Early Learnings from Bank Yearend Earnings

Everyone looks like a business genius when interest rates are at historic lows and money is incredibly cheap. But when the tide goes out, you see who isn’t wearing any swimming trunks.

(Warren Buffett, among others)

This week all major banks will report their 4th quarter earnings.  Yesterday the money center banks released their results.  Today the large regionals report.

Credit union 5300 call reports for the same period will not be available for 60 days or more from NCUA, unless individual firms post their financials independently.

There are three observations from these commercial investment and consumer banking leaders so far.

  1. 4th quarter earnings compared with the same period of 2021 are at best mixed. JP Morgan’s net is up 6%; Bank of America, 2% up; Wells down 50%; Citigroup a negative 21%. Goldman Sachs down 69% and Black Rock’s profit fell 23%.
  2. Goldman’s decline was due in part to a cumulative $3 billion loss since 2020 in its efforts to develop a consumer lending market under the Marcus brand.  The firm has since reorganized these products.
  3. The stock prices of most money center and regional banks have fallen precipitously over the past 12 months.

Some examples:

JP Morgan  -10%

Bank of America -27%

Citigroup -24%

KRE Regional banking ETF  -25%

Each institution singled out different factors affecting their results:  increase in loan loss reserves, falling revenue in certain business lines such as investment banking and trading,  operating expenses too high, rising interest rates, recession worries and economic uncertainty.

The common refrain in the earnings announcements: “These are not the results we expect to deliver to shareholders.

There were a number of negative events called out:  Goldman’s loss in the consumer market, Wells Fargo’s $3.7 billion additional government fine, and  JP Morgan’s $175 million write off of a fintech acquisition.  Results were mixed but not troublesome from a systemic view.

Potential Questions for Credit Unions

ROA for credit unions through September 30 fell about 21% to  88 basis points versus 2021.   The largest single factor was 15 basis points in loss provision expense.

What the 12 months decline in bank stock prices suggests is that the market analysts see a more challenging year for financial performance in 2023 in all banking sectors.  Uncertainty from the  inflation-recession outlook is the major concern.

This overall decline in bank stock values raises questions for credit unions.  For the 20-30 who completed or announced upcoming bank purchase, did they overpay?   Will the purchase goodwill premiums need to be reassessed?   Will purchase offers going forward reflect the market’s valuation declines?

Goldman introduced its Marcus consumer initiative in 2016.   It announced a partnership with Apple for a new credit card.  Since 2020 these “platform” based initiatives for consumers have lost $3.8 billion.  This is one factor in the bank’s announced 3,500 immediate employee layoffs.

The question for credit unions is, if a an expert firm such as Goldman can lose this much entering a new business line, consumer banking, could credit unions face the reverse challenge?

For example, Jim Duplessis in Credit Union Times observed that total credit union commercial real estate loan production has risen 41% in the first nine months to $36.7 billion. For some credit unions these participations are a new lending effort.

Many banking CEO’s are cautious about the future.  It is not just the recession prospect, but declines in mortgage activity, drawdown of consumer savings, and economic impacts  from higher rates not yet fully played out.­

A Proven Track

To the extent credit unions follow their consumer members closely, the future should be sound.

Where the difficulties may occur is forays in areas where experience is limited.  Among these are commercial loan participations, whole bank acquisitions, and investments in “side” business such as technology startups or crypto offshoots.

One of the advantages in this economic and rate transition is that credit unions don’t have to worry about their stock price.   However the market’s negative outlook for bank stocks  should be an alert that prior assumptions in underwriting and investing may need to be reassessed.

What credit union wants to be found swimming without trunks?


When The Bullet Hits The Bone…

Two credit union press releases this week reminded me of the 2012 post below by Jim Blaine.

The first was the announcement that five Minnesota credit unions had loaned $31 million to Opal Holdings, a New York real estate developer and investment firm, to purchase a 17 story office tower in Bloomington, MN.  “The financing included two senior secured notes on equal footing issued in June: One for $22.1 million at 5.1% for 36 years and the other for $8.1 million at 5.32% for 40 years.”

The second from Summit Credit Union stating it had completed the purchase of the $837 million Commerce State Bank  “in the largest credit union acquisition of a bank in the state’s history.”

“Twilight Zone”  (by Jim Blaine)

Nobody said it better than Golden Earring.  No, this is not the golden earring you fearfully imagine sprouting some day from your teenager’s nose or navel.  It’s the late ‘70s rock group and the song is “Twilight Zone”.  The question:  “Steppin’ out into the twilight zone.  Entering the Madhouse, fears that have grown.  What will become of the moon, and stars?  Where am I to go, now that I’ve gone too far?”…  The answer:  “You will come to know, when the bullet hits the bone!  Yes, you will come to know, when the bullet hits the bone!”

The Heartland….

The Amana Colonies, 26,000 acres of picturesque Iowa farmland, sheltering seven immaculate villages, are up Highway 151 about 100 miles east of Des Moines.  This is the Midwest, the Heartland.

The place where the Deere and the antelope play.  A warp in time through which, you may, perhaps, be able to catch a glimpse of the future – the future of the credit union movement.

The Amanas were settled in 1855 by the Society of True Inspirationists.  The sect was formed in Germany; adopted a communal structure; and had unique, idealistic, and firmly held beliefs – sound vaguely familiar?  The communities were self-sufficient and prospered richly.  

All things were shared.  Products, such as woolens, handmade furniture, meats and wines, were sold to the outside world.  A sterling reputation was built upon high standards of craftsmanship and a close attention to detail.  The “Amana” name – remember that refrigerator? – became synonymous with quality and value – sound vaguely familiar?

“Why don’t you download this app…”

The Amanas appeared to be the true Utopia, the new Eden.  But trouble, eventually, always comes to Eden.  At first, the Inspirationists called it “The Reorganization”, then “The Change”, and finally, “The Great Change”.  It started as a murmur, became a grumble, heightened to an argument, and ended in 1932 as a split.  

Eighty years of success forced onto the scaffold of change by a diminished intensity of beliefs, a cooling of religious fervor, a forgetfulness of original purpose and vision – sound vaguely familiar?

Their world, however, did not come to an end in 1932.  The Amana Colonies continued on.  The communal structure was abandoned; the religious and the secular were separated.  Homes and personal property were divided; stock was issued in the businesses and agricultural interests.

The Amana Society Corporation now controls and manages the businesses.  The Amana Church Society now deals with spiritual matters.  Today, the Amanas are on the National Registry of Historic Places and the Amana Heritage Society strives diligently to preserve the cultural heritage of the community and its descendants.  Today, the Amanas are still many things, but mostly the Amanas are a novelty, an oddity, a quaint museum of past hopes and ideas.  

Why did this happen?  The guidebook says:  The Amanas were… “a goal:  visioned through faith; created and established by faith; named for a faith and dedicated to a faith”.  And, “the first generation had an idea and lived for the idea.  The second generation perpetuated the idea for the sake of their fathers, but their hearts were not in it.  The third generation openly rebelled against the task of mere perpetuation of institutions founded by their grandfathers.  It is always the same with people.” – sound vaguely familiar?Which credit union generation is this?  Are you still living for “the idea”?  Is your heart… still in it?

