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  • Writer's pictureW.B. King

Industry Insiders Debate the Merits and Legality of Credit Unions Purchasing Banks

By W.B. King

In late December 2022, Dort Financial Credit Union announced that it had entered into an agreement with Flagler Bancshares Corporation to acquire Flagler Bank, headquartered in West Palm Beach, Fla. While the deal requires approval by bank and credit union regulators, as well as Flagler Bancshares Corporation’s stockholders, if successful, the credit union assets will increase to nearly $2 billion.

“We are working closely with current Flagler Bank CEO Edward Sterling and regulators on the merger,” Dort Financial President & CEO Brian Waldron said in a statement.

“This is a big step in Dort Financial’s strategy, allowing us to better serve our members who spend winters in Florida,” said Waldron, noting that the $1.4 billion credit union currently supports 103,000 members in Michigan. “We also are excited about bringing our services to existing Flagler Bank customers and to potential members in the Palm Beach and surrounding counties.”

This potential acquisition is one of 16 stories about credit unions acquiring banks in 2022, a figure second to 2019’s record-breaking year that saw 21 purported deals.

“Credit unions are looking at new markets. Several of the deals we saw were either entry into new states or expansion into states where maybe credit unions had a very small presence,” Paul Davis, director of market intelligence at Strategic Resource Management, told Finopotamus.

Davis, who previously held a number of positions in the space, including editor of American Banker’s community banking and merger and acquisition beat, added: “Credit unions, I think, also like the commercial banking infrastructure, as long as they remain within legal caps, so that another big draw.”

Acquisitions Exasperate Industry Consolidation

While the pandemic slowed the number of these types of acquisitions, Aaron Stetter, executive vice president of advocacy and strategic engagement for the Independent Community Bankers of America (ICBA), told Finopotamus that he expects to see this debatable trend continue.

“These deals don’t happen in a free or fair market,” Stetter said, noting that ICBA represents the entire community banking community — more than 5,000 institutions — whether they are dues paying members or not.

“What you have is a tax subsidized entity in credit unions that are using their tax exemption and a higher rate of retained earnings to offer sometimes two and half times the book value and assets of the bank,” he said.

Aaron Stetter

Stetter contends that the U.S. Congress, through the existing tax code, is “exasperating industry consolidation by creating a dynamic of economics where larger growth-oriented credit unions are using that tax exemption to purchase community banks at a higher rate.”

Due to the retained earnings benefit, Stetter said larger credit unions are most often looking to purchase smaller community banks, many across state borders, like Dort Financial Credit Union’s deal, and many of which present unique characteristics and offerings.

“If you are a credit union, you are looking into some of the expanded powers and expertise community banks present, such as business lending,” said Stetter. “And perhaps the banks have a more sophisticated technology operation using fintechs and automated systems.”

Certain states, like Florida, are open and agreeable to credit unions purchasing banks, but Mississippi passed a law in March 2022 allowing only FDIC-insured banks to merge with and/or acquire Mississippi-chartered state banks. Other states, including Nebraska and Colorado, have recently thwarted proposed deals between credit unions and banks citing existing laws and/or regulations.

“We are very supportive of the Mississippi law and we would like to see the law adopted in all states. We feel this phenomenon is bad for everyone. It causes industry consolidation, which is ultimately bad for consumers,” Stetter said. “You can make the argument that consumers may be benefiting by the subsidized rate, but what are they losing by forgoing FDIC insurance?”

Davis also noted that there are a number of states that either have legislative or regulatory restrictions in place, adding that many of the battles over credit union-bank mergers will likely be fought on the state level.

“Those who oppose [these deals] would have more traction going on a state-by-state basis opposed to trying to get Washington to stop those deals from happening across the board,” Davis said.

While the National Credit Union Administration (NCUA) has many protocols in place for proposed mergers of two federally insured credit unions, Finopotamus was unsuccessful in securing an interview with the organization regarding its stance on credit unions purchasing banks.

NCUA’s website offers a portal regarding guidance on bank to credit union conversions.

“The National Credit Union Administration (NCUA) occasionally receives inquiries from financial entities, including banks, with questions about converting to a credit union charter. While unusual, such conversions may be possible for some financial entities,” the website states. “Credit unions may be either federally chartered or state-chartered. NCUA charters federal credit unions (FCUs).”

Fintechs in the Merger Mix

Whether or not more states like Mississippi pass legislation banning credit unions from purchasing banks, Davis agrees with Stetter that this trend is likely to continue in states that are less restrictive. And with more credit unions partnering with fintechs in recent years, there may be even more opportunities to consolidate.

Paul Davis

“Credit unions are warming up to the idea that fintech can be a collaborative force rather than a competitive one. The NCUA has been more supportive of fintech partnerships than some of the bank regulators have been,” Davis said. “There is a real opportunity in 2023 for more credit unions to get comfortable with what fintech has to offer — as long as the vetting and due diligence is appropriate.”

For those credit unions looking to acquire a bank, Davis offers some guidance above and beyond vetting the bank’s balance sheet, geographic location, customer base and tech stack. A good general practice is to consult with regulators so the credit union to enter the process with “its eyes wide open,” while having a firm understanding of respective state precedent when it comes to approving acquisitions. Other advice includes ensuring a cultural fit between the organizations.

“A credit union must feel certain it can retain the selling institution’s customers,” he said. “Keeping employees in the fold,” he added, “is especially critical if there will be a push into commercial banking.”

A Call for Congressional Oversight

Davis pointed that of the 160 banks sales in 2022, just 16 were purchased by credit unions. Noting that the overall percentage of these deals is low, he expects more “credit unions buying banks” headlines in 2023.

“This is a tough decision for the selling banks because the banking industry discourages these types of deals, but on the other hand, it is hard for a bank to outright reject an attractive all-cash offer,” Davis said. “So, I think we will see more of these deals. We’ve seen several of these deals go through, but we’ve also seen several fail to cross the finish line.”

Stetter said he has not yet identified a trend as to why certain acquisitions fail, but told Finopotamus that as an example of pushing back, ICBA is actively partnering with the Florida Banker’s Association to convince the [state] department of financial institutions and lawmakers that the state should adopt legislation similar to the Mississippi law. But ICBA is not stopping with the Sunshine State.

“As credit unions become more bank-like, and morph into tax exempted community banks, our role is to pursue congressional hearings that would really take under question the appropriateness of the tax exemption,” Stetter said. “Even though most credit unions aren’t looking into these deals, there is a certain percentage of growth-oriented credit unions that are — ultimately every credit union should pay the same amount of taxes that a community bank pays.”

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