One of the first steps in executing a successful merger and acquisition (M&A) is to find a suitable partner that meets specific financial, geographic, and membership growth opportunities. As “C.U. on the Show,” guest Harry Gunsallus explains, that partner can be another credit union—or a bank. While both a credit union and bank can present the same membership, geographic, and balance sheet benefits, there are some key M&A differences. Harry shares what it is like to merge with another credit union versus purchasing a bank and why a credit union may consider one over the other.
Merging with Another Credit Union
Merging with another credit union entails combining two entities. Politics, egos, and emotions are involved because many of the same executives and board members are still a part of the final deal. It’s essential for the CEOs from each credit union to build a bridge of understanding—this isn’t just a financial transaction. It’s critical for the “mergee” CEO to trust that the acquiring credit union will take care of its employees, board, membership, and community, and to have commitment to continue existing key connections and cultural or morale-building initiatives. If you’re the acquiring CEO, you can build confidence by talking about your employee programs and training and executive benefits that may incentivize the sitting CEO.
Acquiring a Bank
The key difference in acquiring a bank versus merging with another credit union is that a bank purchase is purely transactional because you’re buying it as an asset. Conversations about continuing community events like a 5K for charity, for example, are generally non-existent. Why? When a credit union buys a bank, they are helping a few shareholders make an exit or carry out a “liquidity event” rather than combining efforts. The benefit of purchasing a bank outright is that a credit union will gain equity and a return on its investment almost immediately because a bank holds “tangible bank value” and embedded equity. There are also some “hidden gems” within a bank’s financials, as Harry puts it. Banks generally pay their board of directors a directors’ fee and also pay income tax. When a credit union steps in, these expenses can generally become additional income.
Listen to the full episode to hear all of the details Harry shares in his experience consulting with credit union executives. There are many factors to evaluate when considering an M&A. If you’re interested in more resources to inform your decision, please contact us, and we’d be happy to connect you to consultants such as Harry and his associates.
Speaker 1: (00:00)
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.
Back on the show today to continue our M&A conversation is Harry Gunsallas. Harry has over 20 years of experience working in the credit union and banking space. And uniquely, Harry has helped credit unions purchase banks and merge with other credit unions. Today, we take a deeper dive into credit union M&A, including why your credit union may want to consider a bank acquisition. Tell me about the process of deciding to merge in a bank, to buy a bank as a credit union, and to bring that in. So in the first place, why, in the second place, how is it different than bringing in a credit union, and then, what should other credit union leaders think about who are having those sorts of thoughts?
Speaker 2: (00:46)
Sure. So the reason why you would buy a bank is very similar to why you would merge in a credit union, right? All have the same balance sheet, opportunities, all of the same membership growth opportunities, geography, all of those things matter. Those are all relevant, right? The process of buying a bank, keep in mind, you do not merge a bank. It is an asset that you purchase. So you will write a check. When you merge a credit union, the thing that we say is when you figure out a merger partner, and you bring these two things together, they give you the credit union and then they pay you to take it, right? So they give it to you. So there’s no check that is written. If I’m the merger and Doug, you’re the mergee, we combine and I didn’t have to strike a check.
Speaker 2: (01:41)
And the whole pay you take it is I get your capital, right? Whatever’s left. Now, we’re going to burn down some capital through the process of merging. We’re going to have to exit some contracts and those kinds of things. But when we’re done, we’ve become a bigger entity and we have more capital, right. And that’s a beautiful thing. It sounds very good. There’s really no downside to it other than execution, right? If you cannot execute on it, you should not attempt it. But again, you can hire resources to help you do that. In terms of buying a bank, you will write a check. And typically here’s how it works. What you do is, is you say, look, I want to grow my organization. I want to go into this new market. Well, there are no credit unions to merge in that market, or are there any smaller community banks, right?
Speaker 2: (02:35)
Here’s the math. There’s something called tangible book value, at a bank, otherwise known as equity, right? And you can look at their tangible book value. And the price that you will pay is generally 1.2 to 1.4 times that book. So if they have a million dollars of equity, you’re going to pay a million two to a million four. Now maybe you feel like I don’t want to pay a premium. But understand that the day after the acquisition—that’s the A in M&A—you get a million dollars, right? So through the beauty of accounting, and FASB, what you ended up paying was the $200,000. Here’s how I have convinced boards in the past that this is a good thing to do. If you want to build a branch, if you want to build a branch from the ground up, it will cost you $2 million.