“… destination unknown.” 

“Steppin’ out into the twilight zone.  Falling down a spiral, destination unknown.  What will become of the moon and the stars.  Where am I to go, now that I’ve gone too far? 

…You will come to know, when the bullet hits the bone.  Yes, you will come to know when the bullet hits the bone.”

The Missing Framework for NCUA Success (part I of II)

It is an accepted truism for NCUA board members presenting their credentials  for Senate confirmation, or whenever the agency is justifying a new rule, reg or policy, to state their ultimate goal is “to protect the insurance fund.”

Current board members have even called that objective their goal or North Star.  Their primary job.

This assertion turns upside down the logic of means and ends.

What is NCUA’s End Purpose?

NCUA’s primary responsibility, its purpose,  is encouraging and sustaining the resilience and integrity of a cooperative financial system for American consumers.  The FCU Act states:

The term Federal credit union means a cooperative association organized in accordance with the provisions of this chapter for the purpose of promoting thrift among its members and creating a source of credit for provident and productive purposes

To achieve this end, NCUA was given multiple means in the law:  chartering, examinations, supervision, administration of charter changes, issuing regulations and providing expert guidance.   The tool least used, as it is rarely needed, is calling upon NCUSIF.

Most importantly, the FCU act specifically states the NCUSIF’s financial solvency is protected by the full faith and credit of the credit union system.   All members must deposit and maintain 1 cent of each share dollar in a credit union with the NCUSIF.  Every member is part of this collective guarantee ensuring all other member shares are indeed safe. This is a cooperative movement commitment, unique to the NCUSIF.  It is the law.

If all of NCUA’s every day tools ( the other “means”) are effectively managed, then the members should never be called upon to provide additional resources.  That is how NCUA protects the Fund.

The first four-decades of regulatory responsibility to maintain cooperative system integrity from 1934-1971 did not require the share insurance tool.

One aspect of “integrity” was certainly promoting credit union solvency as there has always been reserving and net worth requirements in the law.

But just as important, system “integrity” (as a source of credit) also included vital cooperative components to provide a distinct financial alternative for members.  These  include democratic governance, values such as education and collaboration, volunteer leadership (unpaid directors and committee members), access for all Americans regardless of financial circumstance (capital), focus on community (common bond), and contrary to the capitalist model, building common wealth versus private equity, to be used by future generations .

Over time additional characteristics have been developed including interdependence (corporates and CUSO’s) and system support augmenting the critical initial role of sponsors.

A Reward for Performance

When Congress approved the NCUSIF for credit unions in 1971, it was a reward for their performance.  As stated at that time, insurance was not due to financial problems with credit unions or the cooperative system.  Rather it recognized their growing contribution to the American economy and that they might not perceived by the public as the equal of their FSLIC/FDIC alternatives.

A Cooperative Policy Framework Is Lacking

For NCUA to faithfully fulfill its mission to protect the integrity of this cooperative financial alternative, an appropriate regulatory policy framework is necessary. Such a framework should be nonpartisan and multi-administration.  Past examples are the deregulation of shares by NCUA or the redesign of the NCUSIF.

Without a thoughtful and evolving framework, NCUA becomes a mishmash of regulatory justifications or each Chairman’s personal priorities.  What do the banking regulators do?  Or let the “free market” work its will.  Or elevating suboptimal tasks and agency operations  to define priorities.

Absent a policy framework, the unique role of cooperatives becomes increasingly confused with all the other financial activity in the marketplace.   No longer are the well-being and rights of member-owners front and center.  Bright shiny objects such as innovation and new technologies take center stage.

The ambitions of managers and boards seeking to outgrow their for-profit competitors become the industry’s defining priority.  Some credit union leaders chart success not by developing a better alternative to attract members, but rather using their decades of member reserves for buying out bank owners at a premium.

That activity would certainly seem contrary to the spirit of the Act.  And therefore worthy of public debate.

Credit union CEO’s, nearing retirement, game the system for personal enrichment  “selling their credit union” via merger.  They capitalize on the transfer of members’ accumulated wealth and loyalty for additional bonuses and extended payments beyond those merited as CEO.

In these transactions, the financial and relationship legacy, its goodwill, is turned over to boards and CEO’s with no prior connection.  And justified only with vague future promises that bigger is better.  The unique character of the charter and its local legacy and traditional focus are eliminated.

Tomorrow Part II, developing a policy framework.

Friday Updates

The following are updates from posts this past week.

VyStar’s Challenges: Continuing to Expand in Georgia

Both CU Today and Credit Union Times report that VyStar has called off its $195.7  million purchase of Heritage Southeast Banking Corporation, a holding company for three local banks located outside Atlanta.

The local TV station NEWS4JAX covering the story included the following quote from CEO Brian Wolfburg :  “Following a thorough evaluation of the transaction between VyStar and HSBI, we have mutually agreed that moving forward separately is the prudent decision. VyStar will continue to expand our services in Georgia.”

This Georgia expansion seems tone deaf to the concerns of members in the credit union’s legacy Jacksonville market.  This recovery challenge appears greater than a botched conversion.

There are dozens of comments posted after every NEWS4Jax story:

Mark 2 HRS AGO

It seems that Vystar management made a poor decision with NYMBUS and are having to force it down members (co-owners) throats, regardless of the inconvenience and future inadequacies of software capabilities. The NYMBUS salesperson probably made bundle of commission off of this sales job to Vystar.

BigSwifty500 21 HRS AGO

This story is worthless and full of non-truths. The login page still says it is “temporarily unavailable”. Time to move my accounts elsewhere.

B coffey 2 DAYS AGO

N Y M B U S….this is the name of the company vystar is sharing “relations” with. They performed, designed this mess. Both companies share Board members. Nymbus  is even located in their (Vystars) building in Jax. Vystar is listed as a Nymbus investor. Starting to see a forming problem here?????

john marshall 2 DAYS AGO

This “upgrade” (that isn’t one) ought to be called Wolfburg’s Folly!


Translation: “We know a dumpster fire when we see one and we know to run the other way. Sincerely, HSBI”


Glad I switched to Community First CU


Crypto Crash: The Selloff in Crypto Assets Resumes (CNBD Disrupter article, June 16)

Bitcoin fell again today as a sell-off in global risk assets resumed, with crypto investors reeling from a dramatic plunge over the last few days that saw the world’s largest cryptocurrency almost drop below $20,000. . .  

Bitcoin is sitting at levels not seen since late 2020. The digital currency is down more than 20% in the last week and has dropped more than 60% from its all-time high in November. . 

The current bear market is often dubbed a new “crypto winter”.  . .


“Good Angel-Bad Angel”-The House Hearings on January 6th Insurrection

When the Music Stopped for VyStar

On May 2, 2022 the $12 billion VyStar Credit Union celebrated its 70th anniversary with a ceremony at its founding location, the Naval Air Station, Jackson, FL.

The press release included the following announcementVyStar is also leading a digital transformation that includes a new website and online & mobile banking platform.  But then reality set in.

The Music Stops

On May 14,2022 the confetti hit the fan. The conversion to the new online and mobile platform failed.  As of the following Friday there were more than 13,444 comments posted on the VyStar Facebook page about the outage.

