Financial institution success is largely driven by economies ofscale. The more cards an institution has to play, so to speak, themore 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 successthrough its proposed merger of the FHLB of Seattle with the muchlarger 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 toprovide are anything but a gamble as well as possibly heralding anew season of merger activity, according to some experts.

On July 31, the FHLB announced the proposed merger followingvotes of unanimous approval by both institutions' boards ofdirectors. Closure of the merger is subject to certain conditions,including approval by the FHFA and ratification by themember-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 roleof the FHFA is to ensure that each FHLB operates in a safe andsound manner and fulfills its statutory mission,” Watt said in aprepared statement on the agency's website.

“Given the fundamental changes that have occurred in thefinancial system since the creation of the FHLBs, FHFA views themerger agreement approved by the boards of the Federal Home LoanBank of Seattle and the Federal Home Loan Bank of Des Moinespositively,” he added.

Currently, the FHLB of Seattle serves 322 community financialinstitutions members, of which 106 are credit unions. The FHLB ofDes Moines serves 1,190 members, of which 109 are creditunions.

Pending final approvals, the merger is expected to close and thetwo FHLBs to begin operating as one bank out of the Des Moinesoffice in the first half of 2015. In total, the current FHLB12-bank system serves 7,500 financial institutions nationwide, ofwhich 1,246 are credit unions, the FHLB said. The voluntary mergerwould be the first for the FHLB system.

“If the merger is approved, the combined cooperative would bethe largest in the FHLB system in terms of membership, providingfunding solutions to more than 1,500 members in 13 states, as wellas the U.S. territories of American Samoa and Guam and theCommonwealth of the Northern Mariana Islands,” the FHLB said in aprepared statement.

FHLBs are cooperative institutions designed to serve theliquidity needs of their members, which are primarily credit unionsand community banks. Credit union members use a variety of FHLBproducts and services, including advances, mortgage services andcommunity investment products depending on the funding needs, goalsand objectives of a specific institution. Those benefits wouldincrease for members of the merged banks, the FHLB said.

“In addition to increased operational efficiencies, the membersof both banks would benefit from a combined cooperative withincreased economies of scale, greater risk diversification and anenhanced suite of product and service offerings,” according to theFHLB. “These same attributes would help to position the cooperativeto fulfill its mission of providing its members with greaterresources to grow their businesses and support theircommunities.”

Credit unions, at least the 31 institutions in Iowa served bythe FHLB of Des Moines, are looking forward to continuing if notimproved services after the merger, Murray Williams, COO for theIowa Credit Union League, said.

“Iowa League member credit union clients of FHLB of Des Moinesforesee little to no impact from the recently announced merger,”Williams said. “Credit unions are confident that they will beserved in the same manner they have come to expect from FHLB of DesMoines before, during and after the merger.”

The economies of scale provided in the merger should increaseservice capabilities for all credit union clients of the mergedbanks, the FHLB said. The merger also may be the first step in thepursuit of improved economies of scale for the financial industryoverall, according to Pete Duffy, managing director at NewYork-based investment banking firm and broker-dealer SandlerO'Neill & Partners LP.

“The FHLB merger is nothing more or less than the kind ofcombinations that should be going on and will be going on as aresult of the way the business has evolved,” Duffy, whose firmserves as financial adviser to the FHLB of Des Moines, said. “Thesetwo FHLBs will become more meaningful to their members, and thatmay signal that the next wave of consolidation is about tostart.”

Financial services has become a commoditized business, one inwhich some credit unions struggle to compete, Duffy said.Increasing costs and higher capital requirements are colliding withdecreasing margins and regulatory pressure on fee income. Thismakes 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 unionsand, by extension, their correspondent relationships are seeingmargins grow tighter,” Duffy said. “Financial services [have]become a low-margin business requiring scale to be viable, andthere is an asset-size threshold below which the business doesn'twork anymore.”

The FHLB merger may provide a lesson to all financialinstitutions regarding the need for greater economies of scale inorder to compete effectively. Without it, credit union servicevalue may suffer in the face of increasing competitive challenges,Duffy said.

“Even the best credit unions may see a possible deterioration ofthat value as larger banks leapfrog them in overall value unlessthe credit unions themselves are able to merge assets on the samebasis as banks, which, so far, has not been the case.”