Article

How Is COVID-19 Impacting Credit Union M&A?

handshake with coronavirus and financial images
By Stephen Morrissette

8 minutes

While the initial trends are understandably down, don’t forget to seek opportunity in turbulence.

Like it has done to so many other business activities, the COVID-19 pandemic has slowed merger and acquisition activity across almost every industry—and will likely impact the shape of M&A for the next year or two. Many expect M&A activity to continue (and perhaps strongly rebound) once economic uncertainty subsides because the fundamental drivers of strategic mergers have not changed and, indeed, may have been intensified by the current turbulence. For instance, the minimum asset size to afford appropriate investments in technology is more acutely felt by smaller institutions.

Let’s start with the bad news. M&A activity has clearly slowed. Across industries, the number of newly announced deals is down 53% for the first half of 2020 versus the first six months of 2019. While some deals did continue and even some new deals were announced, most started pre-COVID and were far enough into the process that the partners decided to continue. Conversely, several bank M&A deals announced in late 2019 were canceled in the first half of 2020 due mostly to economic uncertainty. A recent article in Harvard Business Review cited a survey of executives that showed that 50% of U.S. companies had paused M&A activity for the moment and don’t expect to resume until 2021.

The Pandemic’s Effect on M&A

There are many reasons for the M&A slow-down, all rooted in uncertainty. First, the economic uncertainty is obvious—the shape and severity of the current recession remain to be seen. Institutions don’t know what will happen on such important economic dimensions as unemployment, income, consumer spending, etc. These economic variables will drive the volume of new loan originations—forecasters are projecting a 25% drop in auto sales in 2020.

More importantly, the health of the economy will drive the severity of losses on bad loans. As seen in the headlines, most of the largest banks are socking away substantial additional reserves for loan losses. At times like this, it is more difficult to assess the quality of a merger partner’s loan book, a necessary step when trying to avoid merging into a batch of problem loans.

Loan losses also trigger an institution to consider its overall capital level and ability to withstand a prolonged economic downturn. The credit union industry has significant capital strength today, with average capital levels over 11%. Some M&A transactions, especially the purchase of bank branches or whole banks because assets grow and capital does not, can temporarily reduce a credit union’s capital ratio—an important consideration during periods of economic stress.

The COVID-19 pandemic is also impacting executives and boards. Most obviously, credit union leaders are focused on the significant challenges of adapting institutional activities to a “remote” world where in-person contact between employees is limited and in-person contact with customers is also challenging. In short, CU leaders are putting out important fires and don’t have time to worry about M&A right now.

Stephen Morrissette
Booth School of Business, University of Chicago
Consumer behavior has become less predictable and is causing institutions to re-evaluate.

One final area of uncertainty is consumer behavior. Over the last few months, consumers have adapted to a remote world by drastically changing how they buy products and get served. Most experts see the impact on financial institutions as an acceleration of the existing trend toward more mobile banking and less branch banking.

Most institutions were already well along the online and mobile journey with members and simply saw an increase in this evolution, so it was not the start of a new change curve for them. While COVID-19 may have turned parts of our world upside down, the mobile evolution is not new news. Other industries that cannot (or had not yet) gone mobile (or to video) have truly seen their world turned upside down in a few weeks—think about hotels, restaurants and athletics events/arenas.

Nonetheless, consumer behavior has become less predictable and is causing institutions to re-evaluate branch networks, consider how indirect auto lending will work in the future if online auto purchasing sticks, wonder if there will be demographic shifts from dense urban centers to less dense locations, etc. etc. Whenever the future becomes difficult to predict, it makes investment decisions, including M&A, more difficult.

Another reality is that executive decision-making is impacted by periods of stress and turbulence. Our experience shows that most humans become more conservative and cautious during periods of turbulence. Research has shown that our decision-making processes are clearly impacted by stress. During periods of stressful turbulence, we tend to become more cautious, consider fewer options and even believe negative outcomes are more likely. M&A commentators (going back to John Maynard Keynes) often use “animal spirits” to describe the optimism that undergirds the decision to embark on risky journeys like M&A. During periods of economic uncertainty and stress, fear is high and animal spirits are muted.