Speaker 2: (03:43)
Now, you know, depending on the land cost, etc., but we’ll call it a $2 million branch. And that branch, as we all know, will take five to seven years to break even. We haven’t turned a profit yet. We’ve just broken even. Now, after five to seven years, we’ll start making money on that branch. Right? But it takes a lot of time and a lot of work, or you could spend $2 million to purchase a small community bank that already has a branch. And the very next day, Doug, and I know you’re going to love what I’m going to say next, the very next day you have cash flow. And as in the words of Mr. Wonderful on Shark Tank, cash flow is king. And so you’re making a return on your investment the very first day when you go through that process. And you do the math, what you will find is that your ROI, your return on investment for a bank acquisition, is generally less than 18 months, because remember, you’re only writing down the cost of the premium that you paid because their capital comes over. It’s a wonderful thing. The bank acquisition is generally a lot easier. And I’ll say this because it is surely a financial transaction. When you’re merging a credit union, you have to deal with ego, culture, morality, challenges, those kinds of things, right? What do I do with the CEO and all that industry, right?
Speaker 1: (05:17)
Because that credit was founded by four people that got together in the 1930s in the machine shop.
Speaker 2: (05:27)
Yeah. And the bank, you’re really only trying to make 10, 12, 13 people happy. And none of them work there. They’re called shareholders, right? Not credit union shareholders, bank shareholders. So these are people that came together to start the bank, to form the bank for one reason only to have a return on their investment. Generally speaking, that’s an exit, right? They’ll call it a liquidity event, but generally it’s an exit. And so when that bank has somebody that comes to them and banks, by the way, dirty little secret, they love credit union deals. And here’s why: it’s cash, right? They don’t have to get stock. When a bank merges with a bank it’s a stock transaction, which means Doug, I have to believe in you and your ability to execute on this bigger organization. And so that your stock will appreciate at some level. And then you’re probably locked up for a while, too. Yes, sir. Versus a credit union who comes in and says, Hey, I’ve got a check. I want to buy your organization. There’s no morality, right? There’s no culture fit. The shareholders just don’t care. Now that’s banking, right? Like that sounds harsh. But the reality is it’s an investment. And so it’s easier to do that.
Speaker 1: (07:02)
It sounds like either merging in a bank or credit union can be potentially a great economic strategy, as long as the composition of the entity is in alignment with the entity that’s merging it. So, you can do the search. You can find an entity that’s in the space that you want to go in that has the finances, the financial structure that you’re looking for. But then if you’re talking about the credit union, you’ve got the politics, the history, the emotion. What’s the next step, you know, you look at a county three counties over from you. You want to be in that county, and there’s a small credit union there. How do you start to build that bridge between the two that’s more than an economic bridge? Cause as we know, that’s not what credit unions are.
Speaker 2: (07:59)
Right. One of the things I have found, and I call this a milestone, right? This is a watershed moment. The two CEOs need to sit down and have lunch and they really need to understand what’s in it for both of them. If I’m the mergee, I want to make sure, and I’ll say this generally, there’s three pieces for the mergee. I need to make sure my employees are taken care of, by the way that includes me. Right? That’s a really important piece of this. Because if I’m 35, I have a long time to work. So am I going to have a job. If I’m 65, maybe not so much, right? But if I have a SERP, if I have a pension plan, does that get accelerated? Does it get vested? Change of control generally does that. I understand now what’s in it for me.
Speaker 2: (08:51)
And sometimes the merger CEO has to explain that. So I think it’s really important to know that you’re going to take care of the employees. The membership, obviously is super important, and then thirdly is the money. What we have found that works really well is to create an advisory board, or to expand your board, right? So if the merger credit union has a seven-person board, would my board be willing to go to nine, so that we could accomplish this merger, bring over two of their board members and sit them on the board? Or would I be open to creating an advisory council or an advisory board where some subset of their board members will come over? Not every board member will want to come over, but in every merger at least two do, and generally speaking, it’s the chair of the board and one other, maybe a supervisory committee person, etc.