The situation as described in a CU Times story on May 22:  The brief outage, as explained to members, was planned to last for two days. As May 20 rolled around, seven days later, the $12.3 billion credit union’s 822,000 members still were offline and furious.   One Facebook posting:  “How in the Hell Does a Credit Union go a week with its online systems completely DOWN in 2022???”

The CEO Returns

Brian Wolfburg, CEO had been  on vacation overseas.  Upon his return he was interviewed by a reporter Jim Piggott for the local TV station, NEWS4 JAX.  The complete  18 minute interview is here.  The on air report excerpt  was just six minutes.

Wolfburg repeatedly references the credit union’s 70 year history to indicate that the credit union will “get it right.”   Members posted their skepticism in comments after the story such as:

Mikey19 DAYS AGO: I think the CEO should resign and the person that is in charge of this mess should be fired. Who is with me on this. Let’s email the Board of Directors to let them know our thoughts. VyStarBoard@vystarcu.org

Members File Complaints with Regulator

A June 6, CU Times article detailed member complaints with the Florida Office of Financial Regulation:

Complaint Filed May 20:  “VyStar Online Banking has been unavailable to members for 7 days now with no date given as when to expect the system to be operational. VyStar Management has been vague and evasive with little to no accountability for the botched roll out of its new online banking system. They have gone ‘dark’.   The story added:

CU Times has repeatedly asked for interviews with VyStar executives and board members. The interview requests have not been granted.

Potential Legal Trouble

A June 8 article in CU Today described the  potential of a class action suit.  Also the credit union would end its fee refund of fees incurred by the outage.

VyStar said that it proactively refunded/is refunding fees that it charged members from May 14 through June 9 as a result of the online and mobile banking conversion, but as of June 10 it will not do so.

Members Leaving

In a June 9 CU Today update, the story described members intentions to leave the credit union:

Action News Jax said it contacted VyStar CU regarding how many members have closed out memberships, but said the credit union did not provide any data. 

Class Action Suit Filed

June 13, CU Today reported on a class action suit:

In an interview with FirstCoastNews.com two weeks after the solutions went down, Attorney Austin Griffin, a partner in StoryGriffin PA, a consumer justice law firm in Jacksonville Beach. Fla., told FirstCoastNews VyStar members could go after the credit union with three possible claims: negligence, breach of contract and fiduciary duty.

Griffin told the publication that since VyStar is a credit union and not a bank, there is “an expected higher standard of care.”

VyStar’s Status Today

The latest update on VyStar’s web site reads:

Online statements now available. Access your accounts and make External and Internal Transfers via your computer, tablet or mobile device at online.vystarcu.org. Please note: We will continue to have planned daily maintenance from 1 a.m. to 4 a.m. EST when system access may be unavailable.

The Credit Union Times latest summary  is as of June 14.  Over 28,000 comments have been posted by members frustrated with their experience.

Context for the Event: VyStar Invests $20 Million in Nymbus

There are more factors to this story than a botched conversion.

In  July 2021, VyStar signed a deal with the Jacksonville, Fla.-based Nymbus as the credit union’s online and mobile banking partner.

This statement by Joe Colca, Seniro Vice President of Digital Experience was part of the release:  “Our previous investment already demonstrated our confidence in Nymbus. We’re now proud to lead by example for other credit unions seeking a trusted fintech partner to implement sophisticated technology, people and processes to offer progressive products and member experiences.”

In October 6, 2021 Credit Union Times reported Nymbus had moved into VyStar’s head office location.  “A fintech with credit union funding is moving from Miami Beach to the campus that houses the headquarters of VyStar Credit Union in Jacksonville, Fla.

Nymbus said in a news release Tuesday that it made the move because of its relationship with VyStar ($11 billion in assets, 778,348 members). VyStar invested $20 million in April to help develop Nymbus’ month-old Nymbus CUSO to better extend its services to credit unions. In July, VyStar chose Nymbus as its new online and mobile banking solution partner.

In September 2019, VyStar created a $10 million fund to invest exclusively in fintech companies. VyStar has said it has supported Nymbus because it provides a way for it and other credit unions to keep up with members’ rising expectations for sophisticated online services. Nymbus’ website said it saves banks and credit unions “decades” in developing such services.”

Two senior managers of VyStar were also  members of Nymbus’s Board. Joe Colca, VyStar’s SVP on the board was quoted:

“Nymbus has proven to be an effective, valuable partner in our efforts to improve the member experience at VyStar and strengthen the credit union industry as a whole,” Colca said.

 VyStar’s FOM Expansion and Bank Purchases

Vystar’s first bank purchase was announced on January 15, 2019 with the  purchase of First Citizens Bank: VyStar Credit Union announced it plans to acquire $280-million Citizens State Bank, a Florida state-chartered bank headquartered in Perry. CSB has four locations: two branches in Gainesville, and branches in Perry and Steinhatchee, Fla.

The article continued that this purchase was possible because of an FOM expansion:

In November 2018  VyStar received approval from the Florida Office of Financial Regulation to significantly expand its field of membership by 27 counties—more than doubling the original 22 counties—to include all 49 counties of Central to North Florida. This expansion included Taylor County, where CSB’s Perry and Steinhatchee offices are located. VyStar currently serves the Gainesville community with two branch locations with plans to open additional offices in Alachua and Ocala by mid-year, the CU said.

Subsequently,  on March 31, 2021 VyStar’s purchase of the $1.6 billion Heritage Southeast Banking group  for $189 million was announced.  The closing has been deferred three times.   This would be the largest purchase of a bank by a credit union.

Largest Subdebt Placement by a Credit Union

To support these bank purchases and rapid growth, VyStar issued $200 million of subordinated debt in the first quarter of 2022.  This is the largest subdebt capital placed in credit unions to date. Arranged by Olden Capital, the issue was sold to 41 investors including credit unions, banks, insurance companies and asset managers.

Without this external capital infusion, Vystar’s net worth would have been 7.9% of March 31, 2022 assets.  With the debt and using a four quarter asset average as the denominator, VyStar reported a net worth ratio of 10.15%.

“Values-centric” brand campaign: “Do Good. Bank Better.”

From an October 2021’s CU Today story  New Branding Campaign:

VyStar Credit Union has launched a new “values-centric” brand campaign, “Do Good. Bank Better.”

VyStar said the multimedia campaign has been inspired by the people, businesses and organizations that it serves, and that it elevates VyStar’s “powerful promise to support its members and communities by offering better banking options and giving back to strengthen the places it calls home.”

“We proudly live by the words, Do Good. Bank Better., and this is just the beginning of our efforts to continue sharing our nearly 70-year story,” said VyStar President/CEO Brian Wolfburg in a statement. “As we evolve as an organization, we remain true to our roots by upholding our standard of leading by example and showing goodwill in everything we do.”

The Member’s Chance for a  Choice

VyStar has been on a very ambitious multiyear growth spurt:  converting charters and expanding the FOM, purchasing whole banks, investing in multiple fintech companies, raising external capital and launching a new public relations and branding campaign.

Members’ reaction to the online conversion failure shows how much confidence has been lost in these many expansion efforts.  The situation calls into question multiple initiatives especially the credit union’s investment and role in Nymbus plus its thrice-deferred bank purchase.

