined as a director irrationally squandering asset. To prove waste, the plaintiff must establish that an exchange was so one-sided that no businessperson of ordinary, sound judgment could conclude that the credit union received compensation.

I believe each of these standards is relevant when assessing this transaction.

What the Members of Schools Financial Were Told About the Merger

The primary document provided members was an October 23, 2019 letter to members from the Board Chair. NCUA did not post the financials referred to in the letter so it is not clear how the financial combination was presented, or even if it would have been understood by a member if received.

The Chair’s letter states the merger was a result of a mid-2017 board decision to refocus the credit union’s “efforts upon educators on a state-wide basis.” One public announcement since that mid-2017 date was on January 22, 2019 in which the two credit unions in a joint press statement announced their intent to merge. The Chairman’s announcement of the member vote in October was the implementation of this January decision.

The letter to members is very general in its justifications. The most specific language was two pages of detail about the potential increase of compensation to be received by the CEO ($8 million of the total $9 million described) and five most senior managers as a result of the merger.

The letter did not state:

  • That the credit union’s accumulated wealth of over half a billion dollars would be transferred to another credit union’s control and use;
  • That the credit union’s resources would now be controlled by a board of directors for which no information was provided and is located over 400 miles from Schools Financial primary service area;
  • That the operating control of the credit union’s assets and shares would now be under the control of a management team about which no information was provided and which, like the board, is over 400 miles removed from the Sacramento membership;
  • Any immediate changes of rates on savings or loans that would occur as a result of the merger;
  • Any information about ongoing roles negotiated for Schools Financial’s Board of Directors;
  • Any commitments relating to products and services provided by Schools Financial that are not offered by SchoolsFirst such as Banking for Everyone Savings, business accounts or the shared branching outlets-“each to be evaluated to determine whether to continue or discontinue them after the merger;”
  • Any impact on Schools Financial’s field of membership granted by the State of California which according to the September 5300 Call Report covered up to 4 million potential members.

The members were urged to give up their independent charter and the direct control of their credit union’s resources and all future decisions in return for general promises of “improved financial benefits” and “to gain economies of scale to be able to compete with larger financial services companies.”

On this latter point about the benefits of scale, in the year-end special dividend announcement by Schools Financial, the full year’s ROA of 1.73% would be approximately double the industry average and .60 basis points higher than SchoolsFirst FCU which is eight times the size of the Sacramento based credit union.

Subsequent Announcements by Both Credit Unions

After the voting and special $4 million dividend were announced, the following information has been published by the credit unions on their websites after stating the merger was overwhelmingly approved:

  • The annual membership meeting of the newly enlarged SchoolsFirst FCU will be on May 19, in Tustin, CA approximately 430 miles from the location of the former office of Schools Financial CU.
  • The Nominating Committee of Schools Financial met on December 5th (one week before the December 12th Schools Financial member meeting to vote on the merger) and nominated two of the merged credit union board members to their board: Marie B. Smith who as Chair signed the merger letter, and Theresa Matista, another current board member approving the merger. The annual meeting notice also stated: “The election will not be conducted by ballot when there is only one nominee for each position to be filled. There will be no nominations from the floor.”
  • In a post-merger web announcement titled: An Exciting Time for Schools Financial Members,” Marie Smith, chair of Schools Financial stated: “I along with two other current Schools Financial CU Board Members will serve on the SchoolsFirst FCU Board of Directors. I look forward to our bright future and helping you and your family secure lasting financial security.” Apparently, the Nominating Committee didn’t get the same message for the December 5th nomination described only two board members from Schools Financial!
  • The letter also listed five potential fee reductions such as eliminating $8 incoming wire service fee. The post also reiterated the prospect of “improved savings rates and highly competitive interest rates on loans” but with no specifics.
  • In another section of the web: Returning to our Roots, Schools Financial, a division of SchoolsFirst FCU announces that their FOM is “exclusively open to current or retired school employees and their immediate families,” not the open community charter followed prior to the merger.
  • On the SchoolsFirst website, the FAQ about the merger includes the announcement that the credit union will open a new branch in the Sacramento area in the first half of 2020. But otherwise the credit union twice states, “most things will stay the same,” and again, “all products and services will stay the same.” One way to interpret this assurance is that the junior partner’s product and service profile will be conformed to that of the senior partner.

