As part of a long-term trend of credit union consolidation and expansion, an increasing number of banks and savings associations have been acquired by credit unions over the past 10 years. Most of the banks and thrifts acquired by credit unions have been small, with total assets of around $300 million or less, and the great majority of such transactions in the past five years have involved bank targets with assets of between $100 million and $300 million. The number of such transactions peaked at 16 in 2019 before falling (with all other financial institution merger activity) in 2020; however, many analysts and the financial press expect that larger credit unions will continue to be expansionary and that the pace of credit union-bank deals may well accelerate in 2021 and 2022.

While a credit union acquirer is typically able to pay a higher cash purchase price than a competing bank can, the boards of directors of banks or thrifts considering a possible sale transaction must take into account a number of other pricing factors, as well as timing and cultural issues, when choosing between a bank and a credit union offer. In particular, certain other factors, including income tax consequences, may cause an otherwise higher offer by a credit union to be less attractive to the shareholders of a target bank or thrift than an in-industry bid.

I. PURCHASE PRICE CONSIDERATIONS

A. Credit Unions’ Pricing Advantage

A credit union, assuming a high level of capitalization, will generally be able to make a higher per share cash offer than a bank or bank holding company seeking to acquire a target bank or savings association. There are two reasons for this: 

(1) A credit union has no shareholders and does not need to answer to shareholders’ and analysts’ expectations as to the pro forma impact of a merger on future profitability.

(2) A credit union’s exemption from corporate income tax allows it to accept a significantly lower return on investment from an acquisition than a competing bank requires.

It must be noted, however, that while a credit union often has the ability to pay a higher premium in a bank or thrift acquisition, there are additional costs and expenses associated with a credit union acquisition of a bank or savings association, as set forth below, that will negatively affect the net amount received by the target bank’s shareholders. The cumulative effect of these expenses and the generally longer time required to obtain regulatory approvals and close the transaction may make such a transaction less attractive for the target institution than a lower-priced offer by a prospective bank or savings association acquirer, particularly one with an attractive stock currency.

B. Credit Union Acquisition Must Be by Cash Purchase Only

It is important to stress that — since credit unions are mutual organizations and have no stock — the only consideration a credit union can offer a bank or thrift is cash. A bank or thrift acquirer, on the other hand, has the flexibility to offer consideration consisting of stock, cash, or a combination of stock and cash.

C. Double Taxation of Bank Shareholders (C Corporations Only)

In most instances, the acquisition of a bank or thrift by a credit union must be structured as a purchase of assets and an assumption of liabilities (P&A) rather than as a merger. While state-chartered credit unions are permitted to merge with banks or thrifts in certain states (notably Florida), the great majority of credit union acquisitions of banks take place through a P&A transaction.

In most cases, therefore, a bank’s sale to a credit union will be a taxable asset sale, and the premium paid on the transaction will be first subject to federal and state taxation at the corporate level to the extent that the selling institution recognizes a gain on the sale of its assets. (This factor does not, of course, apply in the event that the target bank or thrift is an S corporation, in which event there is generally no tax payable at the entity level.)

After the target company pays those taxes and distributes the remaining sale proceeds to its shareholders, the shareholders will have tax liability on the liquidation distribution received on their shares. In a merger with another bank or thrift, by contrast, there would be no double taxation and the target company’s shareholders would generally only pay tax to the extent that they receive cash (rather than stock) in the transaction, provided that at least 40% of the transaction consideration is in the form of the acquirer’s stock.

As a result of this double taxation, an acquiring credit union (except in certain states, where a state-chartered credit union may acquire a target bank through a merger) will generally need to increase its cash offer to offset the impact of the corporate tax event occurring prior to the liquidation distribution to the shareholders of the bank or thrift.

D. Retention of Reserve by Target Holding Company

In credit union transactions involving the P&A of a bank or thrift in a holding company structure, the target holding company will subsequently be dissolved and liquidated. The holding company may be advised by its tax advisers to undergo an extended liquidation process of several years and to retain, until the completion of the liquidation, a holdback of a small percentage (3% to 5%) of the purchase price in order to cover any unexpected claims against the company, including IRS and state tax claims. In such circumstances, the company’s shareholders would not receive the full liquidating distribution on their share of the purchase price until the company is finally dissolved.