This episode and its background are now occurring in a rapidly changing economic and financial environment.  Investments and other assets that appear sound when the cost of funds is near zero now have a very different risk profile.

Once again the regulators have been on vacation.

The credit union’s reputation is being stained. Its operations, business initiatives and internal capabilities appear strained on several levels.  The net worth ratio is created, not earned.

The best solution may be to follow the advice of the member who posted:  Let’s email the Board of Directors to let them know our thoughts. VyStarBoard@vystarcu.org 

Members are the owners.  They should do more than vent frustration by exercising their power to choose their representatives for the board.  They should take back their “home” if they truly want to see the credit union “do right” for its members and communities.






FOMO Business Decisions

One of the most common sales pitches in life is “hurry up and get this  deal before someone else buys it.”

The Fear of Missing Out (FOMO) has many variations.   For some it impels stocking up on toilet paper in a pandemic.  For others it is a rush into NFT’s, crypto currencies, a meme stock or  IPO offering.  Home sales today are increasingly all cash offers, no contingencies-FOMO.

For the virtual generation, it is the sharing pictures on social media of a special meal  or vacation adventures to stay in touch with peers-FOMO.

In credit unions, this tendency shows up most frequently in mergers and whole bank purchases. Both transactions are enabled by consultants, brokers and other experts who only get paid if a sale occurs.   Creating a sense of urgency-FOMO- around each opportunity is part of the pitch.

This blog will focus on bank purchases.  Many press  announcements  of another deal close with a momentum building observation such as:  “The pioneer (arranger) for credit union purchases of banks, emphasized again that the speed of CU purchases of banks is quickening.” FOMO

FOMO Bank Purchases

A number of credit union bank purchases are repeat buyers.   GreenState in Iowa during 2021 announced three  bank purchases in a 12-month period.  All were out of state and entering separate new markets.  Three deals with different banks, requiring multiple system and cultural conversions all at once.  To keep up with this purchased growth, the credit union has issued $60 million in subdebt to sustain its capital ratio.

Vystar’s purchase of Heritage Southeast Bancorporation, Inc. ( HSBI )is the largest bank acquisition by a credit union to date. HSBI is a holding company of three local community  banks which together manage $1.6 billion in 22 branches across Southeast Georgia, through Savannah and into the Greater Atlanta Metro area.

To support this acquisition, the Jacksonville based Vystar just issued $200 million in subdebt to maintain its net worth ratio.  The final closing has been postponed twice this year.

In early March  he $2 billion Barksdale Federal Credit Union in Bossier City, La., agreed to buy the $74 million Homebank of Arkansas in Portland, Ark.  Here are some details from the Credit Union Times story:

This is Barksdale FCU’s first bank purchase. Homebank was founded in 1908, employees 25 and has about 1,000 customers.  The bank was issued FDIC Consent Orders in 2011 and 2019.  The Bank reported a loss in 2020 of $419,000 and $50,000 in 2021.  Capital is $7.4 million

In explaining the purchase which would seem to bail out the bank’s owners, Barksdale’s CEO  stated:   “We believe that the structure and policies we have in place with our operation will satisfy the consent order items.”   One wonders what the members would think of this use of their funds.

The Risks in Bank Purchases

Buying whole banks at multiples of book value, or at prices much higher than recent market valuations,  creates an intangible asset called goodwill.   These are all  cash purchases. The total member funds paid for the premium and net worth goes to the bank’s shareholders.

In almost every case, but especially in private bank purchases, there is very little transparency for members or analysts to evaluate how the decision will succeed financially.  There is no expected ROI on the investment, nor business plans for achieving it. The incantation used is variations on the theme of scale.

In cases of very large transactions relative to the credit union’s assets  (see Memphis-based Orion FCU’s efforts), or multiple acquisitions in a short time, or when the bank is underperforming, all of the normal risks are multiplied.   Yet the actual outcome may not be known until years down the road.

A  Former CEO’s Observations

I was copied on an email in which Jim Blaine, retired CEO of SECU (NC) highlighted some of the differences in community bank practice and credit unions.   The dialogue began after a credit union member asked his impression of the $4.8 billion Summit Credit Union’s intent to buy the $837 million Commerce State Bank in West Bend Wisconsin.  Here is a part of what  Blaine wrote:

This is an example of the “other problem” floating around in CUs. As you’ll note, Summit is not merging, it is “acquiring” an investor-owned  bank. First, it is illegal for a CU to own a bank charter, so actually Summit is acquiring only the assets/liabilities of the bank (the loans and deposits, the buildings, computers, etc but not the capital!)…and after doing so the bank charter is cancelled.

To judge the fairness of the deal, look for the acquisition multiple…usually quoted as some multiple of the the bank’s net worth (i.e. capital)…if the bank’s net worth is $100 million for example and Summit is purchasing the assets/liabilities for a multiple of “1.5X”then Summit will pay $150 million to the bank stockholders. (Paying 150% of the book value!!)

Just as with CU mergers, these bank “purchases” can be open to significant valuation variance. In an investor-to-investor transaction the owners on both sides scrutinize whether or not the deal is for “fair value”. With a CU there is not an activist group of shareholders to protest a bad deal. Not too hard to imagine an insider “wink and nod” transaction…in the example above that $50million excess might lead to some “flexible ethics” …certainly happened with the mutual S&Ls!

Many folks question both the viability of small banks and those branches! (ed. Commerce is the 32nd largest bank in Wisconsin) And besides in banking, customers are loyal to the individual banker, not the bank. The officers and directors at the bank will usually collect on the sale of the bank stock and then as soon as possible leave and take their book of business to another bank…and of course refinance away those loans the CU bought! On the deposit side, many of the larger deposits are tied to loan customers who  will also leave. Lastly, all the bank customers have always had the chance to join the CU…and didn’t…what does that tell you about their future loyalty?

A Different Kind of Deal

Other acquisitions this year include the $2.8 billion Arizona FCU (AFCU) purchase of the $539 million Horizon Community Bank in Lake Havasu City;  Georgia’s Own purchase of Vining Bank; and Robins Financial acquisition of Persons Banking company.

AFCU’s activity is somewhat more public in that some of the financial information is available.   It appears the credit union is paying about twice  book value.  In the year before the sale was announced, Horizon’s holding company stock traded between $8.20 and $10.40 per share.   The bank’s sale announcement projects  shareholders should receive approximately $18.91 per share when finalized.

In addition to the factual circumstances Blaine cites in his comments, there are two other operational challenges.    Are credit unions acquiring  matured/declining banking businesses especially when recent market valuations are substantially less than the purchase price?

The conversion of a community bank’s clientele to credit union control entails an “identity transplant” both internally and in the bank’s market.  How will the value of the acquired assets and liabilities be affected by this change?

Finally in several examples above, the credit union’s loan to asset ratios ranged from the low 40% to just over 50%.   If the leaders are unable to deploy existing funds in loans to members, how will they be more successful buying bank assets?

The lack of transparency in these purchases, the absence of any financial projections or specific business tactics suggest these are events based on good intentions but limited operational planning.

