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.

The Versatility of Co-op Designs

On Tuesday November 12th, the largest milk company in the Unites States, Dean Foods, filed for bankruptcy.

Among the contributing factors were too much corporate debt and changing consumer attitudes toward both branded products as well as the traditional dietary recommendation to drink three glasses of milk per day. In 2017 Americans drank 37% less milk than in 1970 according to the Agriculture Department.

The solution to continue providing distribution of dairy products according to newspaper accounts is “to sell itself to Dairy Farmers of America, a marketing cooperative that sells milk from thousands of farmers.”

This situation illustrates the ability of persons and firms affected by the market conditions can potentially ally via a cooperative to address changing circumstances for mutual benefit.

A Lesson for Credit Unions

What can credit unions learn from this example? When the taxi medallion crisis arose, credit unions were best positioned to help borrowers transition to the new, lower valuations. But these options were stopped as NCUA liquidated the credit unions experienced in these kinds of transition problems. Without a firm that can renegotiate and continue to serve these borrowers, the only option is to force collections even if this causes member bankruptcies.

Meanwhile Uber reported a $1.2 billion loss in the third quarter. 

It is forecasting a profit sometime in 2021 as it runs through investor capital. The taxi industry will adapt, just without credit union participation.

A Great Place to Work: Minimum Wage at $41,000 per Year

Bank of America announced this week that they are accelerating the implementation of a new higher minimum wage to $20 per hour at the end of the first quarter 2020.

This equates to a full time salary of $41,000. In explaining this one year speed up of the increase, CEO Brian Moynihan also explained that the bank had reduced the cost of health insurance by half all with a goal of making Bank of America a great place to work.

The action also speaks to the increasingly competitive labor market at full unemployment described in my blog How Tight is Today’s Labor Market.

What Makes a Great Place to Work?

Starting salaries certainly matter, especially for a first job. But is salary sufficient to retain the people an organization relies upon to build a sustainable future?

Successful credit unions also create cultures in which people feel good about their work carrying out the organization’s purpose, what they do for and with members, and expanding career challenges.

Financial rewards are only one aspect of a dynamic and leading organization. Necessary, but not sufficient.

Who or What is FRED?

Context and perspective is critical in evaluating current performance and planning future goals. Financial data and trends on credit unions and banks for a given market is readily available from multiple providers, including Callahan & Associates.

However finding relevant and comparative local and macroeconomic data is often harder.

One of the most comprehensive databases for the latest information on a national, regional or MSA market is the Economics Research unit of the St. Louis Federal Reserve Bank.

One of its services is multiple economic and financial databases compiled under the acronym FRED. The FRED® data service is updated daily and allows 24/7 access to over 500,000 financial and economic data series from more than 85 public and proprietary sources.

The following are three examples of different local economic data downloads that illustrate different perspectives about a market.

Data Examples for Three Cities

The Case-Schiller housing price index for Washington DC shows that the prices have yet to exceed its pre-2008 crisis peak:

A second example shows the unemployment rate in Springfield, Illinois, the state capital:

A third  graph portrays the average hourly earnings of all private sector employees in the Dayton, Ohio MSA.

Connect for Research, Data Monitoring, and Business Analytics

The St Louis Fed’s Research Division is in the top 1% of all economics research departments worldwide. It’s Page One Economics working paper series provides emerging research ideas and analysis for the general public as well as economic and financial professionals. Email sign up is available. Have your business analyst bookmark FRED.

What Regulatory Leadership Looks Like: Promoting Innovation and Cooperation

One of the critical qualities of leadership is the ability to rally support for vital issues through cooperation and example. When this leader is a regulator with the ultimate power of coercion, to see an approach based persuasion, logic and we’re-in-this-together is enlightening.

The FDIC Chair Jelena Williams outlined a new approach to innovation, not via a rule or policy statement, but rather in a public op-ed in the American Banker. I thought the following comments were powerful:

…if our regulatory framework is unable to evolve with technological advances, the United States may cease to be a place where ideas and concepts become the products and services that improve people’s lives.

At the FDIC, we want to foster innovation…By promoting and encouraging our supervised institutions toward a more advanced technological footing, the FDIC can help lead a transformation in the financial sector — one that results in easier access to banking products and services, brings more consumers into the banking fold, and makes the banking system safer and more stable…

We are looking for techies to join our ranks…

Should I Be Jealous of Bankers Over Their Regulator’s Appeal?

In this recent commentary, Randy Karnes outlined the leadership vacuum facing credit unions in the regulatory arena. He stated in part:

Does the credit union industry even have a process that is capable of placing a real leader of people, communities, and our CU stakeholders on the NCUA board today? Or are we doomed to a continuing future of cardboard, keep your head down, tactical players who only confirm the bureaucratic functions versus board members that could balance the need for a strong regulator with the passion for a strong credit union industry, and sell it?