E. Target Bank/Thrift’s Transaction Costs

The acquisition of a bank or thrift by a credit union is considerably more complex than an acquisition by another financial institution, involving both the P&A with the credit union and the related dissolution of the target institution, the latter of which is a time-consuming, and often expensive, project. The projected costs to the target bank or thrift, and the impact on the net consideration to be available to shareholders, must be carefully calculated in the target company’s consideration of a possible credit union transaction.

F. Liquidation Account Payout (Converted Thrifts Only)

A previously converted stock savings institution is required to establish a “liquidation account” at the time of its mutual-to-stock conversion that represents the ownership interest in the mutual thrift of its “eligible depositors” just prior to the conversion. Because a credit union acquisition of any stock depository institution must in most cases be effected through a P&A transaction rather than a merger, a credit union acquisition of a converted thrift is considered a “liquidation” by the Federal Reserve Board. As a result, following the completion of the P&A transaction, the target stock thrift must pay out the remaining balance of its “liquidation account” to the remaining eligible depositors.

While liquidation account balances generally decrease fairly rapidly following a mutual-to-stock conversion, the liquidation account for a recently converted thrift may remain large enough to cause a credit union acquisition offer to be noncompetitive with a lower offer by a prospective bank/thrift acquirer. A thrift that has converted to stock form in the recent past should consult with its investment banker or its independent auditors and calculate its current liquidation account balance liability in advance of its consideration of a potential sale to a credit union. Such an advance calculation of the liquidation account value would allow the thrift to more accurately compare any credit union offer against other offers by banks and thrifts during the bidding process.

II. REGULATORY APPROVAL AND TIMING CONSIDERATIONS

In light of the significant number of credit union acquisitions of banks and thrifts that have been completed since 2012, the regulatory approval process for such transactions is well traveled and fairly predictable. While credit union acquisitions can be approved, the complexity and the time required for the regulatory approval process in such transactions are considerably greater than they are for obtaining approval for bank/thrift mergers. At a minimum, the following regulatory approvals will be required:

A. The acquiring credit union must obtain approval for the P&A from the National Credit Union Administration (NCUA) and, if applicable, its state regulator. The NCUA does not have prescribed application procedures for such transactions (although it has a proposed rule-making outstanding to institute such procedures), nor has it published guidelines as to processing periods.

B. The target bank or thrift must apply for the following approvals:

(1) Approval of its primary regulator for the transfer of assets and deposits to the credit union, the liquidation of the bank, and the transfer of the cash consideration to its holding company

(2) Approval of the FDIC for the transfer of assets and deposits to the credit union and the termination of FDIC deposit insurance

In addition to the above regulatory approvals, the shareholders of the target bank or thrift will need to vote to approve both the P&A with the credit union and the liquidation and dissolution of the target institution and any holding company.

As a general matter, in light of the additional regulatory approvals and the procedural steps required for a P&A transaction and a bank dissolution, a bank’s acquisition by a credit union may be expected to take two or three months longer to complete than a typical merger with another bank.

III. CULTURAL ISSUES

A. Employee Retention and Compensation

A bank weighing a credit union acquisition offer will wish to consider the effects of such an affiliation on its officers and employees — in particular, will the bank’s personnel be offered positions with the surviving credit union, and if so, will the compensation structure be competitive with that of the bank?

A target bank would also need to assess how its tax-qualified retirement plans and SERPs (if any) will be treated in the transaction.

B. Impact on Bank Customers

A bank or thrift will want to consider whether its customers, both retail and commercial, will find the banking services offered by the credit union to be comparable to those that they expect from their current banking institution. Retail customers will likely find comparability. Whether the credit union will continue to serve the commercial customers of the target bank or thrift will likely depend on the products and services currently offered by the credit union.