One CEO explained his purchase  this way: “We believe that quality growth and diversification is essential to continued success in our industry, and we intend to achieve it both organically and through mergers or acquisitions.”

This sounds like a strategy driven by FOMO, not member focus.

Subdebt: The Fastest Growing Balance Sheet Account for Credit Unions

Outstanding subdebt (subordinated debt) for  credit unions grew 51% in 2020 to total $452.1 million.  In 2021 the increase was 109% and with credit unions reporting  $938.9 million.

The number of credit unions using this financial option grew from 64 in 2019 to 104 credit unions at December 2021.  The total assets of these credit unions was $96 billion or about 5% of the industry’s yearend total.

A Product with Many Facets

This financial instrument has many characterizations. Subdebt is reported as a liability, that is a borrowing, on the credit union’s books.  But because of the structure of the debt, NCUA considers it to be capital when calculating net worth for RBC-CCULR and all low-income credit unions.

Subdebt can be sold to other credit unions as well as outside investors. Purchasers perceive it to be an investment, but technically it is a loan to the credit union which makes  it as an eligible “investment”  for credit unions to hold.

“A Watershed Moment”

Earlier this month Olden capital announced the largest placement yet: a $200 million borrowing sold to 41 investors including credit unions, banks, insurance companies and asset managers.

The process as described in the release required: The coordination of a team that included leaders from the credit union, investment bankers, lawyers, other consultants and service providers. . . Olden labelled it “a watershed moment, notable for its size and breadth.

Certainly considering size that is an accurate statement.  This one placement exceeds 40% of the total of all 2021 debt issuance.  Credit union demand is certainly picking up and more intermediaries are getting into the business to arrange transactions.

Olden did not name its client, although the purchasers were aware that it was Vystar Credit Union.

Why the Rapid Subdebt Growth?

This borrowing is a form of “Buy Now, Pay Later” capital for credit unions.   The terms of the debt are generally ten years with no repayment the first five, and level amortization of 20% each in the remaining years.

The interest paid is based on several factors including market rates and the credit union’s overall financial position.

Traditional credit union capital comes only from retained earnings. Maintaining well capitalized net worth means that comes only  from earnings means the process places a “growth governor” on a credit union’s balance sheet.

By raising subdebt this organic “growth governor” is removed in the short term.  Some credit unions have been bold to say that their intent is to use the newly created capital for acquisitions.  Both VyStar and GreenState ($60 million in subdebt) have been active buyers of whole banks.

The overnight increase in the well capitalized net worth category from 7% to 9% by NCUA on January 1, 2022 is also causing credit unions to look at ways to comply with this higher requirement.

Others believe it will help them accelerate investments that might otherwise be spread over several years.

Getting into the Leverage Business

Because subdebt has a price, unlike free retained earnings, and its function as capital is time-limited, its use requires increased asset growth to be cost effective.

It refocuses credit union financial priorities from creating member value to enhancing financial performance through leverage.   This leverage requires both increased funding and  matching earning assets to achieve a spread over the costs of these increased funding.  Buying whole banks is an obvious strategy to accomplish both growth goals at once.

The Unintended Consequences

The use of subdebt as a source of capital was provided as a sop to help credit unions meet NCUA’s new higher and much opposed RBC capital standards.

The irony is that its use will entail a more intense focus on balance sheet growth to pay the cost of this new source of net worth.  Unlike retained earnings, the benefit is only for a limited period.

The event will impose a new set of financial constraints or goals that have no direct connection with member well being.  It converts a credit union’s strategy from “member-centric” to maximizing balance sheet financial performance.

In later blogs I will explore some financial model options for subdebt, the transaction costs and other factors in its use.

One of the most important needs at the moment is for greater transparency for individual transactions.

These are ten-year commitments that may exceed the tenure of the managers and boards approving the borrowings. The financial benefits and impact on members will  not be known for years.  This is  especially true when the primary purpose is to acquire capital as a “hunting license” to  purchase other institutions.

This rapid and expanded use will have many consequences for the credit union system, some well-meant, others unintended.   It is a seemingly easy financial option to execute that the cooperative system will need to monitor.

CCULR/RBC Unconstrained by Statute: An Arbitrary Regulatory Act

The new RBC/CCULR rule must meet two administrative procedural tests, as any other rule, when NCUA claims to be implementing a law.  The first was outlined yesterday:  Was there substantial objective evidence presented to justify the rule?

As I described, NCUA presented no systemic data or individual case analysis whatsoever. In fact, the credit union performance record  shows an industry well capitalized and demonstrating prudent capital management over decades.

In the December board meeting Q&A , staff confirmed that in the last ten years, only one failed credit union would have been subject to RBC.  But today 83% of the industry’s assets and 705 credit unions are now subject to its microscopic financial requirements.

The second test is whether the rule conforms to Congress’s legislative constraints when giving this rule making “legislative” authority to an agency.  The PCA law was very specific in this regard when extended to the credit union system.

NCUA’s PCA implementation must meet three tests: that it apply only to “complex” credit unions, “consider the cooperative character of credit unions,” and be comparable to banking requirements.

NCUA had already passed these PCA implementation tests before. In 2004 GAO reviewed NCUA’s risk based net worth (RBNW) implementation of the 1998 PCA requirement and concluded:

The system of PCA implemented for credit unions is comparable with the PCA system that bank and thrift regulators have used for over a decade. and,

. . . available information indicates no compelling need. . . to make other significant changes to PCA as it has been implemented for credit unions.

At that time the risk based capital (RBC)  requirements had been in place for banks since 1991.

Today  NCUA’s new RBC/CCULR rules clearly fail all three of these constraining criteria.

A “Simple” Interpretation of “Complex”

NCUA 2015 RBC rule declared that the complex test include all credit unions over $100 million.  After the full burden of the rule was apparent, in 2018 the board changed complex to mean only credit unions over $500 million in assets.

Some credit unions clearly undertake operational activities or business models that are more involved than what the majority of their peers might do.

Examples could include: widespread multi-state operations, conversion to an online only delivery model,  lending focused on wholesale and indirect originations, high dependence on servicing revenue, using derivatives to manage balance sheet risk, funding reliant on borrowed funds versus consumer deposits, innovative fintech investments, or even the recent examples of credit unions’ wholesale purchases of banks.

The agency did not define “complex” using its industry expertise and examination experience to identify activities that entail greater risk.

Instead, it made the arbitrary decisions that size and risk are the same. In fact, most data suggests larger credit unions report more consistent and resilient operating performance than smaller ones.

In changing its initial ”complex” definition by 500%, it demonstrated Orwellian logic at its most absurd.  Complex turns out to be whatever NCUA wants it to mean, as long as the definition is “simple” to implement.

Universal for Banks; Targeted for Credit Unions

For banking PCA compliance, RBC was universally applied.  Every bank must follow, no complex application was intended.

By making size the sole criterion for “complex” the board reversed the statute’s clear intent that its  risk-based rule be limited in scope and circumstance when applied to credit unions.

The absurdity of this universal, versus particular,  definition is shown in one example. The rule puts $5.6 billion State Farm FCU, a traditional auto and consumer lender with a long-time sponsor relationship, in the same risk-based category as the $15.1 billion Alliant, the former United Airlines Credit Union. Alliant has evolved into a branchless, virtual business model with an active “trading desk” participating commercial and other loans for other credit unions.

