Has your credit union board considered partnering with a stronger credit union to expand your field of membership, improve the quality of your services, or mitigate financial concerns? Perhaps your board members and executives have already begun having informal conversations to see which institutions align best with your membership, employees, and community values. While it may make logical sense on several fronts, undergoing mergers and acquisitions (M&As) poses various financial, social, and political factors credit unions must evaluate before proceeding.

In the latest “C.U. on the Show,” Doug is joined by Jeff Cardone, partner at Luse Gorman, specializing in representing credit unions in M&A transactions with other credit unions, banks, and fee-based businesses, as well as secondary capital, or subordinated debt transactions. Jeff discusses the stages within a typical credit union M&A, how credit unions can prepare from an executive compensation perspective, and what may stop a deal from going through.

On the executive compensation side, Jeff discusses what credit unions should be aware of and avoid to lead to the success of an M&A, including:

  • How the NCUA views M&A-related payments, and why a credit union may consider preparing executive compensation incentives years before an M&A.
  • How credit union leaders can manage perceptions among credit union members regarding compensation disclosures during an M&A.
  • How robust executive compensation arrangements can provide value to the credit union, employee morale, key members, and business relationships by incentivizing management to stay on during the transition and beyond.
  • What change-of-control provisions, including single or double triggers, may benefit credit union executives.
  • Why executives should be well-versed in the payment terms, provisions, and healthcare options defined in their employee contracts if or when an M&A occurs. 

Jeff explains how social and regulatory factors can make or break an M&A before executive compensation even comes into play. For example, the merging credit unions must flesh out the details of their continuing board members, upper management seats, branch closures, and more. Additionally, the NCUA must evaluate the acquiring credit union’s safety and soundness, the field of membership, charter, and other approval requirements. Jeff discusses how only after these initial reviews and decisions can an M&A realistically move forward. 

As Jeff puts it, “preparedness equals successful execution.” Stream the full episode for valuable insight if you’re a credit union board member or executive considering or undergoing an M&A.

Jeff Cardone and Luse Gorman are not affiliated with or endorsed by ACT Advisors, LLC. 

Audio Transcription (pulled from the podcast)

Doug (00:03):

Hello credit union executives. Welcome to “C.U. on the Show,” where we give you up-to-date information on how you can reduce risk, keep key talent, and take a strategic approach to your personal financial wellness. Hosted by me, Doug English, a CERTIFIED FINANCIAL PLANNER™ and former credit union insider with Act Advisors. My guest on today’s podcast is Jeff Cardone. Jeff is a partner at Luse Gorman who specializes in helping credit unions and other financial institutions with mergers and acquisitions, executive comp employee benefits, and tax planning. In this episode, Jeff shares how the merger and acquisition process begins, what to look for when planning for your merger on the comp side, and the importance of understanding your employment contract. So Jeff, for our talk today we’re going to discuss how credit union mergers and acquisitions activity usually begins. So tell me, how do you see them start?

Jeff (01:08):

Well, this is the way a lot of these deals are consummated. There’s what I’d call the formal solicitation process where a credit union says, look, we’re at a point in our business where we’re ready to partner up with another institution, we’re going to hire sort of an investment advisor, or we call it investment bankers, to go out and solicit and call other bidders or potential acquirers. So that’s kind of like the formal process. Like the board has determined at this point, yes, we’re ready to move. And we want to kind of partner, rather than acquire; I’d say that’s probably more common in the credit union world. The way deals are consummated is more what I call the informal way.

Doug (01:52):

That’s what I thought.

Jeff (01:55):

And board members are going to conferences. They have relationships with other credit unions and they have conversations, lunch meetings, and you get to a point where, hey, you know what may make sense? Let’s partner up. Let’s have discussions about combining economies of scale. And I’ll tell you that is probably more common in terms of your question, how does the process start? It usually starts with a conversation on an informal basis. So you can go the formal route or the informal route, but in the credit union space, I’d say it’s more often the informal route that leads to the deal.

Doug (02:30):

All right. So, discussions start between the board and the CEO or the two CEOs. And at that point, what’s the next step to determine if this is a waste of time, or maybe this really has legs? What do you see happening now?

