Merge or Convert? Consider a Third Option
A March 27 article on CUTimes.com (“Citing HAR-CO Conversion, Maryland Bankers Assail Credit Union Mergers”) suggests that conversion is an option to merger and nontaxed credit unions should stop taking advantage of their status and follow the HAR-CO model.
Kathleen Murphy of the Maryland Bankers association sites the merger between SECU of Maryland and Anne Arundel County FCU as the poster child of the abuse of tax status of credit unions in this matter.
She is wrong. The merging and converting boards of credit unions may not have done their due diligence when it comes to both of the recommended decisions to merge or convert. There is a tremendous franchise value that boards consistently ignore when it comes to their determination and recommendation to membership about their best interests. Members deserve a third option, and it should be also put to the vote prior to any decision to merge or convert.
This option should be to liquidate and pay out. If members only knew that they had a dollar interest in the franchise value of their institution that is never presented to them as an option seems to be misleading when it comes to full and fair disclosure.
Merger is a great option, for the merging credit union, because the merging credit union usually gets an undervalued asset at book value. If the merged credit union has greater capital because its undervalued capital position is not recognized, than the merging credit union is even a bigger winner. Accounting principles never state that the balance sheet is an accurate reflection of value.
The HAR-CO issue is a done deal. Whether the Anne Arundel County FCU merger or any small to large credit union merger is appropriate is another question if the members are not clearly given an option to take their money and run. Members in Maryland have plenty of options at both credit unions and banks for their financial services. I wonder if they would not take their money and go if provided the option.
What would happen if the balance sheet was disclosed to the member in terms grossed up for liquidation value of the institution? Projected sale of undervalued assets like loan portfolios and buildings could significantly alter the capital ratios. Consider the premiums that credit cards go out at.
In the banking world when a larger bank buys a smaller bank, it usually pays a significant premium for the value of the institution. This is part of the reason why credit union boards sometime recommend the vote to convert to a bank. It does unlock trapped value. Not to mention it has some direct potential benefit to their pecuniary interests. Not that a credit union CEO or board ever made a dime in the conversion process.
When I worked for a certified public accounting firm that had a bank and savings and loan client base along with a credit union operation, I was exposed to the bank merger process. A rule of thumb for a quick determination of bank franchise value was a multiple of the acquired bank footings. Basically it is equal to reserves and undivided earnings in a credit union. Two times was good, three times was great and four times was cause for champagne. In credit union terms, a 9% capital credit union could have a capital value of 20% to 30%.
Back to merger without proper determination of credit union value, the merging board is not providing members with a fair understanding of their rights without a proper liquidation value of the credit union. Plus, why not give members the right to take their money to the credit union of their choosing. If they do it after merger, they are losing their stored value.
I am not suggesting that SECU is not a very fine credit union. I am suggesting that members may want a smaller, more personal credit union to do business with. Or that they have relationships with other area credit unions that they may want to expand.
Merging was traditionally a tool to reduce the cost to the insurance fund of liquidating a credit union. It is understood that many credit union officials are exhausted with the pressure of all the crazy regulatory requirements and consider merging as a strategy to remove this chalice that is hanging over their heads. I do understand that unnecessary burden can seem about as bad as imminent crucifixion but not justification for merger without getting value. Merger is just too frequently used today as a tool because boards lack the understanding of the limitation of accounting.
Murphy is only correct in her suggestion that credit unions should consider conversions if members are fairly advised of their value. I believe that many conversions and mergers would not happen if members only knew.
From where I sit it is a disservice to members to recommend either conversion or merger without a proper disclosure of potential member value. Lacking the information, members are voting on two potentially equal evil solutions.
Bill Brooks is a certified financial planner with CU Prosper.
302-258-4668 or firstname.lastname@example.org