March 26, 2010

In “Purchase & Assumption Agreements Part I,” I discussed some general principles behind P&As.  This article addresses some issues your credit union might want to take into account if it is considering bidding on a P&A.

Generally the P&A process begins when the NCUA or the troubled credit union contacts potential bidders. When the NCUA makes contact (which is the more likely scenario), it is  usually with a credit union that maintains good relations with its examiners, holds enough capital and assets to absorb the target credit union, and has previously expressed interest in P&A opportunities. The “bidding” process is quite informal, and differs between regions, and even between supervisory examiners. The best advice a bidding credit union can take in terms of process is to discuss things with its own examiners and NCUA contacts—insight from them can be quite valuable.

Apart from seeking preliminary guidance with the NCUA, though, a bidding credit union must consider its own interests and the issues discussed below before bidding.

One of the most important aspects of any transaction, of course, is due diligence. The due diligence process is similar to due diligence in the merger context, but focused on specific assets and with an eye toward liabilities.

However, due to the nature of troubled institutions and the P&A process, due diligence often occurs on a shortened time-line, and bids are often submitted with limited information. Nonetheless, due diligence is important to determine the price your credit union will wish to pay for the P&A opportunity, liabilities you wish to exclude, and any assistance you might require. Otherwise you may find yourself spending your members’ capital on another management team’s underwriting (or other) indiscretions.

Additionally, before bidding you will need to make sure you are clear with your accountants and auditors on the accounting treatment in credit union combinations (both for financial statement and Prompt Corrective Action purposes). Acquisition accounting can create pitfalls or benefits for a continuing credit union. In short, acquisition accounting in mergers and P&As requires a fair valuation of the acquired assets and institution; you can no longer merely add the assets to your balance sheet at book value. This can result in your credit union booking good will and other intangibles that significantly impact your balance sheet after the acquisition.

Beyond due diligence, there are a number of variables to consider in writing your bid, far more than can be discussed in one article! Here are, however, a few major considerations:

• pricing the risk in the assets,
• assessing liabilities,
• valuing core deposit relationships, and
• adding a premium for the obtained FOM.

In particular, you should look at the bid carefully for potential liabilities. You cannot assume that assets or liabilities will be excluded, so it may be best to include only the assets you wish to acquire, and explicitly exclude all unlisted liabilities, both known and unknown. Some undiscovered liabilities that should certainly be excluded are pre-existing employment liability, pre-acquisition consumer law and lending violations, and pre-existing intellectual property claims.

Your bid itself should be as attractive as you can make it within your risk tolerance—your competition will be doing the same. The NCUA has an interest in your taking problems (or as many as possible) off its hands. Thus, despite the risk, if you want the FOM or particular assets, you may need to work to accommodate the NCUA’s interests. The NCUA may not come back to ask for second offers, but bidders that show more flexibility may end up with a chance to make amendments.

There is no guarantee that any bid will be accepted. Indeed, the NCUA has the option of refusing all bids and merely liquidating the credit union. The uncertainty and informality of the P&A market can make bidding a roller-coaster experience. All in all, a well-crafted winning bid can be a windfall for your credit union; however, a loose or ill-informed bid, though “winning,” could end up sinking two credit unions, not just the troubled one.

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.