Speaker 2: (09:47)
So you have to make accommodations for those three pieces, right? How am I going to treat the membership? Right. If we have donations that we make every year to the VA hospital, we want to make sure that can continue. That’s really important in a credit union merger. Right? We have an employee drive and we contribute to Light the Night. That’s really important. Will that continue? So as the merger credit union CEO, you have to be prepared to answer those questions and be honest about those things. From a membership perspective, look, these are the things that we do. We have a family fun day. We bring everybody out to, you know, whatever, and we want to make sure those things continue.
Speaker 2: (10:44)
We’re really passionate about financial literacy. Are you going to continue our financial literacy thing? So those are the kinds of cultural process things that you have to click through. The board’s a big deal. The CEO is a big deal. And then you have to be honest about taking care of the employees. One of the things that I’ve always said is if your employees will pass our pre-employment screening, then they will have a job. And that’s really important, right? Because if I’m an employee at a credit union for 25 years, you probably haven’t drug screened me, done a background check, or pulled my credit. And if I had to go do that again, as the CEO of the merger credit union, I want to make sure I know what I’m getting. Yeah. I think it’s important as the merger credit union CEO, to talk about things like training programs, right?
Speaker 2: (11:39)
We train our employees, we take pride in our employees and we invest in our employees. If I were on the other end, I would want to hear that. I want to make sure my employees are taken care of. My board is taken care of. And the membership is taken care of. That’s the cultural stuff. In a bank, you won’t have a single one of those conversations. You just won’t. So the thing about merging credit unions versus buying a bank, the credit union tends to be a lot more emotionally based, right? It’s all about culture and emotion and feeling, and politics plays a big role in the credit union merger, because they’re going to have a continuing effect on the combined entity, right? So if you merge a credit union and you’ve got two of their board members sitting on your board, they’re going to have a continuing impact and a vested interest long-term ongoing with that merger.
Speaker 1: (12:35)
Any idea, is there an average time to merge in a credit union? Is there a length of time that takes?
Speaker 2: (12:40)
I would give it a year. I would give it a year. Yes, sir. Obviously the smaller ones are faster, but you’ve got to wait on regulatory approval. I would plan anywhere from nine months to a year, and almost regardless of size. Now when we talk about that credit union, you’ve got to understand they’re going to be a part of you forever, right. Versus a bank; it’s a transaction, they’re exiting. They don’t care if you tore down every building the day after—they really don’t. And the thing about buying a bank is there’s some hidden gems in the balance sheet and the income statement. Hidden gems are good. So we built a model where we can show you as an example, there are two things specifically that banks do that credit unions don’t do.
Speaker 2: (13:37)
And the two things are, they pay their board members director fees, and they pay income tax. Now, look, I’m not getting into the debate, Doug. I don’t touch that high-end director fee or income tax. I’m just saying all banks do this. And when the credit union purchases the bank, that money goes away, sorry, becomes income. It becomes income. It’s a beautiful thing. And so, as an example, we were looking at buying a hundred million dollar bank and they paid $280,000 in income tax. All of that went away. So when you model this ongoing operating expense piece, you’ve got to subtract those things out. There’s several nuggets in there in, in the financials of a bank, that a credit union would not continue. That becomes income, right?
Speaker 2: (14:42)
Or at a minimum, they’re not a drag on earnings. And so this bank that made $200,000 a year—think about this, right? Their net income was automatically doubled by the removal of the director fees and their income tax. So there’s a lot of power in both of these scenarios. And so if you understand them, it will help you make the decision to buy a bank or to merge a credit union. And again, I’m happy to help because that really is the question, isn’t it? Doug it’s not to be or not to be, it is to buy a bank or not.
Speaker 1: (15:26)
Right. To buy a bank or merger credit union. Thank you, Harry, your insights on M&A probably have a lot of listeners asking themselves that very question.
Speaker 2: (15:37)
You’re very welcome, sir.
Speaker 1: (00:02)
That’s all the insider credit union knowledge we have for this episode. Can’t wait for the next episode. We’re always available through our website at act-advisors.com. That’s A C T-advisors.com. See you next time on C.U. on the Show.
Speaker 3: (00:01)
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 reference is historical and is no guarantee of future results. Indexes are unmanaged and cannot be invested into directly.
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