Jeff (02:46):

The next logical step? A lot of times the numbers make sense, the metrics, but you gotta really drill down on the social issues, particularly if it’s what I call merger of equals, generally credit unions with the same asset size, board seats, composition, senior management team, name of the credit union. Are we going to keep employees at branches? That kind of thing. I mean, I think you really have to address those because until you really do that, getting to the more formal phase of a deal would just be sort of a waste of time because the numbers make sense, but you might say, well, listen, we can’t have two CEOs; you can have two CFOs and up two chairpersons, but do you really have to work that out? And you’re just really going to take two institutions, particularly when it’s a merger of equals that really want to work together. Now, if it’s the other way where you’re a much smaller institution, or maybe it’s not quite a supervisory merger, but you’re partnering up with a much larger institution—you’re not going to get equal representation on the board and there’s not going to be an even split among the management team. So a lot of it depends, but the merger of equal types, you really got to drill down.

Doug (04:00):

Interesting. So the social issues you’re defining as who gets the board seats, who stays as the leader and who’s the CEO, who’s the president. When credit unions begin these talks and are just exploring them, is what sinks the ship, that is, what stops it, usually both wanting to be in charge?

Jeff (04:22):

Well, I’d say that’s probably, I’d say number one. Number two then is the field of membership. Can you make that work from an onboarding perspective? Does that work? Do we have to go to the regulators or the NCUA and kind of expand our field of membership? We’ve had situations where that caused deals to not come to fruition. So I would say those were the big two. The other key piece to say kind of once you’ve worked through the social issues and you’re kind of ready to move forward, I think then the third piece would just be, are there any safety and soundness issues that would result in the regulators preventing the merger from happening? So I think once you’re at a point where you’ve had a meeting of minds and the social issues, the next phase is a more formal letter of intent or term sheet to kind of lay out what those are and whatnot, then you say, okay, let’s go talk to the regulators, just to give them a head nod that they’re going to give you a definitive answer. Like, yes, we’re going to approve this, but is there anything out there, is there any reason why this can’t happen? You know, looking at our field of membership, looking at our charter and whatnot, and that’s kind of the next step, because you want to make sure that’s not going to be an issue as well. In addition to the social issue.

Doug (05:29):

Well, let’s go a little deeper. I want you to talk about safety and soundness issues.

Jeff (05:34):

If you’re a three rated institution, you have, for example, BSA issues. The NCUA is probably not going to allow you to acquire another institution because they want you to kind of get your ducks in a row first, before you onboard and grow. So that’s an example where there could be safety and soundness issues. Usually on the sell side, that’s not so much of an issue because frankly, if there’s an issue with the credit union, the institute is going to want you to merge with somebody else, a more healthy institution. So it’s really on the inquirer side or the continuing credit union. Is there anything out there? BSA is certainly at the top of the list in terms of if you’re deficient there that could really cause a deal not to happen.

Doug (06:17):

So let’s pretend that there’s two credit unions and they’ve got maybe some overlapping footprint in the community that they’re in. They like each other, they’re thinking maybe there’s something to it here. You mentioned term sheet LOI. Let’s say they’ve reached out to their attorney and begun a more formal process. I know you told me a story in preparation for this call about a rogue director and kind of things to watch out for. Can you share that with our listeners?

Jeff (06:51):

Yeah. Well, I think for that issue, yes. So I think once you’re at that point, obviously you want to make sure the board is acting as one. Certainly if there’s some issues it’s not that the boards aren’t going to debate, but really if you’re going to undertake a sale process or you’re going to merge with another credit union, you want the board to kind of be in lock-step. To retell the story that I had told you, we were involved in a situation where you have to get a member vote to approve a merger with another institution. And one of the directors was sort of going out and calling members and sort of soliciting, saying don’t vote for this. And that ended up kind of causing the deal not to come to fruition. So that’s sort of a one-off cautionary note, but obviously acting in concert with support from a board perspective is key. The other thing that comes up, too, that’s real sensitive if you’re merging, and we talked about this before, are the compensation arrangements for the CEO and for the next four covered persons and also any board members, anything that’s being paid in connection with the transaction has to be disclosed both to the regulators and to members.

