Credit Union M&A Tip – Do the Math on Comp

Credit Union M&A Tip – Do the Math on Comp  

“Credit unions will face stiffer competition for bank deals in 2024. CUs’ appetites for bank deals won’t wane this year, but potential buyers are expected to face more hurdles,” according to research from S&P Global Market Intelligence, hurdles like “stiffer competition from bank bidders and capital restraints.”

“When I talk to credit unions interested in acquiring a bank, for-profit deferred compensation/ non-qualified plans set up for the bank executives can give credit unions heartburn,” said Tedd Meyer, Director, Newcleus Credit Union Advisors.

Credit unions play by different rules than for-profit banks when it comes to deferred compensation plans. So, when your organization is prospecting an acquisition, taking the time to “do the math” is critical in identifying the pain points and challenges during due diligence rather than at the 11^th hour of the transaction.

“We have been through the acquisition process multiple times with clients on both the credit union and community bank sides of the fence,” said John Moreno, Managing Director, Newcleus Credit Union Advisors. “Banks and credit unions have very different regulations when it comes to deferred compensation.”

When your credit union sees a SERP on a prospective acquisition’s balance sheet, that’s a red flag to unravel all your credit union would be required to live up to upon purchasing the bank. While credit union executives are often familiar with benefit prefunding and bank-owned life insurance, the structure of for-profit deferred compensation is often very different from what is the norm in credit unions.

 

For profit vs nonprofit

Banks are for-profit entities where taxation of a deferred compensation benefit occurs when the executive receives the benefit. For the bank, only when the benefit is paid can the compensation expense be posted as a tax deduction.

Credit unions are nonprofit entities and credit union executives are taxed on the basis of forfeiture of risk. When the compensation plan is no longer subject to a risk of loss due to departure or vesting of the executive, then taxation to the executive occurs on the present value of all future benefits to be paid from the plan. The credit union would be subject to an excise tax if the total compensation for an individual exceeds $1 million.

In-place deferred compensation plans can be adjusted so they are attractive or at least not an M&A deterrent. The options include:

• creating separation between the executive, compensation or retirement asset and the acquiring entity at merger/change of control
• an executive not being retained can be vested at change of control

Such an adjustment should only be made under the guidance of duly qualified counsel as significant penalties could result if such a change is made improperly.

 

When a Credit Union considers buying a Bank

S&P Global Market Intelligence reported that a Federal Reserve memo in late 2023 noted that “larger credit unions were ‘receiving an increase in inquiries from banks seeking to sell, primarily because other banks are unable to make acquisitions in the current environment.’ The memo added that credit unions with ‘ample liquidity and capital hold a distinct advantage, positioned as desirable’ buyers of banks.”

The purchase of a bank by a credit union is a cash transaction where a merger of banks could be accomplished under a pooling of interests approach. Credit unions frequently pay a premium to acquire a bank due to the tax status of the all-cash purchase.

“In a recent transaction, a credit union paid 118% of the bank’s closing share price the date the acquisition was announced, a premium, which helped make up for the taxes that resulted from the all-cash purchase,” Moreno said.

At acquisition by a credit union, if a bank executive has a guaranteed compensation or a retirement benefit payment promised from the bank, the executive is taxed on the present value of any remaining payments in an upfront lump sum which will likely result in the executive being taxed at a higher rate than expected over the long term. Further, a significant tax payment is often required shortly following the acquisition.

 

Are you prepared for change of control?

If your credit union is considering a bank acquisition, it’s important to collect all the data about SERPs, retirement contracts and deferred compensation plans. This is where the expertise of an advisor well versed in both types of entity is invaluable.

Newcleus is in the unique position of maintaining a client base that includes 750 credit unions and community banks. If your credit union is considering acquiring a bank there’s a one in five chance that the bank you are evaluating is already a Newcleus client.

The benefits an experienced advisor can provide include:

1. deep knowledge and significant depth of understanding on both sides of the transaction
2. familiarity with deferred compensation plans for both banks and credit unions and perspective on existing plans and how they can or can’t transfer
3. knowing the math and where the deferred comp plans and payout structure don’t fit the acquiring credit union’s regulatory model
4. providing recommendations for plan amendments to ease the transition from bank to credit union
5. helping the acquiring credit union understand how the bank has structured its deferred comp and BOLI
6. understanding how compensation regulations will affect the acquisition’s complexity

Moreno has found that community banks and credit unions have a lot in common – together they hold about 40% of the deposits in the US – when competing for retail and commercial business.

The Credit Union Times reports that, “There are several trends keeping some financial institutions in the exploratory stage for now. However, conversations are happening across the industry even if immediate action isn’t always taken.” The report goes on to say, “Uncertainty in the economic and regulatory environment, more competition from non-financial services providers, as well as the increasing complexity of transactions are causing some Boards and executives to proceed with caution.”

As the banking industry evolves, both credit unions and community banks are continually exploring ways to best deliver banking services to their customers and members. As acquisitions continue, using the right guidance and analysis, attractive deferred compensation plans and retirement packages can be structured to retain talented executives and bridge both the bank and credit union regulatory structure.