Anyone in our industry can tell you that more members are being served by fewer credit unions today. While the trend is toward greater consolidation, it's not just larger credit unions merging in troubled ones. This shift is also seen among healthy, equal-sized credit unions, as well as those looking for a competitive edge. Consider the numbers: Through June of this year, the NCUA approved 83 mergers. Of those, half stated their reason for merging was to expand services to their members.
In some situations, mergers are a matter of survival. In others, mergers of choice make good sense. Doing business in today's marketplace is more costly than ever-increased competition, tighter margins and a changing compliance landscape all impact the bottom line. By combining operations, credit unions are able to share resources, expand reach, broaden service offerings and improve member return.
Of course, there's no doubt that many smaller credit unions can survive and thrive-especially those with strong sponsorship support. But for some, a better option might be to operate as a larger, more cost-efficient institution.
Whether credit unions merge out of necessity or by preference, it can be a lengthy process. Mergers typically take 10 to 12 months to complete, from start to finish. And significant changes have made the associated regulatory requirements much more challenging.
Last year, the Financial Accounting Standards Board adopted new accounting rules affecting all mergers occurring after Dec. 15, 2008. Now, instead of pooling the balance sheets of the merging credit unions to determine the book value of the new entity, credit unions must use the acquisition method of accounting. This means identifying the acquired entity, determining its fair value, and measuring and recognizing the assets that are being assumed, along with the liabilities. This new rule also means establishing goodwill and evaluating it for impairment for each reporting period. And unlike past mergers, goodwill will not be amortized.
Credit unions should not be discouraged by the complexities that are now part of mergers-if a merger might be a good business decision, they should find out. However, it is critically important that credit unions have access to valuation and appropriate accounting resources. To help evaluate the viability of a potential merger and secure regulatory approvals, many credit unions will benefit from outside expertise. Working with professionals that understand the industry and are experienced with the new merger rules can add confidence to the complex merger process.
In our work to help credit unions complete merger valuations that comply with Statement of Financial Accounting Standards 141-R, ALM First and our partners, RP Financial and Sacher Consulting, have noted several important considerations.
Establish loan values using separate credit and interest-rate impairments: It's essential that credit unions separate projected loan losses that are based on credit impairments from market rates when valuing loans. That way, loans can be monitored for actual credit losses versus projected losses. It also allows credit unions to evaluate adjustments to the credit portion of the valuation adjustment.
Involve the auditor early in the merger process: The auditor will need to be satisfied that the valuation techniques used by the credit union meet the relevant accounting standards, including SFAS 141-R and SFAS 157. However, because they must maintain independence over the process, auditors cannot conduct the valuation analysis. Engaging the auditor early on saves time, especially given the variations in auditing firms' documentation standards and methodology expectations.
Materiality determines the analysis level: Different merger situations require different levels of analysis. If the merger is considered immaterial, a broad-based valuation analysis may be appropriate. More multifaceted merger events will likely require in-depth, loan-level detailed analyses, as well as the development of amortization schedules. If the credit union has participated in a "bid" process, an entity evaluation may not be necessary. Check with auditors for guidance on the level of analysis needed.
Benefits of two valuations: When considering a merger, credit union management often wants an assessment of the target credit union's value. In addition, merging credit unions must receive regulatory approval before entering the process. In both instances, it's useful to conduct an initial, broad-based analysis. A preliminary study also helps set realistic expectations and provides critical background information during the early merger stages. Then, once a merger has been finalized, a comprehensive and detailed analysis can be completed, if needed.
Mergers bring credit unions together for a number of reasons. While the process may be more complex, the outcome is manageable. If your credit union's strategic plan includes merger activities, be sure you have the resources in place-whether internal or external-to effectively meet the changing valuation and accounting requirements.
Emily Hollis, CFA, is partner at ALM First.
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