These after the fact disclosures illustrate the lack of transparency surrounding this $2.1 billion transaction. The assessment begun in May of 2017, triggering the joint merger press release in January 2019, which suggests the board had over two years to evaluate and to negotiate on behalf of the members. Yet the most detailed part of the letter to members concerns compensation to the CEO and senior managers, and no details of any potential benefits or losses for the membership.

Which raises the most important question, what options did the board consider and evaluate for the members’ best interest?

What Could $540 Million Endowment Contribute to the Sacramento Community

Separately from the issue of whether the board talked to or considered mergers with local credit unions such as Safe or Golden 1 to enhance the future for Schools Financial members, is whether the credit union even deliberated investing some or all of the wealth created by the members to benefit the future of the community which created this surplus.

Did the directors consider paying forward the reserves for helping the school districts and communities versus giving half a billion dollars to the control of a board and management whose primary responsibilities are rooted hundreds of miles away in a different part of the state?

What could a half billion-dollar fund do for the needs of the Sacramento educational community?

  • How might it help with affordable housing options for teachers to live closer to the communities they work in?
  • For scholarships to seniors from families that cannot afford to contribute to higher education expenses?
  • For teacher training especially in areas that fall outside the immediate priorities such as the arts, technical and vocational skills?
  • For equipment for schools that are short-changed versus wealthier districts in the allocation of funds for classroom technology or extracurricular sports?
  • For educational programs for those adults striving to get a GED or other certifications?
  • For pilot programs for encouraging and supporting new online educational options?
  • For reducing the college debt burden to hire new graduates for teaching careers so they do not have to worry about paying off loans?
  • For special grants to local community colleges and universities to underwrite innovations in educational experiences and curriculum?

With a 6% grant rate and a half billion-dollar fund, over $30 million could have been donated annually to benefit the community that created, supported, funded and made the credit union a force for good in the Sacramento area.

SchoolsFirst, the fifth largest credit union in the country, had the capital to absorb the credit union which would have allowed the credit union to transfer the wealth for the benefit of the community that created it in the first place. If the rejoinder is that the SchoolsFirst Board can now do the same work, one needs only look at the credit union’s track record to know that that is highly unlikely. For in the 2018 Annual Report, the $16 billion SchoolsFirst reports as follows: “In 2018 we partnered with local, national and global educational and credit union charities to give back in significant ways. We made more than $2 million in charitable donations including donations to local schools and colleges, Children’s Miracle Network, Hospitals, Habitat for Humanity and CUAid.”

Part II of this analysis will be posted tomorrow. It will address why credit unions should care about this wealth transfer and the circumstances which enabled it to occur.

 Consumer Trust and Financial Services

In a February 2019 article in The Review of Financial Studies a research report by professors at the Columbia Business School was published.

The professors’ objective was to ask why US homeowners were slow to consider refinancing options even when it could provide significant savings.

The study was based on one financial institution’s offer to 550,000 eligible borrowers under the Home Affordable Refinance Program (HARP).

What were the behavioral factors that caused the homeowners not to take the refinancing offers? All current borrowers were sent pre-approved applications; there were no fees. Yet 51% passed on the opportunity which would provide an average savings of $9,000.

The Primary Reason for Not Acting

“Survey data indicate that among all the behavioral factors examined, only suspicion of banks’ motives is consistently related to the probability of accepting a refinancing offer,” concluded the authors.

The study also looked at the impact of incentives including use of Fannie Mae and Freddie Mac to increase credibility, a $500 cashback if the process took more than 30 days, and a gift card for an immediate acceptance.

The result: “We report the results of three field experiments showing that enticing offers made by banks fail to increase participation and may even deepen suspicion.”

