Credit union mergers are about promises—promises to members, the community, employees and other stakeholders about the value a combination will create in the future. Setting and meeting these promises form the basis for assessing whether a merger makes sense and whether it delivers the intended value.
The merger process is very much like finding a life partner, with different stages of “dating.” If everything works out, it leads to the “ultimate” promise—the vows of the “marriage”—which the partners then need to faithfully work to keep.
Getting Ready for the First Date
Many credit unions can survive with the moderate growth that comes from providing basic financial services to members. However, this level of growth alone will not be enough to generate a lot of earnings and capital that credit unions need to invest in new products and services. To make these kinds of investments, credit unions must achieve the sort of financial flexibility that will enable investments in new products and services, provide better rates to members, serve members in an expanded field of membership, and grow capital to support more credit to members. To reach this goal, a credit union has two options: go it alone or complement its growth strategy by pursuing a merger.
The credit unions that will find it most difficult to choose from these options are the “tweeners” (those between $200 million and $1 billion in assets). Does staying single make sense or do they start looking for committed relationships? Many of these credit unions have achieved some financial flexibility, but boards and management struggle to determine whether it is enough in light of:
- the mounting regulatory burden that translates to increased costs;
- how CUs are investing in technology to create differentiated experiences, only to find that any differentiation is copied and, to stay ahead, they have to regularly revisit their efforts;
- changes in member behaviors and attitudes toward financial institutions; and
- emergence of lending and payments financial technology companies.
Saying that your credit union will pursue mergers opportunistically in your planning process is not enough to be effective—both reactively and proactively—in evaluating opportunities. Instead, boards and management need to think about the type of promises they want to make to members. For example, what value will members get from a merger? What level of financial flexibility will the institution achieve? And what does leadership want to do with that level of financial flexibility?
This planning effort includes defining ahead of time such non-negotiables as board structure, surviving brand and credit risk profile, and making sure board and management are in alignment.
A credit union can’t necessarily plan when a merger opportunity will present itself. But once a merger is in motion, a CU can influence the timing and pace of the process leading to completion.
This includes defining the steps proposed to be taken and the timeline for how the merger will progress; identifying how and when to engage management, board and third parties during the process; and outlining top due diligence priorities and responsibilities, including credit, compliance and risk mitigation.
It is important to note that cultural fit is a key consideration in all mergers. Given its importance, it is critical to define what it looks like and how it is assessed for your credit union.
The First Date
What’s the objective of a first date between two people? To get a second date! It is the same in initial merger discussions between credit unions.
The first meeting (typically CEO to CEO) is exploratory, and focuses on identifying the elements behind the common belief between the CEOs (and their understanding of their boards’ feelings) that there are compelling strategic reasons to continue “dating.”
This belief ultimately centers on whether a merger will provide the combined credit union with the increased financial flexibility needed to better serve members, and that a combination will accelerate and achieve financial flexibility better than each institution going it alone. If the CEOs don’t find commonality here, they should part as friends.
If the driving rationale behind a merger is to get bigger or to gain scale, then the reasons for the combination are flawed. Getting bigger is insufficient strategic justification for a merger, and scale is a means to an end—not the target outcome.
The Second Date
If there is common ground and the credit unions want to pursue a second date, the next meeting typically centers on “value to member,” or the strategic opportunities a combination can create for members. Value to member comes from two perspectives: that of the individual member-customer and that of the collective member-owners.
Value to member for the member-customer focuses on better offerings, greater convenience, differentiated member experiences, and better rates. These discussions need to include depth on “how much” members will benefit. Identifying the key metrics that will change (e.g., products per household, lending pull-through rates, and member satisfaction) will make the discussion tangible and create the beginning of the promises that will be made to stakeholders to gain support for the combination.
Value to member for the collective member-owners focuses on the benefits to the overall membership. Discussions from the owners’ perspective include capital position, balance sheet diversification (to reduce risk), brand strength, staff, and management depth. These are more inward-looking, and financial discussions are critical to solidifying the foundation for a credit union to thrive long term. The promises in this area also include those made to employees (more career opportunity, enhanced development) and to the community (ongoing support, involvement).
While these discussions are meant to generate excitement about a formal combination down the road, they should be balanced by the risks associated with integration and execution of the future business model. It is during these conversations that gaps in thinking are identified, and candid discussion will help determine whether the gaps can be bridged or if they are deal-breakers.
Deal-breakers come in two flavors: business model deal-breakers and deal structure deal-breakers.
Business model deal-breakers typically fall into four categories:
- Human resources—Is the approach to managing and rewarding people significantly different? This is one of the biggest cultural differences we see in failed mergers.
- Financial—Will we achieve the financial flexibility we seek and are we OK with the near-term impacts to achieve it (merger costs, staff reductions, capital dilution)?
- Credit—Are we all right with the current credit profile of the loan portfolio and is the credit approach compatible for future lending strategies and risk appetite?
- Compliance/legal—Is there outsized risk exposure that may constrain a combined credit union’s ability to operate as planned?
The most common deal structure deal-breakers come from discussions of the following:
- the structure and composition of board and management governance, including how many board seats will be allocated to each CU, who will be the CEO
- of the surviving credit union, and who will report to the CEO;
- which of the merging credit unions’ brands will survive;
- whether any branches or operations locations will be shut down; and
- the level, nature and timing of any staff reductions.
Talking about the deal-breakers may be awkward, but it is crucial. It is important to pinpoint any deal-breakers as early as possible so time is not wasted on due diligence if these key issues cannot be bridged.