Seeking Opportunity in Turbulent Times

So, the current pause in M&A is unsurprising and rationale. Then, why are some, including some credit union executives, still talking about M&A? Experience and research have shown that turbulent inflection points are often the most important strategic moments in a company’s journey—some would say that times like this separate the “winners” from the “losers.” Winners will find the opportunity in turbulence and use this time to leapfrog competitors.

To help companies look for opportunities as the recovery from COVID-19 begins, Bain Consulting looked at winners and losers after the 2008-2009 recession. While most companies played defense and experienced sluggish growth coming out of the recession, about 20% of the companies made changes that propelled them to 18% growth—almost four times the growth of the defensive group.

Clearly there are ways to find opportunity in turbulence. Bain highlights M&A as a tactic used by the winners. Likewise, research by BCG looking at over 51,000 deals over 40 years shows that M&A transactions done during economic downturns provide significantly better economic results for buyers. Clearly, M&A is one way to “win” during turbulence.

BCG explains that now is a rare moment for consolidators: “The window is now open for institutions that are in a position to be bold.” BCG forecasts more large deals that can transform an organization including merger-of-equals deals. Likewise, a recent article in CUInsight reported that credit union executives are now open to larger deals.

Where are the opportunities? One obvious issue is that some institutions have been very challenged to make the conversion to remote service and remote work. The challenge may be technology deficits, but it can also be cultural, especially in adapting to remote work for credit union employees.

While these institutions may have been on the change path, COVID-19 accelerated changes that are happening too fast for these shops. They may have “hit the wall” and couldn’t quickly roll out services like loan appointments via video and digital signatures for loan closings. Or maybe they couldn’t transition their collections department to remote work. For some of these institutions, joining with a partner that successfully made these transitions is a way to provide members the safe and secure service needed in a remote world.

Another opportunity is that some institutions that had pondered the member benefit of joining with a partner, may realize now is the right time. And don’t forget the stress on leaders during these turbulent times. In fact, a recent article in American Banker discussed “management and board exhaustion” due to COVID-19 as a factor likely to lead to some merger activity.

This could also be an ideal time for credit unions to join forces without fully merging via a relationship similar to the holding company structure used by banks for many decades. This structure allows a group of banks to benefit from shared services—especially in such areas as technology, risk management, specialized product offerings, etc.—while preserving their independence and close ties to their particular field of membership.

Lastly, this turbulence will clearly lead to opportunity to purchase bank branches and perhaps whole banks. Many banks have branches in “non-core” markets due to previous mergers. While these may be fine branches in solid markets, they might not be located in the bank’s core markets.

Stephen Morrissette
Booth School of Business, University of Chicago
Winners will find the opportunity in turbulence and use this time to leapfrog competitors.

Indeed, many credit unions thrive in markets not deemed “core” by large banks. Already banks are starting to announce “branch rationalization” programs during the COVID-19 crisis. This could be a generational opportunity for credit unions to enter certain markets without the risks of de novo branching.

Also, with bank stock prices being lower, there will be less competition from banks when whole banks come up for sale. Attorney Michael Bell, who has advised many credit unions on bank acquisitions comments, "Depending on when [the pandemic] ends, I expect all of those things that are paused to heat right up. So, either the end of this year will be really busy or 2021 will be busier than it was going to be."

What can a credit union do to be an “M&A winner” during this turbulence? Be prepared for opportunity. Revisit your strategy so you know what is an opportunity and what is a distraction. Be sure to have board discussions in advance so you have clarity about strategic objectives and priorities—and clear consensus regarding appetite for doing a deal. Is your board only playing defense or are it also willing to talk about a little offense? A CEO wanting to look at deals while the board only wants to play defense can lead to frustrations.

These are difficult and turbulent times. Certainly, the primary focus needs to be the health and safety of our members, our teams and our institutions. But this is also a period of opportunity for those who can see it and capable of capturing it. A few years from now, we will surely see that some institutions seized the opportunity.

Stephen Morrissette teaches mergers and acquisitions at the Booth School of Business, University of Chicago and is the lead faculty for Strategic Growth Institute™. He has worked on strategic planning and M&A with banks and credit unions for 30 years.

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