The paper’s bottom line: “Our findings highlight the important role of trust in financial decisions.”

Can Trust be Marketed?

Most credit union teams know trust matters. It is common sense. The challenge is how to communicate this fundamental characteristic of cooperative design. Is it by emulating the marketing strategies of the banking industry? Or honoring the loyalty and relationships that build a cooperative?

What Credit Unions Can Learn from Bank Purchases

I am uncertain on the issue of credit unions’ whole bank purchases. Are they an aberration, an opportunity, or events for just a moment in time, even though the practice dates back to 2012? While consequential for some individual credit unions, the 30 or so total purchases are not yet a significant factor in the industry’s $1.6 trillion assets. And it is mostly a side show in comparison with the 200-250 voluntary mergers occurring per year.

Largest Bank Purchase Announced

In early December, the largest bank purchase to date was announced. Suncoast Schools CU will buy Apollo Bank to extend the credit union’s reach into the greater Miami market.

No financial terms were announced. Apollo Bank reported $747 million in assets and $74 million in bank capital as of September 30, 2019. Its $545 million loans are primarily in real estate and commercial, not consumer credit. It has five Miami area offices.

Suncoast sees the acquisition as a way to jump into the 6 million greater Miami market area, expand its consumer loan portfolio, and enhance its commercial lending capability.

The Financial Impact on Suncoast

Even though both boards have approved the purchase, the value of the transaction was not released. Therefore, it is not possible to analyze the transaction’s risk, if any, to the credit union. From call reports, we learn that Apollo Bank has been profitable. The stock is not publicly traded so we cannot use a market valuation to compare with the purchase price.

In traditional bank sales, a price in excess of book for a steadily performing firm is commonplace. Because this cannot be a stock transaction, Suncoast will pay the total negotiated value in cash to shareholders. Its board’s approval suggests they anticipate no major change in Suncoast’s financial or risk profile that might delay the purchase.

How a Bank-Credit Union Purchase Works

Should Apollo Bank’s negotiated share price be approximately 125% of book value, this purchase would cost Suncoast $100 million. To simplify myriads of accounting details, assume the bank’s assets and liabilities are valued near book. This would result in Suncoast recording a net equity acquired in merger of approximately $77 million and a goodwill entry for the amount in excess of the net book figure, or approximately $25 million.

The bank’s shareholders receive cash. They can do whatever they choose with their $100 million. They can deposit it in the credit union, buy stock in another company, pay off loans or spend it. The purchase agreement will ordinarily contain other conditions such as terms for retained employees with possible performance goals, representations, non-compete agreements, and other understandings. Purchase documents for shareholders can run into hundreds of pages. Teams of outside accountants, consultants and advisors are normally engaged by each party to complete the transaction.

Comparing Bank Purchases with Credit Union Mergers

If Apollo Bank were instead Apollo Credit Union whose board and CEO had agreed to the merger, the credit union’s member-owners would not be treated the same as its bank shareholders. In fact, no merger of two sound credit unions has never resulted in a meaningful payout of the accumulated reserves created by generations of member loyalty.

A hypothetical Apollo Credit Union merger, under current practice, would transfer all its accumulated equity to Suncoast. The total wealth transfer is double the equity amount under current credit union merger practices. Suncoast books the excess of assets over liabilities as “equity acquired in a merger,” similar to the bank transaction. But then, as no cash is paid from equity to member-owners, the credit union recognizes the amount of equity transferred over and above the net assets, as “negative good will”. This is income for the credit union to use however it chooses to spend its revenue.

Needless to say, there would never be a bank purchase under these terms. A bank CEO and board that would even suggest doing so, using a rationale of expanded services and capabilities available from the much larger credit union ($10 billion Suncoast), would be subject to potential legal liability by shareholders for failing to represent their best interests. Shareholders would undoubtedly turn such an offer down, and start looking for another CEO and board.