Doug (08:07):

Yeah. I really want to go deeper on this, Jeff, thanks for bringing that up because in prior interviews, talking to executive benefits specialists and when they are involved in a merger, both institutions, but certainly the one being acquired, the executives tend to get immediately vested, right? It’s a change of control. So if they had a benefit that was going to vest over 15 years, but in five years there was a merger, there is a huge event that is going to occur at that change of control. So talk us through what happens, how is that disclosed? 

Jeff (08:46):

Yeah, so the NCUA is not prohibiting merger-related payments. When I say merger-related payments, an easy example of that would be if the CEO has an appointment agreement and on a change of control, he or she would get two times, three times wherever the multiple is. I’m using that as an example, or you have a 457f plan, which has a provision that you have to work until age 65 to get your benefit. Let’s say the CEO is 60. And then as a result of a change of control, that f benefit accelerates. For the merger, would this dollar amount be paid? And if it’s being paid as a result of the merger, not only do you have to disclose it, the existence of the plan or the arrangement, you also have to quantify it.

Jeff (09:36):

And that could kind of lead to some issues, you know? So again, the answer is not saying you can’t do it, but they want full disclosure. And then this could create for CEOs and management teams a little bit of political issues, because now it’s going to be in the public domain, both to the employees and members, what they’re getting paid. And there’s a lot of sensitivity to that as well. So I would say also part of the process of planning for your merger on the comp side is to kind of look at what your existing plans are and how are they going to be quantified and disclosed? Are there any issues?

Doug (10:08):

All right, I want to go deeper still, because this seems like a real area where strategy being ahead of this activity could prevent a lot of difficult conversations. So you’ve been through many transactions that had these events, these disclosure requirements, and a delicate dance, I’m sure, around them. What could those executives have done years prior to have either sort of managed those perceptions or to change the need to make it less impactful? The amount of disclosure that’s required, what sort of strategies could they be thinking about in advance to make that less difficult?

Jeff (10:50):

Yeah, I mean the one thing that rule does contemplate, they sort of have a safe harbor two-year window. So for example, if you enter into an arrangement right before you’re having your virtual discussions, they’re going to view that as merger related, but if you had an f plan at least two years prior to the merger, or you entered into an employment agreement, that just sort of carries over, because a lot of times what happens in mergers is the acquirer or the continuing credit union wants to keep the senior management team for a period of time. So they might say, look, we’re not going to pay you severance, but if you stay for one year, two years, three years, that’s great. And then you sort of get paid to see the management team where it gets paid that way sort of indirectly, while it’s not severance, it kind of softens disclosures. So the selling credit had these arrangements in place prior to the merger, at least two years in advance. And so it’s kind of just rolling forward. That’s not really an agreement that was entered into because of the merger and that kind of softens the disclosure obligations for that.

Doug (11:52):

So would that also apply if you had a 457f 10 years ago?

Jeff (11:55):

Yeah. We have a situation where a merger we’re going through right now, the CFO has a f plan. And the nice thing was it was in place in the last 10 years. There’s no true accelerated provision. There is some termination protection, but again, because this was a legacy plan that was already in place well past the two-year safe harbor period, the view on that is that’s not disclosable. That’s not merger related and they were comfortable with that. So there’s sort of ways to get the covered person, the CEO, their money, but in a way that’s going to kind of soften the disclosure from a political perspective. And again, that planning’s key. They’re going to do this well in advance of undertaking the merger process.

Jeff (12:42):

Now you can go the other way. Some covered people might say, we don’t care about disclosure. We want the protections; we want to get paid. And we sort of built the institution and what it is for lack of a better legal phrase. But then you just disclose it. And again, to reiterate the answer, he’s not saying you can’t pay severance. They just want the members aware of what that, what that is because of that conflict of interest, because the covered persons are sort of the ones making the decision, the board members, the CEO, about the sale and obviously getting paid severances is a conflict of interest for members. And so, again, as long as it’s adequately disclosed, the answer is fine with it.