Merger mismatches are typically identified in the deal structure phase rather than from diligence findings. Avoiding tough questions about deal breakers allows uncertainty to fester, creating frustration and more cynicism in decision-making.
If both credit unions are still excited after the second date and have their eyes wide open to the risks, the stage is set for future dates and the “prenuptial agreement” (the term sheet).
Setting Promises and the Prenup
The next steps in the process generally center on four things:
- term sheet,
- strategic vision,
- due diligence and
- communication plan.
Term Sheet—This is where credit unions can take a page from banks. Typically, banks create a non-binding term sheet that outlines key aspects of the combination and touches on the most sensitive points from either side (including the potential deal-breakers). The CEOs are empowered to negotiate this term sheet with final approval by the boards.
The most successful term sheets are those that are fact-based and, in merger-of-equals situations, provide a third option for decision-making as opposed to one side “winning.” Future anxiety and distraction for management can be avoided with early decision-making—either the credit unions can bridge differences on their most important issues or they can’t.
Strategic Vision—Parallel to the term sheet, the two credit unions should develop a clear vision of what a combined CU will look like. This would define the key strategic priorities for keeping the promises as well as the success metrics to monitor progress. The strategic vision highlights what new aspects of the business model will be created and where the increased financial flexibility will enhance the combined business model.
A significant part of the strategic vision is your risk appetite and how it may change. Doing what you do today may prevent the CU from achieving the level of financial flexibility you are promising. It is important to determine what risks (credit and non-credit) may be more acceptable (or not) in alignment with your strategic vision.
Your strategic vision needs to take into account your ability to absorb risk exposure and potential loss, where scrutiny could increase (such as from regulators or members); and what risks may require more care and oversight if your business model changes. If the term sheet is the prenuptial agreement, the combined strategy, including updated risk appetite, is the summary of the joint goals and life plan.
Due Diligence—Due diligence is a key “gate” in the merger process. It’s like inviting your significant other to meet your parents, which you only do when you think things are serious. In this major step, the two credit unions need to share confidential information, bring in more managers to perform diligence, and start delving into integration planning. Due diligence should focus on three things:
- validating and refining the initial promises (strategic and financial);
- identifying and planning for the biggest integration issues and costs (systems, benefit plans); and
- defining the cultural fit and how it is assessed.
The biggest mistake we see is when credit unions try to look at every process and document at once. It is not a question of whether you do rigorous diligence. It is a question of prioritization and sequencing in terms of impact on deal structure and integration.
For example, do you want to understand overlaps and differences in systems and human resources compensation and benefit plans early on? Absolutely. Do you need to do detailed process reviews in all areas or identify how your cost center hierarchies roll up? No, not right away.
Due diligence is the beginning of the discovery process. The key to efficient and effective due diligence is laying out a plan that assigns key focus areas to an owner, and then having a candid discussion among the diligence team (facilitated by the CEO and risk department) to ensure the appropriate scope and depth are defined.
At the end of the due diligence, the credit unions should have defined all the major integration and risk points to determine what promises will be made to stakeholders in the merger agreement.
Communication Plan—The best practice is to develop an internal and external communication plan as early as possible. It should be co-owned by someone from each CU. The plan should cover all stakeholders, including regulators, and should include clarification of roles, communication objectives, and calendars. When these elements are completed to everyone’s satisfaction, the regulatory approval, member vote, and merger agreement process will go much more smoothly.
Keeping Your Promises
If the dating rituals lead to a trip to the altar, the credit unions now need to focus on keeping the promises they made to their stakeholders. As one client said, “Everyone has worked hard so far, but now the hard work starts.”
Achieving financial flexibility through a successful integration is just the first part of meeting the promises. Strong managers in the right roles with the right incentives to leverage that newfound flexibility comprise the other part. It is critical that everyone in the combined organization understands the promises made, the metrics underlying them, and how systems, policies, and processes contribute to keeping the promises—and these rock star managers will be key drivers of this awareness.
When it comes to integration, one thing is clear: Systems conversion is not an end goal but a means to an end. The root cause of many CU mergers not meeting their potential is that success is often defined as a successful conversion rather than meeting the broader promises. Putting your top performers on integration will increase the probability of success. Backfill their current roles with temporary employees and have your top people focused full time on driving breakthrough change while managing execution risk. In addition, this can be a great talent and leadership development opportunity for your credit union.
A word of caution: Avoid a “Phase 2” mentality. Instead, use the continuing discovery process to develop better ways to sell and service members. Often, the combined credit union will adopt one of the CU’s processes with the intent of enhancing them later. Unfortunately, Phase 2 rarely comes and financial flexibility is not maximized, especially in a merger of equals.
Integrating and then managing a larger organization—especially in a merger of equals—is a lot different than in a smaller organization. The “I don’t know what I don’t know” scenario will be more common in a larger merger, especially for “homegrown” managers. Trial and error as a methodology for managing a larger organization often works … but then again, it often doesn’t.
CEOs can manage execution risk and support their teams by assessing their people and putting them in roles to be successful—realizing that this may elicit emotional responses in executives who no longer report to the CEO. The CEOs need to design an organization that will best keep the promises made, and bring in managers to fill in skill gaps. While staff attrition is a key risk, there are ways to reduce that risk—for example, organizational design and retention plans that create new opportunities.
While not everything will work out perfectly, there are many steps CEOs, the board, and the management team can take to help merger partners better define and keep promises to each other and their stakeholders—leading to a happier and successful marriage down the road.
Vincent Hui is a senior director with Cornerstone Advisors, a CUES Supplier member and strategic provider based in Scottsdale, Ariz.