FHLB Merger Promotes Scale
Financial institution success is largely driven by economies of scale. The more cards an institution has to play, so to speak, the more hands it can be expected to win.
When it comes to dealing a winning hand, the Federal Home Loan Bank network is betting on increased success through its proposed merger of the FHLB of Seattle with the much larger FHLB of Des Moines, Iowa.
The economies of scale created by the merger and the better, more economical services the blended institutions will be able to provide are anything but a gamble as well as possibly heralding a new season of merger activity, according to some experts.
On July 31, the FHLB announced the proposed merger following votes of unanimous approval by both institutions’ boards of directors. Closure of the merger is subject to certain conditions, including approval by the FHFA and ratification by the member-owners of the Des Moines and Seattle FHLBs.
The FHFA has already expressed its support for the merger, according to Mel Watt, the agency's director.
“As the regulator of the Federal Home Loan Bank System, the role of the FHFA is to ensure that each FHLB operates in a safe and sound manner and fulfills its statutory mission,” Watt said in a prepared statement on the agency's website.
“Given the fundamental changes that have occurred in the financial system since the creation of the FHLBs, FHFA views the merger agreement approved by the boards of the Federal Home Loan Bank of Seattle and the Federal Home Loan Bank of Des Moines positively,” he added.
Currently, the FHLB of Seattle serves 322 community financial institutions members, of which 106 are credit unions. The FHLB of Des Moines serves 1,190 members, of which 109 are credit unions.
Pending final approvals, the merger is expected to close and the two FHLBs to begin operating as one bank out of the Des Moines office in the first half of 2015. In total, the current FHLB 12-bank system serves 7,500 financial institutions nationwide, of which 1,246 are credit unions, the FHLB said. The voluntary merger would be the first for the FHLB system.
“If the merger is approved, the combined cooperative would be the largest in the FHLB system in terms of membership, providing funding solutions to more than 1,500 members in 13 states, as well as the U.S. territories of American Samoa and Guam and the Commonwealth of the Northern Mariana Islands,” the FHLB said in a prepared statement.
FHLBs are cooperative institutions designed to serve the liquidity needs of their members, which are primarily credit unions and community banks. Credit union members use a variety of FHLB products and services, including advances, mortgage services and community investment products depending on the funding needs, goals and objectives of a specific institution. Those benefits would increase for members of the merged banks, the FHLB said.
“In addition to increased operational efficiencies, the members of both banks would benefit from a combined cooperative with increased economies of scale, greater risk diversification and an enhanced suite of product and service offerings,” according to the FHLB. “These same attributes would help to position the cooperative to fulfill its mission of providing its members with greater resources to grow their businesses and support their communities.”
Credit unions, at least the 31 institutions in Iowa served by the FHLB of Des Moines, are looking forward to continuing if not improved services after the merger, Murray Williams, COO for the Iowa Credit Union League, said.
“Iowa League member credit union clients of FHLB of Des Moines foresee little to no impact from the recently announced merger,” Williams said. “Credit unions are confident that they will be served in the same manner they have come to expect from FHLB of Des Moines before, during and after the merger.”
The economies of scale provided in the merger should increase service capabilities for all credit union clients of the merged banks, the FHLB said. The merger also may be the first step in the pursuit of improved economies of scale for the financial industry overall, according to Pete Duffy, managing director at New York-based investment banking firm and broker-dealer Sandler O’Neill & Partners LP.
“The FHLB merger is nothing more or less than the kind of combinations that should be going on and will be going on as a result of the way the business has evolved,” Duffy, whose firm serves as financial adviser to the FHLB of Des Moines, said. “These two FHLBs will become more meaningful to their members, and that may signal that the next wave of consolidation is about to start.”
Financial services has become a commoditized business, one in which some credit unions struggle to compete, Duffy said. Increasing costs and higher capital requirements are colliding with decreasing margins and regulatory pressure on fee income. This makes competition difficult for all but the largest institutions, especially in the face of growing consumer demands, he added.
“Increasingly and without exception, banks and credit unions and, by extension, their correspondent relationships are seeing margins grow tighter,” Duffy said. “Financial services [have] become a low-margin business requiring scale to be viable, and there is an asset-size threshold below which the business doesn't work anymore.”
The FHLB merger may provide a lesson to all financial institutions regarding the need for greater economies of scale in order to compete effectively. Without it, credit union service value may suffer in the face of increasing competitive challenges, Duffy said.
“Even the best credit unions may see a possible deterioration of that value as larger banks leapfrog them in overall value unless the credit unions themselves are able to merge assets on the same basis as banks, which, so far, has not been the case.”