Doug (13:18):

And the example you just cited, did that executive experience immediate vesting because of change of control or not?

Jeff (13:25):

The one where we’re going through now, they did not. But if it did, we would have to disclose.

Doug (13:32):

So that’s a really interesting point. So I’m used to seeing change of control as part of the contract. I don’t know how frequently you see that, but I know I’ve seen it in a lot of the credit union executives we work with. If there’s a change in control, they get immediate vesting. Would you say the majority of the structures you see include that?

Jeff (13:50):

I would say yes. And you know, when I talk to boards for the sale process, particularly about compensation, there’s a little bit of this misconception, like every dollar executives get paid, that’s a dollar being taken away from the members. It doesn’t really work that way from an acquisition, because what happens is when an acquirer comes in and they’re assessing doing a deal, they’re going to have in their modeling expenses and whatnot, obviously there’s no deal consideration for credit union mergers because they’re cooperating. But you’re looking at costs related to termination report processing, any continued coverage and compensation is kind of a part of that. So again, if you tell an executive, look, we’re not going to pay you these change controlling benefits, that’s not necessarily going to flow to the members because it’s kind of built in.

Jeff (14:40):

And then the other thing boards have to keep in mind and where there’s real value to have an accelerated vesting provisions on change control on these severance benefits is once you sign up a merger, you and the board approve it, you’ve kind of then moved to the regular. You have your LOI, you negotiate what it’s going to be in it, all the boards approve it. You put together the merger plan and you submit it to the NCUA. It’s a monthly approval process. So from that time, from when you file your application and you’re like, yes, we’re moving forward to when you close. And then you finally execute the definitive merger agreement. You’ve got to keep that management team in place. I mean, somebody’s got to run that institution. So these benefits really incentivize these key people to stay.

Jeff (15:24):

So there is true value to the members and that benefits the members. In addition to value, obviously the executives really get paid, but that’s important because otherwise, if there was not, if there was no incentive, and the CEO gets a job offer elsewhere, he or she says, look, I’m outta here. Why am I staying? I was trying to educate the boards about that because there is that misconception. It’s not dollar to dollar. We take $5,500 from the CEO and that goes to members—it doesn’t really work that way, economically speaking.

Doug (15:56):

If the design is right, the retention of the management team is what’s in the best interest of the members. Absolutely.

Jeff (16:04):

Yes. Because in the non-banking credit union world, deals get signed up and they just close right away. But in our industry, you have a very thorough regulatory approval process. You have to have a member vote. So there is a time horizon. And then the other thing is if you keep the person around post-closing, they have to work to a certain date to get the severance. I mean, obviously, they can’t quit beforehand. Then again, it’s an incentive to not only get to closing, but also to stay on for a transition period, which is also helpful because you can have your CEO and your other key people reaching out to key members and business relationships, and generally for keeping all the employees, just for employee morale. So there is true value in these compensation arrangements sort of beyond what’s in it for the CEO just getting this windfall holding parachute payment.

Doug (16:55):

If you were advising a credit union executive of a smaller institution about the design of their executive contract, change of control is obviously one option. Is there any kind of optionality that you could put in there that would make sense if there was a merger? And is there some sort of making whole provision as a result of the merger where immediate vesting doesn’t occur? Tell me about that.

Jeff (17:23):

You can do what’s called a single trigger provision where the change of control itself triggers the vesting or triggers the payment or conversely you could do what’s called a double trigger. The way double trigger works is you have to have first the change of control itself, but that doesn’t trigger the payment. The next trigger would be the subsequent termination of employment. So if the change of control happens, let’s say we want the CEO to stay then. Then that’s not going to necessarily trigger payment as long as you keep the CEO, but then subsequent to the merger, if the CEO is terminated, CEO, CFO, whoever the individual is, then they get paid. You see that as well, because that kind of adds to the incentive for the CEO, or whichever person has the contract. So the double trigger is sort of another way of doing it as well.

Doug (18:16):

And so is it possible that if you had that double trigger and the two institutions talk to each other and the management team that’s being acquired, they get to an agreement on a new compensation structure under the new entity that makes them whole, they then agree to go through the process and the immediate vesting isn’t necessary because they’re sort of made whole with that new comp?