Leaders Who Can be Assets, not Liabilities

In a dynamic, technology driven and competitive financial services market place, the soundness of the system is more than an aggregation of individual balance sheets and operating statements. For the cooperative system is interdependent in ways the banking industry is not. That means weakness in any leadership role can jeopardize the future of the industry. Jelena Williams shows how a proactive, positive focus can be an incalculable asset, not a liability or burden, in the ongoing arena of financial competition. Isn’t it time for credit unions to expect nothing less?

How Shadow Banks and Fintechs Keep Increasing Their Role As Financial Intermediaries

Amit Seru, a Stanford University Professor, presented his most recent data updates on the role of shadow banks and FinTechs at the FDIC’s 19th Annual Research Conference last week.

The slides he used can be found here.

The trends show that more and more lending is originated by non-depository institutions in both the mortgage and consumer lending arenas.

Two of his slides (#10 & 11) illustrate this growing market penetration geographically by county between 2008 and 2015.

These alternative financial firms enter markets as depository firms withdraw primarily due to their lack of profitability.

FinTechs’ role

Seru was especially interested in the role of FinTechs firms, which he defines as firms relying on virtual channel operations that can be completed from beginning to end without human intervention.

The FinTech advantages of faster processing, use of broader data sets for marketing and decisioning, and a superior quality online experience, are well known.

But he also suggests their success is not because of a price advantage over banks. In some cases consumers pay more for online convenience and speed.

Why the loss of market share?

Seru concludes that the Fintech technical advantages account for only 30-40% of the shift in market share. He asserts the most important factor (60-70%) in this ten-year market share change is the impact of regulation on banks’ ability or willingness to continue serving specific markets. This regulatory burden has increased substantially since the 2008 financial crisis primarily as a result of regulations from the Dodd-Frank legislation.

Even with a lesser regulatory burden, FinTechs are not all-powerful. He points out they are mostly dependent on the secondary market for final loan funding. Importantly, the balance sheets of depository institutions gives them more flexibility in certain products such as jumbo loans. Should the secondary markets become more selective or volatile, then the banks traditional funding advantages may reassert themselves.

Credit union takeaways

For both traditional and new entrants in the consumer and small business lending markets, the key factor to long term growth and resilience is access to liquidity. Generally depositor relationships are more stable and often less expensive than wholesale and secondary market reliance. Convenience, not price, seems to be the primary reason FinTechs disrupt traditional service models. However this advantage in the digital channel is rarely permanent. An all-channel strategy is especially valuable for community institutions.

Credit union relationships based on loyalty and trust are a significant advantage versus competitors focused on transaction capture. For 110 years the cooperative model has followed a second-to-market innovation strategy that has resulted in growth and evolving business models. Cooperative design, aligning with members’ needs, would seem to be a continuing advantage regardless of where disruption may occur.

The End of Risk Based Capital for America’s Community Banks

On September 17, the FDIC board eliminated risk based capital (RBC) requirements for community banks with assets of less than $10 billion.

It replaced the international banking BASEL-inspired approach with a simple leverage ratio. A community bank will be considered well-capitalized under required prompt corrective action (PCA) regulations if the tier 1 leverage ratio is 9%.

Banks will not be required to report or to calculate a risk-based capital according to the FDIC’s press release.

The FDIC Chairman Jelena Williams said the new rule ensures that the regulatory framework is commensurate with the operational reality of these institutions.

“The final rule. . .supports the goals of reducing regulatory burden for as many community banks as possible. . .and will allow community banks to significantly reduce the regulatory reporting associated with capital adequacy on the call report.”

The rule was also supported by all the other banking regulators,  the comptroller of the currency and the Federal Reserve.

An Example for the NCUA Board

The final RBC rule passed by the NCUA board was over 400 pages and requires all of the regulatory and reporting burdens cited by the FDIC as the reason for eliminating this requirement.

Surely the NCUA can learn from this experience! There is no better time or precedent to cancel this ineffectual, burdensome and deeply flawed approach to capital measurement. For if such a rule had been effective, it would have stayed. The FDIC’s experience shows RBC doesn’t work in practice.

The simple to understand leverage ratio, now in effect, has served credit unions well since deregulation and the imposition of PCA in 2008.

Don’t be misled by the 9% well-capitalized FDIC level versus the credit union’s 7% well-capitalized PCA standards into thinking cooperatives need to raise their capital. All of the capital reserves in credit unions are “free.” More than half of bank capital is in equity shares, whose owners are expecting a return on their investment.  Free cooperative reserves do not have this performance burden..

There is no better time for NCUA board to withdraw this misguided rule. Will the board show the leadership demonstrated by the FDIC?

All credit unions would give a great sigh of relief to have this burden removed from the horizon.

A Regulator on Bank Ethics

Recently the CEOs of the Business Roundtable issued a policy statement that proclaimed the purpose of the corporation is to promote “an economy that serves all Americans.”  Hopefully that would embrace the vital role of cooperative credit unions.

