Over the last few years, there has been a rise in the number of credit unions acquiring community banks. Several additional complexities exist when a credit union acquires a community bank in comparison to acquiring a credit union. The largest difference is that cash is changing hands because the credit union is purchasing the assets (known as a purchase of assets and assumption of liabilities, or P&A) of the community bank, with those proceeds flowing to the shareholders. Credit unions must understand the differences when acquiring an S-corp versus a C-corp tax-paying entity because the financial implications on the combined balance sheet could be significant. S-corps are only taxed at the shareholder level, whereas C-corps are taxed at both the corporate and shareholder level. ALM First cannot stress this enough—a buyer must fully understand the tax implications before making any offers, especially if the community bank is classified as a C-corp tax-paying entity.
The majority of deals that ALM First has analyzed involving a credit union with a community bank have not made sense financially for the credit union. Specifically, a credit union cannot report equity acquired from a community bank acquisition because there is no equity to be reported. The credit union is purchasing the bank’s assets and then paying those proceeds to the shareholders, whereas, in a credit union merger, the book value of retained earnings is carried over to the combined balance sheet. The removal of the community bank’s equity can have a significant impact on the credit union’s GAAP capital and Regulatory Net Worth (in our analyses, we have seen a minimum of 100 bps decrease in the credit unions net worth ratio). Furthermore, most transactions involving a credit union acquiring a bank result in goodwill.
Bank purchases are still an area we see a lot of our clients wanting to explore and it still may make sense; however, there continues to be some confusion as to how the combined financials are to be reported. In an effort to add clarity to this strategic growth strategy, in the FEDERAL REGISTER, the NCUA recently notified the public of the proposed issuance of rules and regulations regarding “Combination Transactions With Non-Credit Unions; Credit Union Asset Acquisitions”. Since this notification by the NCUA, ALM First noticed a change in the amount of retained earnings acquired through a business combination reported within the PCA Net Worth Calculation page of the 5300 report of some credit unions that have acquired banks in the past. The change in calculation caused those credit unions’ net worth to decline between 25 and 300 basis points. However, ALM First found no evidence that this new NCUA notification was cause for this call report change nor has ALM First found a formal ruling that sparked the change in how those credit unions calculated PCA net worth.
ALM First reviewed every whole company and franchise transaction involving a credit union acquiring a community bank since 2012 and found, on average, a credit union’s net worth dropped by about 100 basis points. The post-acquisition net worth ratios in the graph below were adjusted to reflect recent updates to how some credit unions previously calculated PCA net worth, which appeared to erroneously include retained earnings from the acquired banks.
It is critical for a credit union to fully understand the impact that a community bank transaction can have on the combined institution’s net worth. In the past, we’ve seen scenarios where the net worth of a credit union interested in acquiring a community bank dropped as much as 250 basis points. Mergers can be very costly, and due diligence early in the discussion process could save your institution millions down the road while preventing future headaches. Cutting costs during the due diligence process may provide short-term savings, but could cost the institution millions of dollars over the long-term or result in valuable internal time and effort spent playing catch-up. Bank acquisitions can still be a viable growth strategic for credit unions; however, ALM First strongly advises institutions who are interested in purchasing a bank to engage with third party experts early on in the fact-finding process to get a full understanding of the financial impact.
Eric Tran joined ALM First in 2016. As an Associate, Eric works with clients by focusing on their strategic growth initiatives—ultimately assisting in facilitating an entire merger and acquisition process, conducting industry research, and building practical financial scenario analyses models for clients. Eric holds a bachelor’s degree in Economics from The University of Texas at Dallas.