Jeff (18:43):

Yeah, you can just do that, too. Because you can have the contracts, but then an acquirer can come in. This is common. They’ll sit down with a key person, and say, look, we want you on our platform. They may ask them to give up an employment contract in consideration of a job and getting on their package and there’s negotiation. And that goes back to my earlier point about social issues, particularly in these deals. If that’s important to an acquirer and what the CFO or the chief lending officers need, you really want to try to address that on the front end, during the LOI phase, before you officially move forward, rather than on the back end. Because once you kind of are down that path, then it becomes more difficult to negotiate that, because now you’re giving a lot of power to an executive or a key person because he or she might say, look, I don’t want to stay, but at least you want me to. You’re better off finding out on the front end or upfront then after the fact.

Doug (19:39):

Excellent. One last question is about knowing your contract in situations like this. Talk to me about some examples you’ve seen where folks really didn’t understand their employment contract, what to look for and think about if you’re the entity being merged by a larger entity.

Jeff (19:59):

Yeah. I would say probably of the big two that come up contractually, know your contract is one. Typically if there is severance protection, it’s usually a multiple of salary and bonus and salary is easy. You can say salary in effect on the date of termination or change control. But the bonus, it’s sort of like, well, what’s the bonus? Is it a bonus for the prior year? Well, is it a bonus paid in the prior year? Or is it a bonus earned with respect to our year? And those could be two different numbers. And then you may have a situation like what happens if the merger closes during a partial year? Do any bonuses during that year kind of factor into that? So that is one that always comes up. Oh, another one would be the health insurance piece.

Jeff (20:50):

I’m going to get continued coverage because pre-Obamacare, they used to be able to just continuously acquire, come in, and let’s say a CEO leaves. You say, okay, you can come in our group health plan and those days are over. So it was clear how if you’ve got continued health coverage, how does that work? You just have a lot of times what ends up happening is you just sort of quantify it and you pay the individual out. But that could be an issue as well from a comp perspective. I mean, I would say those two come up quite frequently with contracts. The other one, too, really comes into play for double trigger arrangements. So you say you have a change of control or the termination of employment, but what about a situation where let’s say the buyer credit union comes in and says, look, we want you, but you’re going to take a lesser role.

Jeff (21:35):

You’re going to be a market president. You’re not going to be CEO. The CEO says, well, I don’t like that. I want to have the right to quit and still get paid. You know what I get paid? And again, a lot of it depends on the contract because you can put in what’s called a good breeze and provision that says if you resigned because there’s a material diminution of your duties or your role or your position sort of a constructive termination. So again, I always say this and emphasize this with planning. That’s why it’s important to know your contract. And really before you undertake a process, you’re thinking about selling, make sure your contracts are in order, and everybody knows the terms, how they work, what triggers payments, the payment amount. We just talked about the bonus, how all that works. I think it’s important, right?

Doug (22:19):

So today we focused on if you’re the entity that’s being merged in, generally you’re the smaller entity. For our next episode, we’re going to connect with Jeff again to talk about if you’re the acquirer and you’re looking to purchase banks or credit unions, what to look for in those larger acquisitions. Jeff, any final thoughts for our listeners?

Jeff (22:45):

My final thought is, preparedness goes a long way to successful execution of a deal.

Doug (22:50):

I think that was a Boy Scout saying, right?

Jeff (22:54):

Correct. That was one word. That’s my phrase. Imperatives equals successful execution, right?

Doug (23:05):

Right, and thanks, Jeff.

Jeff (23:08):

Appreciate it. Thanks for having me.

Doug (23:12):

That’s all the insider credit union knowledge we have for this episode. Are you enjoying the conversation? Be sure to subscribe and share your thoughts with other credit union leaders by leaving us a review. See you next time on “C.U. on the Show.”

Speaker 3 (23:31):

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. Economic forecasts set forth may not develop as predicted. All performance references are historical and are no guarantee of future results. Indexes are unmanaged and cannot be invested into directly.

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