NCUA’s “complex” application of the PCA statute is totally arbitrary based on neither reason nor fact.

Capital design: the most important aspect of “Cooperative Character”

The PCA authority additionally requires that the Board, in designing the cooperative PCA system, consider the “cooperative character of credit unions.” The criteria, listed in the law are that NCUA must take into account: that credit unions are not-for-profit cooperatives that:

(i) do not issue capital stock;

(ii) must rely on retained earnings to build net worth; and

(iii) have boards of directors that consist primarily of volunteers.

The single most distinguishing “character” of credit unions is their reserving/capital structure. Virtually all credit unions were begun with no capital, largely sweat equity of volunteers and sponsor support.

The reserves are owned by the members. They are owed to them in liquidation and even partially distributed, in some mergers.

These reserves accumulate from retained earnings, tax exempt, and are available for free in perpetuity-that is, no periodic dividends are owed.  Many members however can receive bonuses and rebates on their patronage from reserves in years of good performance.

Most products and services offered by credit unions are very similar to those of most other community banking institutions. The most distinctive aspect of the cooperative model is its capital structure, not operations.

Cooperative Capital Controlled by Democratic Governance

This pool of member-owner reserves is overseen by a democratic governance structure of one-member one- in elections.  The reserves are intended to be “paid forward” to benefit future generations.  This reserving system has been the most continuous and unique feature of cooperative “character” since 1909.

This collective ownership forms and inspires cooperative values and establishes fiduciary responsibility.  Management’s responsibility for banks is to maximize return to a small group of owners; in coops the goal is to enhance all members’ financial well-being.

This capital aspect of the cooperative charter is so important that if credit union management decides to convert to another legal structure, a minimum 20% of members must approve this change. No other financial firm has the character of a coop charter with its member-users rights and roles. Not even a mutual financial firm.

Bank’s Capital Structure Very Different from Cooperatives

For banks, capital funds are raised up front, usually from private offerings or via public stock. Owners expect to profit from their investments. Dividends are paid on the stock invested as part of this anticipated return. Today shares represent about 50% of total bank capital.  In credit unions, it is zero.

Bank capital stock, if public, can be traded daily on exchanges. The market provides an ongoing response to management’s performance.

This capital is not free as most owners expect a periodic dividend on their investment.  As an example, in the third quarter of 2021, the banking industry distributed 79% of its earnings in dividends to owners.

There is no connection between a bank’s capital owners, and the customers who use the bank, unless customers independently decide to buy shares in the bank. In credit unions, the customers are the owners.

The remaining component of bank capital is retained earnings. However, every dollar of earnings before  added to capital, is subject to state and federal income tax. Credit union retained earnings are the only source of reserves as noted in the PCA act.  These coop surpluses accumulate tax free.

In design, accumulation, use and governance credit union reserves are of a totally different  “character” than bank capital. Their purpose is to support a cooperative financial option for members and their community.

Bank capital is meant to enrich owners through dividends and/or future gains in share value.  Credit unions’ collective reserves are to benefit future generations of members.

Credit unions are not for profit.  Banks are for profit.

In a capitalist, private ownership dominated market economy, the cooperative’s capital structure is the most distinctive aspect of credit unions.  This is not because of its amount or ratio.  It is its “character,” from its origin, perpetual use and  oversight by members.

Nothing in the CCULR/RBC rules recognizes this especial “character” of credit union capital.  By not addressing this issue, the rule ignores this constraint of the  PCA enabling law.

The historical record demonstrates that  credit union reserves are not comparable to bank capital.  Rather they are a superior approach tailored to the cooperative design.

Tomorrow I will look at the third test, whether RBC/CCULR conforms to the PCA’s requirement of comparability.

Asset Bubbles and Credit Unions

During his time as Vice Chair of the FDIC, Thomas Hoenig challenged the agency’s implementation of risk-based capital requirements.  He questioned both the theory and practice, pointing to the lending distortions which contributed to banking losses during the Great Recession.

I became aware of  his views when in 2014 NCUA began the process of imposing the same flawed system on credit unions.   Hoenig believed the best capital indicator was  a simple leverage ratio, the credit union model for 110 years, until December 2021.  Then NCUA dictated a complex, three-part capital structure, CCULR/RBC, to replace this century long capital standard.

Hoenig’s Other Regulatory Dissent

Hoenig was a career regulator.  He began as an economist in bank supervision at the Kansas City District Federal Reserve Bank an area of the country where he had grown up. In the 1970’s during a period of unprecedented double-digit inflation, he saw first-hand the impact on lenders and their borrowers whose relationships were underwritten with collateral-based loans.   The security was believed to be ironclad during this decade of ever-rising prices for farmland and commercial real estate.

Hoenig’s story is told in a new book, The Lords of Easy Money,  and a summary article in Politico. The article describes how he became the lone dissenting vote in November 2010 on the Federal Reserve’s Open Market Committee.  He opposed extending the monetary policy called quantitative easing beyond the Great Recession to jump start the economy.

His opposition was based on his early Midwestern regulatory experience, as the Fed tried to get inflation under control. From Politico:

“Under Volcker, the Fed raised short-term interest rates from 10 percent in 1979 to 20 percent in 1981, the highest they have ever been.

“You could see, Hoenig recalls, that no one anticipated that adjustment.” More than 1,600 banks failed between 1980 and 1994, the worst failure rate since Depression.”

But the banking failures and borrower bankruptcies were not the primary reason for Hoenig to  oppose Fed Chair Bernanke’s continued quantitative easing.

The “Allocative Effect” of Asset Bubbles

When borrowing rates are effectively negative, as now, this fuels inflation with surplus liquidity looking for places to go.   Too many dollars chasing too few goods. With funding costs near zero, any reasonable investment looks like a sure thing.

As asset prices rise quickly, a feedback loop develops. Higher asset prices today drive tomorrow’s asset prices ever higher. Especially when those assets are pledged to support more borrowing.

For Hoenig, his greatest concern with this low interest rate policy is the distortion or  “allocative effects”  of the additional wealth created by this monetary stimulus.

As summarized in Politico:

“Quantitative easing stoked asset prices, which primarily benefited the very rich. By making money so cheap and available, it also encouraged riskier lending and financial engineering tactics like debt-fueled stock buybacks and mergers, which did virtually nothing to improve the lot of millions of people who earned a living through their paychecks.

Hoenig was worried primarily that the Fed was taking a risky path that would deepen income inequality, stoke dangerous asset bubbles and enrich the biggest banks over everyone else. He also warned that it would suck the Fed into a money-printing quagmire that the central bank would not be able to escape without destabilizing the entire financial system.”

The Economic Consequences Hoenig Warned About

Those distortions are here now.  One need only look general stock market levels as well as individual company valuations that are unhinged from  performance to see examples that don’t compute.

In a January 7 essay “A Stock Market Crash is Coming and Everyone Knows It” the writer notes wild stock valuations: The price earnings ratio for the S&P index of stocks historically averages 15.  Today the ratio is 29 times;  Amazon’s ratio is 60 and Tesla’s 330.