The Critical Issue from Credit Unions Buying Banks

In a credit union bank purchase, the owners are given much greater respect, due diligence information, and ultimately money, than the member-owners receive in a credit union merger. The underlying economics of the situations are virtually identical. Moreover, the 30 bank purchases demonstrate the financial strength of credit unions to indeed pay owners their full equity interest ,and possibly more, and yet still have a mutually agreeable and sound transaction approved by regulators.

Should the boards and CEOs of well-run credit unions considering mergers be more assertive representing their member-owners’ interests? The bank transactions show that it is not only financially feasible, but also a fiduciary responsibility.

NCUA’s Role

When Chairman Hood was asked about bank purchases in Congress recently, he responded that these were voluntary market transactions, but that NCUA would be looking into them. He did not explain what that meant. However, the critical issue these transactions raise is whether member-owners in the economically equivalent situation of a bank purchase, are being given proper consideration in mergers.

Clearly these “voluntary, market-based” bank purchase transactions would never happen if the terms were similar to current credit union mergers. So why are NCUA and state regulators routinely approving the same economic events that transfer member-owners double equity value with no compensation? These may be “voluntary” but are hardly market-based transactions.

Merger Terms Now Available

Moreover, credit union mergers are not documented in any way similar to bank purchases as to why the transactions are in the members’ best interests. When reviewing the information now publicly available on all mergers, the descriptions of member benefits are rarely more than assertions of a brighter future or marketing “happy talk.” The most explicit details are the increased compensation CEOs and senior managers will receive from the transaction. Even when there is a token “special dividend” to encourage members to vote for the merger, the amount is minuscule compared to the double equity being transferred to the surviving credit union.

Reviewing the published letters boards of directors sent to members encouraging their approval of merger proposals, it is clear that the most immediate benefits go to the CEO and managers giving up their leadership responsibilities to another credit union. In a number of cases the members who are supposedly gaining something, could have joined the surviving credit union anyway, if it indeed offered a better value.

What Is Being Lost in Mergers

In most mergers routinely approved by NCUA, there are no safety and soundness issues. So, what is the regulator’s responsibility? Should it not be to ensure that the members who are being urged to give up control of their credit union are indeed treated equitably? For the members and their communities are losing not just their collective resources, but also any meaningful say over the direction, priorities, leadership and institutional role in their home markets. The credit union system loses another leadership cadre. Employees find future leadership opportunities diminished.

All credit unions start small. Some emerge to become large and some even evolve into national leaders. With every cooperative charter cancelled, a potential source for breakout growth and entrepreneurial innovation is extinguished. The community or market being served loses a critical component of its financial and economic ecosystem. Choices become fewer. For in some instances, the merger intentionally removes a cooperative competitor that the surviving credit union could not otherwise successfully dislodge.

Rethinking Current Credit Union Merger Process and Practice

If Chairman Hood believes market-based transactions are good, shouldn’t credit union merger practices be more substantive with real market disciplines? Why should a cooperative’s wealth be transferred in negotiations where members are now excluded from the process in any meaningful way? There has never been a merger turned down in a member vote. This is not democratic control, rather it suggests that incumbents take advantage of their position oblivious to the legacy they inherited as well as their responsibility to future generations.

As cooperatives, credit unions are a blend of financial and market concepts. Credit unions buy banks; however current merger practice is little more than legally sanctioned theft of the member-owners’ collective contribution to their credit union’s success.

As cooperative architects, both regulators and credit unions who believe in this member-owned, one person, one vote model, must address this merger inequity. For it is incentivizing behaviors that undermine the hopes of cooperative owners and contradict the public promises that gave credit unions a unique standing in America’s financial system.

The purchase of banks is showing that credit union member-owners are not receiving comparable consideration and respect for similar economic transactions.

Credit unions should take the lead to reform a system that is becoming corrupt in appearance, if not in practice. If they do not, then external forces in Congress, the media, consumer advocates or even private lawsuits are likely to challenge the entire cooperative system’s structure and oversight. And then all 100 million plus members may lose.