What to Consider Before Pursuing a Bank Acquisition

Leaders should start by mapping out credit union objectives with their boards. This discussion could yield a combination of strategies and result in a solid framework to identify bank acquisition targets that make sense.

Do the Numbers Pencil Out?

While checking the first box of “why” is the most important one, credit unions must also negotiate a deal that works for both the buyer and the seller. Leaders have a responsibility to remain good stewards of their credit union’s capital, and capital used in one transaction cannot be spent in another.

When buying a bank, the capital a credit union spends on the purchase price, deal costs and “double tax” (discussed below) disappears from the pro forma institution entirely; this contrasts with a credit union-to-credit union merger where the capital of the two institutions – other than what is spent on deal costs – combines and remains in the pro forma institution. Given this meaningful additional capital outflow for bank acquisitions, it is imperative to ensure that a cooperative pays no more than the transaction is worth and considers how it will benefit its legacy members.

With the help of an M&A advisor, a credit union can better determine the value of a particular transaction. A trusted advisor can assist in projecting pro forma earnings, which will typically include some general and administrative expense savings, revenue enhancements from cross-selling unique product lines to the seller’s customers (and vice versa), and other scale-related opportunities. The advisor will use these projections and toggle potential purchase price values to assess metrics like the period of time it takes to replace the capital expended in the transaction, the internal rate of return, and the annual earnings accretion. As a basis for its potential offer for the bank, the credit union will then determine which price points result in acceptable pro forma metrics.

On the other side of the transaction, the bank will have expectations that are typically guided by the pricing of recent transactions with similar-sized sellers, with similar performance and in similar markets. Occasionally, those expectations may be higher based on unique characteristics or opportunities the seller believes it can offer.

The ‘Double Tax’

In most M&A transactions across industries, when a buyer seeks to acquire a target entity, it simply acquires the stock of the entity – what is called a stock purchase. The shareholders of the selling entity would be subject to a single level of taxation, which is on the gain on the sale of their shares, assuming the purchase price exceeds the selling shareholders’ bases.

However, credit unions are generally prohibited from executing a stock purchase to acquire a bank and must transact by means of an asset purchase. From the buyer’s perspective, an asset purchase is similar in substance as it consists of a direct purchase of the same assets and liabilities of the entity that would accompany a purchase of the entity’s stock (with some exceptions).

For the seller, there could be a meaningful difference in substance between the two transaction types depending on the legal structure of the selling bank. If the seller is an S Corporation, there is minimal difference in substance between the two transaction types. However, for C Corporation sellers the overall tax burden could be materially higher with an asset purchase. Here is why: Whether the target is a C Corporation or an S Corporation, an asset purchase consists of two phases – the direct sale of the assets and liabilities, and the subsequent dissolution of the overall entity. For S Corporation sellers, as they are flow-through entities for tax purposes, the taxable gain from the asset purchase (or rather asset sale from the perspective of the seller) is subsequently added to the basis of selling shareholders prior to the dissolution of the entity, which prevents the gain from being taxed again. With C Corporation sellers, however, the taxable gain from the asset purchase does not increase shareholder basis prior to the dissolution of the entity, so it essentially gets taxed again, resulting in a so-called “double tax” situation.

Since credit unions have no option to acquire banks other than through an asset purchase, their ability to compete for C Corporation targets, absent some sort of additional outlay, would be disadvantaged by the known triggering of this additional tax burden to the seller. To compensate for this, and to allow for apples-to-apples comparison with offers structured as stock purchases, credit unions will offer a “double tax” reimbursement beyond the typical purchase price.

This reimbursement is what puts an offer from a credit union on equal footing with one from a bank. Therefore, it is an accepted and standard feature of nearly every credit union offer for a C Corporation bank target. In determining what a credit union buyer can pay for the bank, this special outlay must be considered part of the overall expenditure on the transaction, which otherwise includes the purchase price and other deal costs.

Other Questions for Potential Buyers to Consider

• Is offering a fixed dollar price or a multiple of book value based on equity at closing preferable?
• How can the credit union properly incentivize the seller’s management between now and closing?
• What is typical for change of control payments, along with non-solicitation and non-competition agreements?
• What deal costs of the seller will the credit union be expected to cover?
• What options does the credit union have if there are assets or liabilities it does not, or cannot, take on?
• When going through the transaction process, what resources are available in-house and what needs to be outsourced?
• What does the M&A advisor provide – just pricing guidance and negotiation, or are broader capabilities like purchase price adjustments, new member communication and onboarding, integration advisory, loan sales, etc. available?

With the opportunity to acquire banks, credit unions have more arrows in the quiver to provide financial stability, generate more value for stakeholders and expand their visions. Buyers that have properly prepared and maintain an open mind will be the ones that reap the long-term rewards.