June 4, 2010

Mergers are currently at the forefront of many board and management conversations. More and more credit unions with low net worth are seeking merger partners, and the motivation for well-capitalized credit unions to take on merger partners continues to wane. This is particularly true considering the field of membership restrictions on credit union mergers: for federal credit unions and many state-chartered credit unions, FOMs in a merger must retain their common bond (or at least the common bond type—multiple, single or community). An exception to this rule is the “emergency merger.”

Section 205(h) of the Federal Credit Union Act gives the National Credit Union Administration  expanded authority to bypass field of membership rules and member voting requirements in approving mergers when the merging credit union is in danger of insolvency. 

For credit unions that are in danger of insolvency, emergency mergers are opportunities to find merger partners outside the normal strictures of federal field of membership rules. For example, a multiple common bond FCU could obtain a community group in an emergency merger. Also, a federal credit union could obtain an otherwise impermissible FOM of a state-chartered credit union. Taking this one step further, emergency mergers that cross state lines allow credit unions to diversify geographically and obtain valuable FOM segments that would otherwise be impermissible.

Emergency mergers provide diversification opportunities for continuing credit unions—and a wider field of potential partners for merging credit unions.

Emergency mergers differ from purchase and assumption situations (discussed in our articles of March 23 and March 26, 2010) in several ways. Emergency mergers are true mergers—they do not allow the credit unions to exclude certain assets or liabilities from the transaction. However, in an emergency merger, the NCUA generally does not require multiple potential partners to be involved—the merging credit union has more control over its destiny, and the continuing credit union does not face the same degree of competition. Thus, for credit unions that meet the criteria for emergency mergers and can locate a merger partner, emergency mergers can prove to be beneficial tools.

While the NCUA has not previously supplied a definition of “in danger of insolvency” to determine who qualifies for an emergency merger, it recently put forward a definition in a proposed rule issued Dec. 17, 2009, as part of proposed amendments to the Chartering and Field of Membership Manual. Under the proposed rule, a credit union would be in danger of insolvency if:

• The credit union’s net worth is declining at a rate that will render it insolvent within 24 months.

• The credit union’s net worth is declining at a rate that will take it under 2 percent net worth within 12 months.
  

• The credit union’s call report net worth is between 2 percent and 4 percent, and NCUA determines that there is no reasonable prospect of the credit union becoming adequately capitalized in the succeeding 36 months.

Credit unions should also interpret these as indicators of when the NCUA will certainly urge a credit union into a merger, or force a credit union to merge through aggressive use of letters of understanding, orders, or conservatorship. Credit unions in these categories should closely examine their operations and balance sheets to determine if a merger is in the best interests of their members, or if shrinking the balance sheet and cutting expenses is plausible while maintaining the credit union’s franchise value.

While danger of insolvency is the threshold for these types of mergers, the NCUA must further find that an emergency requiring expeditious action exists, no other reasonable alternatives are available, and the action is in the public interest. However, these tests are relatively easy to establish, once a credit union is in a position where an emergency merger is being contemplated.

Comments were due on the proposed rule mentioned above on April 15.

Tim Oppelt is an attorney with Styskal, Wiese & Melchione, and devotes his practice to the representation of credit union clients in regulatory and transactional matters. He is also an author of CUES Complete Guide to Mergers.