This disconnect between stock prices and a company’s financials is most visible in meme stocks, IPO’s and SPAC’s often with no history of positive net income.  These new offerings and crypto-currency  asset hype are explained as harbingers of  a  newly emerging digital-metaverse economy.  Predictions of these asset bubbles bursting go back at least two years.  Because it hasn’t happened yet, doesn’t mean the Fed’s changed policy won’t be disruptive.

The Credit Union Impact

Credit unions are creatures of the market. Co-ops whether by design or neglect that have become distant from their members, are even more dependent on market sourced opportunities.

Approximately 80% of all credit union loans are secured by autos, first and second mortgages, or commercial assets. Before asset bubbles burst, decisions about new loans and investments look straightforward, easy to project future returns.

The most frequent example today of this financial euphoria is credit unions buying whole banks, frequently in new markets.  When the cost of funds is .25- .50 basis points, paying a premium of 1.5 to 2.0 times book value for a bank looks like a can’t lose opportunity.   Even when the bank’s financial performance is being supported by the same low cost of funds and its underwriting  secured by commercial loans with continuously appreciating assets.

GreenState Credit Union in Iowa, Hoenig’s home state, is so eager to take advantage of these current opportunities that it is buying and absorbing three banks simultaneously, all operating outside its core markets.

In North Carolina, Truliant  Federal Credit Union announced in December that it had raised $50 million in an unsecured  subordinated term note at a fixed rate of 3.625%, The purpose reported in the press: “Truliant has primarily grown the credit union’s loan portfolio organically, however management is open to acquisitions in the $500-$750 million asset range.” 

The announcement is a public invitation for brokers to bring their deals to Truliant’s table.

When funding looks inexpensive and asset values stable or rising, what could go wrong?

The short answer is that  the Fed’s inflation response will disrupt all asset valuations and their expected returns.  The larger question is whether buying businesses whose owners believe now is the time to cash out, and whose results were created by a very different model and charter, will even match a credit union’s capabilities.

In an earlier analysis of credit union whole bank purchases I raised these issues:

As credit unions pursue whole bank acquisitions, are they buying “tired” business models built with different values and goals? Are these credit unions giving up the advantages of cooperative design and innovation attempting to purchase scale? Will combining competitors’ experiences (and customers) with the credit union tax exemption create an illusion of financial opportunity that fails to prove out when evaluated years down the road.

The Discipline Required of the Co-op Model

The co-op member-owner model protects credit unions from some of the rough and tumble accountability of constantly changing stock market valuations.  This difference requires strong management and board discipline to remain focused on the people (members) who respond to and need a credit union relationship.

Buying into new markets and customers through financial leverage, versus winning them in competition, is a new game for credit unions.  Organic growth builds on known capabilities and experiences, not externally purchased originations.

Hoenig’s critiques offer a third lesson relevant for these leveraged buyouts.  The financial consequences of public policy changes can take years  for their consequences to be found out.

It took seven years for the FDIC to recognize there was no cost-benefit outcome with RBC. And eleven years to understand the full economic impacts from when he first opposed quantitative easing as the primary tool for the fed to keep the economy growing.

Credit union success is not because they are bigger, financially more sophisticated, or even led by superior managers versus banks.   They win when their capabilities  align with member needs.  Members join based on their choice, not because their account was bought from another firm.

The beginning of a significant economic pivot, long forecast by the Fed, seems a very suspect time to use member capital to pay out bank owners.   The bank owners are asking for members’ cash, not the stock that other bank purchasers would offer, to protect these sellers from valuation uncertainties.

Credit union leaders buying banks are betting (paying premiums) that they can  manage the bank’s assets and liabilities for a higher future return than their for-profit managers were able to do.

Rather than compete with a superior business design, buying banks intending to run them more effectively, feels like surrendering to the opposition.

A Dangerous Way of Thinking: Clayton Christensen’s Final Message

Harvard Business School Professor and creator of disruptive innovation theory, Clayton Christensen described the use of marginal cost/revenue analysis as “a dangerous way of thinking.”

Here is the critique from his case analysis of Blockbuster’s corporate failure:

Blockbuster followed a principle that is taught in every fundamental course in finance and economics: When evaluating alternative investments, ignore sunk and fixed costs (costs that have already been incurred), and instead base decisions on the marginal costs and marginal revenues (the new costs and revenues) that each alternative entails.

But it’s a dangerous way of thinking. This doctrine biases companies to leverage what they have put in place to succeed in the past, instead of guiding them to create the capabilities they’ll need in the future. 

Previously I showed how he applied this concept to personal, moral decisions.  How easy it is to give into the ever-present temptation to do something “just this once.”

But he also had great doubt about this approach to everyday business decisions.  I believe his analysis is relevant to some of the largest transactions now undertaken by credit unions:  buying whole banks.

How Credit Union Whole Bank Purchases are an Example of Christensen’s Concern with Marginal Cost Analysis

Twelve whole bank purchases have been announced by credit unions in 2021.  These are cash purchases of all the assets and liabilities of a bank.  A credit union cannot own a bank charter so the existing firm is bought as a single entity,  and any activities not authorized for credit unions sold off.

Cash is paid because credit unions cannot issue stock.  Stock is the more common currency in which interbank purchases are transacted.   The selling shareholders receive shares in the new combined entity.  These shares’ future value will depend on institutional performance and market trends.   There is no such future risk with a cash sale.  The seller can use the proceeds for any purpose.

These sales are off-market transactions.   That is credit unions negotiate the purchase in private, and unless the bank is publicly traded, the terms are rarely revealed.  Because the transactions are carried out without credit union-buyer disclosures, the bank seller controls the critical information about other offers and why the credit union was the chosen purchaser.

Unlike bank sales paid for with shares of stock, there is no  follow-up process  to determine if the promised benefits and/or institutional goals are achieved.   Sometimes the stated purposes is to offer bank customers the advantages of credit union services.   This is circular reasoning. In a purchase customers do not choose to join the credit union, their accounts were sold to benefit the bank’s stockholders.  It might even be counter- productive for the credit union to re-write customer loans purchased if this lowered the rates and thus the ROI on the credit union’s investment.

Without public statements of expected outcomes, the results of mergers become mashed in with all the credit union’s other financial outcomes.   There is no separate accounting of whether the return benefits the current member-owners.

The existing members’  should be informed how their value is increased  when their collective savings (reserves) are paid out to bank owners.  The price paid is often at a significant pick up over the bank’s reported book  or stock value.   This is especially important when the acquisition is outside of the credit union’s current market area and bringing no immediate service benefits.

Christensen’s critique of marginal analysis is most critically a strategic concern.  The prospect of  incremental growth is the frequently  stated or implied  reason for these purchases.   By adding  the existing savings and loans of bank customers,  the credit union will increase scale and incremental ROA and  maybe eliminate duplicate overhead expenses when combining firms.

Moreover the credit union’s net income is tax exempt, a fact that may be used to project enhanced earnings results than achieved by the bank.

Christensen’s observation of “dangerous thinking” is not about the financial math.  There can be more revenue, cost cuts and higher net income when adding more assets and liabilities.   That is not his point.