The Chairman of the Business Roundtable is Jamie Dimon, who is also CEO and Chair of JP Morgan Chase and Co. The statement is a positive example of a vision for corporate America that transcends the single-minded pursuit of shareholder value.

But the challenge is more than an expanded purpose statement as we are reminded in the following comment:

“There is evidence of deep-seated cultural and ethical failures at many large financial institutions. Whether this is due to size and complexity, bad incentives or some other issues is difficult to judge, but it is another critical problem that needs to be addressed.”

William Dudley, President, New York Federal Reserve Bank, November 7, 2013

This observation was years before Wells Fargo’s decade long mistreatment of consumers became public.

What is IBM Doing to Stay Relevant?

In an era when the longevity of an S&P 500 company is about two decades, the fact that IBM is still around from its 1911 initial combination of three businesses, raises the question of how it has survived. This is an especially challenging issue in an era of unending technology change in which the Internet has replaced the in-house main frame as the core of back office processing.

IBM began as the Computing, Tabulating & Recording Company (C-T-R). Their first large contract was to provide tabulating equipment for the tabulation and analysis of the 1890 US census.

Thomas Watson Sr. became CEO in 1914 and in the early 1920s the name was changed to International Business Machines (IBM). When he renamed the company, he put a plaque on his New York head office building in the 1930s reading, World Peace through World Trade.

From Machines to Intangibles

Following WWII, IBM became the world leader in providing computer systems for both business and scientific applications. The company continued to excel at inventing and making things (machines). In 1964, IBM revolutionized the industry by bringing out the first comprehensive family of computers (the System/360). This caused many of their competitors to either merge or go bankrupt, leaving IBM in an even more dominant position.

IBM’s historical role as a manufacturer of computer mainframes now makes up only 10% of the company’s revenue, even after 55 years of market dominance. 85% of the company’s revenue is from software and information management.

Its primary service is helping companies manage and transfer data. It is placing itself at the center of the “data economy” an intangible (compared with manufactured goods) network of information and transaction processing vital to every business. Its software and managed services are involved in 87% of the world’s credit card processing and service 90% of top 10 retail firms.

An Exploding Market

Today over 70% of the firm’s revenue is from outside the US. While global trade in goods and services is declining, the “trade” in data transmission and digital information is exploding.

The digital economy is a world economy, not limited by traditional physical boundaries and barriers. One estimate is that over 80 terabytes of information flow into and out of the US every minute of every day, a volume of information equal to eight Libraries of Congress.

The digital revolution is part of the service economy that today dwarfs the manufacturing sector in the US. Operating the “back office” of this growing information and processing activity is how IBM intends to build ongoing success.

The company, over 100 yeas old, was formed at the same the time as the first credit unions were chartered. Are there parallels in IBM’s evolution serving businesses, for what credit unions do for members? What might be vital information management needs in the digital economy that credit unions can provide members? Answering that question and designing services providing relevant data could be the key to the next 100 years of cooperative success with members.

Habits Never Die, They Just Recycle

A colleague of mine used to describe human nature thusly: People do what they do. Or the traditional observation that a leopard cannot change its spots.

The benefits of bureaucratic organization are many. Structured processes, experience and expertise, and explicit design. These organizational advantages replaced the arbitrary and unpredictable rule by all powerful leaders in authoritarian regimes. Bureaucracy is an essential component of government activity in a democracy.

But the strength of bureaucracy is also its weakness. It is stable, but rarely innovative; it is predictable, not situational in response; it is self-perpetuating even when the original circumstances may have long ago disappeared.

I was reminded of this bureaucratic paradox  when I received the Weekly National Rates and Rate Cap Report from the FDIC seen below.  After deregulation in the 1980s I thought government got out of the business of setting deposit rates.

No, as shown below, when the next big crisis came in 2009, the FDIC reactivated old habits. It passed a new rule setting the maximum rates that any FDIC insured institution could pay that was deemed to be “less than well capitalized.” Every kind of account at every level of maturity is listed. And the rate caps are reset weekly!

Regulatory responses to new events is to reprise old habits. This is definitely not isolated to the FDIC. The same is true of the NCUA. The difference should be that in a cooperative democratic system, the response should always be driven by what is in the members’ best interest, not the bureaucracy’s instinctive recall based on self-preservation.

Weekly National Rates and Rate Caps – Weekly Update

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On May 29, 2009, the FDIC Board of Directors approved a final rule making certain revisions to the interest rate restrictions applicable to less than well capitalized institutions under Part 337.6 of the FDIC Rules and Regulations. The final rule redefined the “national rate” as a simple average of rates paid by U.S. depository institutions as calculated by the FDIC. The national rates and rate caps for various deposit maturities and sizes are provided below.

For more information. see Financial Institution Letter FIL-25-2009

Weekly rate cap information for the week of June 3, 2019.