Think your credit union is merger-exempt? Think again.

Written By:

Peter Duffy
Nationally-recognized advisor to credit union boards

“Hey, what’s going on?”

Borrowing from the song “What’s Up?” by the musical group 4 Non Blondes seems appropriate as many credit union folks are asking, “what’s going on with this, and what can we expect going forward?”

The “this” in this case is mergers, and they’re here to stay.

We’ve seen large credit unions merging together while some CUs have acquired a bank or two.

The fintech SOFI acquired Golden Pacific Bancorp of Sacramento in 2022, launching the foray of some fintechs to seek deposits (as if there wasn’t enough competition already).

Already this year,  Arrha Credit Union in Springfield, Massachusetts, announced it is selling to Pittsfield Co-operative Bank. Yes, banks can acquire credit unions.

Also of note, a spate of recently announced CU mergers did not consummate (including one between two large Florida credit unions), prompting boards and managers to ask…why are some mergers successful while others are not, and is there a process that provides for better outcomes? What can we do to understand all of this without the pressure of feeling like we should seek mergers with others, be they smaller, larger or the same size?

I’ve spent a lot of time in the boardroom of credit unions over the years and there is clearly an accelerated interest in understanding the proper role of a merger in the strategic plan. Credit union boards have seen growth and income slow for a sustained period and desire a deeper understanding of why this is occurring and how the knowledge should inform the strategic plan, including those not satisfied with their merger efforts so far.

Expectation #1: Mergers will continue to accelerate.

This is by no means a complete discussion of why strategic combinations will accelerate, which in a way also explains why mergers will accelerate.

There are many reasons and they’re all material to the competitiveness of a financial institution (FI). This is a discussion best left to the board room. I refer to the reasons as “The Drivers of Consolidation.” Key drivers include the expensive and wide-ranging impact of technology, new and prodigious competition, increased costs and the complexity associated with new and proposed regulation, among other things.

At the center is the key driver of all – the extreme imbalance of supply (lenders) and demand (consumers). Specifically, America has more lenders to choose from than Americans need. Combine this with how easily and efficiently consumers use technology to “shop” multiple FIs for the best rate and it’s easier to understand the long-term trend of margin erosion.

Since 1994, margin is down 19% for all CUs while ROA is down 34% (thru 2023, according to NCUA call reports). The importance of this cannot be overstated.

Since 1994, the costs to operate an FI (labor, health benefits, branches, technology, marketing, etc.) have increased while margins have eroded, which is why ROA is down more than the margin. This is NOT because FIs are frivolous in their spending.

As a result, economies of scale play an outsized role in determining competitiveness.

What is the economy of scale? An FI is at or above economy of scale when their size becomes a competitive advantage. This happens when the FI is spreading operational costs over a customer base much larger than competitors, bringing the “breakeven” per customer significantly lower.

FIs without scale match rates when possible, but at the extreme expense of ROA. Over time, and lacking what I call the “competitive ROA” needed to invest in the value expectation of members, it impedes growth.

Through the third quarter of 2024, the aggregate group of credit unions with assets less than $1B (4,055) experienced a decline in membership, continuing a trend. As a group, the CUs above $1B (444) saw varying degrees of membership growth. However, $1B in assets does not represent economy of scale.

Expectation #2: Mergers between large credit unions will accelerate.

There’s a story playing out in America’s community banks and credit unions since 2000: Each year, the asset size equating to economy of scale has increased. In the early years of this century, FIs with assets around $1B enjoyed a surplus (income) after non-interest expense was subtracted from net interest income. Thus, net interest income covers non-interest expenses.

This income surplus, added to non-interest income, created a higher ROA for the $1B+ FIs. Once a company achieves a consistent income advantage, they’re able to invest more in the business, and over many years this can make a huge difference in adding more customers, depending on IF the income is invested and HOW it’s invested.

Each year since 2000, the asset size needed to achieve the surplus increased.

Each and every year.

So much so that by 2021, the aggregate group of credit unions with assets less than $10B no longer saw interest income cover non-interest expenses. Said another way, credit unions below $10B in assets are no longer profitable without fee income. And, what’s the future for fee income? (The last couple of years as rates dramatically accelerated, margins improved but ROAs did not).

Importantly, this is a long-term trend rooted in the fundamentals of the business and reflecting dynamic changes in customers and competitors. The impact of the Drivers of Consolidation has triggered an acceleration of boardroom discussions among FIs unwilling to accept a deterioration in competitiveness. Boards should be aware of the Drivers and the various strategies – mergers being one – that can begin to address the challenges.

What does this mean for credit union strategic planning? Get prepared.

Seek out discussions and fact-based research that enables a deeper understanding of the key trends (including consumer trends) impacting credit unions. From that knowledge, become proactive in understanding the various strategic choices to consider and therefore build institution confidence in the choices you make to sustain member satisfaction and build membership.

As a CU CEO said to me a while back, “I have a merger target list, and I’m on the list of others.”

Your CU will be approached for merger consideration (if it hasn’t been already) and your CU may have a list of others you’d like to approach about merging, or banks you’d consider acquiring.

What process did you follow to determine your strategic choice(s) and are they all merger related? Were you able to compare the choices based on their individual pros and cons? If some type of merger is part of your plan, how was the potential partner list generated? What are the characteristics of a good merger partner for your CU? Were you able to avail yourself of case studies that show what has and has not worked with previous merger attempts?

Now seems like a good time to investigate and prepare the right posture for your CU and membership.

For decades, Peter Duffy has advised credit unions on their M&A strategies. He is a frequent speaker at credit union conferences and board meetings.

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2025-02-05T08:04:24-08:00
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