In these transactions credit unions are buying businesses that are mature.  The bank owners decided to cash out now and seek a better return for their funds versus continuing to grow  the bank’s business.

Marginal analysis to support investments in yesterday’s business models can jeopardize a credit union’s future.   Tomorrow’s financial services are being shaped by new fin-tech models, the growth of crypto currency transactions, and decentralized autonomous organizations (DAO’s) which operate outside current regulatory boundaries.  This is not what credit union’s are buying in these transaction.

Even the increased regulatory and competitive threats to overdraft (courtesy pay) income and credit and debit exchange fees, could upend the financial assumptions in these purchases.

Credit unions are buying financial firms whose owners believe their best days are over.  These credit union purchases are cash spent on yesterday’s businesses not tomorrow’s. Buying a firm’s old business models might boost short term marginal  revenue  but accelerate a longer run decline in competitive positioning.

Quantifying the Risk

As the number and scale of these transactions grows so does the risk. Most transactions are done at a premium over the latest stock price or a multiple of  book value. One analysis reports  recent sale prices range from 1.3 to 1.9 times book value

In the examples that follow, the three credit union purchasers report total net worth of $1.863 billion in their September 30 call reports.   The five banks being purchased by these credit unions report total book equity of $678 million.  If the agreed purchase price was just for book value, these  bank  investments would average 36% of the credit unions’ total net worth.

However, if the purchase price was greater than book, for example at 1.5 times, then the credit unions have paid out cash of over $1.0 billion, or 55% if their net worth, to these bank stockholders.  The difference between the bank’s book value and purchase price would be recorded as goodwill, an intangible asset, for the credit union.

The examples share common operational challenges and also demonstrate three different primary risks.   They illustrate why increased transparency by  credit unions in these deals is sorely needed.

In each example, the credit unions are playing with “house money” that is the members’ collective savings/reserves. If the risks assessed and returns hoped for are not achieved, then the investment shortfalls will reduce existing member-owners  value. And if the purchase proves totally mistaken, the risk is the entire credit union system’s.

Playing with House Money

Example 1:

Vystar’s Purchase of Heritage Southeast Bancorporation (HSBI) is the largest bank acquisition announced so far.   HSBI is a bank holding company, a recent combination of three previously separate firms, with $1.6 billion in assets and 22 branch locations.

Before the purchase was announced, HSBI’s stock price traded in the $14-$!5 range.   Immediately after Vystar’s offer of $27 per share (approximately $196 million) the stock jumped overnight to $25-$26, where it has stayed since.

HSBI’s assets are only 14% of Vystar’s $11.4 billion.  But this investment would equal approximately 21% of the credit union’s September 30 net worth.    The critical question in this deal: was HSBI woefully undervalued by the market and Vystar negotiated a good deal?

Can Vystar turn around a three-bank conglomerate that had yet to achieve its financial potential?  If the pre-purchase market price is a better indicator of HSBI’s franchise value, Vystar has bet almost $100 million that the market value was under-priced and that it can realize its full value.

Example II:

In early August the $1.027billion Orion FCU announced the purchase of the  $751 million Financial Federal Bank, in Memphis, to “expand its products and services and deepen market share in private banking, residential and commercial lending.”

At September 30, Financial Federal’s $792 million in assets were77% of Orion’s total assets.  This would be by far the largest whole bank acquisition as a % of the purchasing credit union’s assets.

Financial Federal is privately owned.   The bank’s capital at September was $93 million.  If the purchase price were 1.5 times book, this would be a cash payment of about $140 million.   This amount would be 120% of Orion’s September 30 net worth.   If book value was the cash purchase price, that would equal 80% of Orion’s reserves.

The credit union is putting all of its chips on the table with this purchase.  In November a state judge imposed a temporary injunction  on the purchase  at the request of the Tennessee Department of Financial Institutions.  TDFI argued that it is a prohibited transaction under the state’s banking act.

If upheld, might TDFI have done a favor for the credit union?

Example III:

The $7.91 billion GreenState credit union headquartered in North Liberty, Iowa has announced three bank purchase and assumptions in 2021. They are:

  1. Oxford Bank, Oakbrook, Il. $759mn Assets and $71 mn capital
  2. Premier Bank, Omaha, NB. $383 mn Assets and        $40 mn capital
  3. Midwest Community Bank, St Charles, IL. $352 mn Assets and $54.3 mn capital

The three are privately owned and no terms of  the transactions have been announced.   The total assets of the three at September 30 are $1.5 billion with capital of  $166.3 million.

These $ totals would be 19% and 21% of the GreenState’s assets and capital respectively.  If the purchase prices averaged 1.5 X book,  the cash payouts would be 30% of GreenState’s new worth.

What makes this series of transaction different is not the financial risk scale but rather the operational complexity.   Three banks, three different computer systems, three geographic markets and three very different business models  tied into their local communities.

Oxford has six branches and a head office, Premier bank four branches, and Midwest Community, three branches, a loan production office and a subsidiary Blue Leaf with six loan production offices.

In addition to the operational transitions, are the cultural challenges introducing employees to the credit union way of doing things.  The three bank franchises are distant from GreenState’s existing service network and market network.   This brings the additional challenge of introducing the credit union’s brand to three or more, new marketplaces when the prior community legacies no longer exist.

In March of 2020, Greenstate completed purchase of seven branches of the First American Bank in Iowa with total deposits of $470 million, $200 million in loans and 10,000 customers. The transaction was closed despite the objection of the Iowa banking regulator, himself a bank owner:

The superintendent’s approval of the application is solely for the purpose of settling this dispute, and the superintendent does not admit that an Iowa state-chartered bank may sell substantially all of its assets and liabilities to a credit union under Iowa code. Rather, the superintendent reiterates his conclusion that such a transaction is not authorized and that IDOB will quickly deny any future application based on a similarly structured transaction.

Did this regulatory opposition force GreenState to look out-of-state for future bank purchases?

What Needs to be Done

Christensen’s “dangerous way of thinking” analysis cautioned against the temptation to justify investment decisions by incremental short term benefit at the cost of long term sustainability.

No one knows whether these whole bank purchases above will succeed or turn out bust. Or somewhere in between.  ROI will take years to assess.  In the meantime many other events can make subsequent analysis difficult.

An immediate step to improve the soundness of these transactions is to ensure the full details are disclosed to the members whose funds are being put at risk and to the credit union system which is the ultimate backstop.

Keeping everyone in the dark except the deal makers means no one is accountable.   The asymmetry of information in which the seller holds most of the cards puts credit unions at a disadvantage when sizing up a selling bank.  Every bank owner’s goal is to buy low and sell high.

An example: if the purchase is to gain expertise (eg. commercial lending experience) and/or relationships the credit union does not possess, how does the credit union evaluate situations they claim to know little about?

The credit union model expects leaders to be responsive to members.  But when the data and assumptions underwriting these investments is withheld, there is no accountability.  The transaction is “off market” for members; only the bank sellers are in position to decide it this is a satisfactory deal.

The quicker the entire purchase picture is in the open, only then can those whose funds are at risk and the credit union community at large determine whether these deals make sense.

The time to make this a routine disclosure is before one of these deals goes really bad, not after the lesson becomes a Blockbuster-type case for the cooperative system.