Profits Over Growth

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The last few weeks have been a whirlwind for banking. As bank stock indices plummet and investors make bets about which bank will fail, I’m headed to one of Bank Director’s most important conferences. 

But the agenda isn’t packed with discussion about investor and depositor panic. Experience FinXTech on May 9-10 in Tampa, Florida, is for bankers and technology company leaders who want to make connections and learn from each other. Still, the news headlines will be on people’s minds. I’m thinking about how the new environment is going to impact banks and technology companies. Two years ago, a consultant to tech companies said to me, “The last five years have found that you don’t have to be profitable to be a company.” 

Tech founders focused on growth, not profitability; and once they had market share, they went public or sold to a bigger company, taking their billions in equity to retire at 30 on an island in the Caribbean.

The times are changing.

Some banks may pull back on planned tech implementations. I think some fintechs will be forced to sell.  Venture capital deals fell 60% in value in the fourth quarter of 2022 compared to a year prior, according to the news site PitchBook. Banks are choosing a vendor or partner while also considering the company’s financial stability. Banks don’t want their partners and vendors to disappear or be gobbled up by larger companies that disinvest in the platform.

But the current environment is not all bad for partnerships, either. In a contrast from two years ago, fintech founders tell me they’re concentrating on profitability these days and not just growth. The good news is that fintechs in general have gotten leaner, more focused and driven to create successful partnerships. 

Bankers still need to act like private detectives and investigate those fintechs. Bank Director Managing Editor Kiah Lau Haslett explores due diligence in Bank Director’s recently released FinXTech report, “Finding Fintechs.” But I’m convinced a group of fintechs focused on bank success — rather than growth for its own sake — can only be good for banks.

Community Banks Fuel the Future of Renewable Energy

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The transformational Inflation Reduction Act (IRA) contains a number of provisions designed to entice a large numbers of community and regional banks to deploy capital into renewable energy projects across the US.

Large U.S. banks and corporations have made significant renewable energy tax credit investments for over a decade. Through the IRA, there is greater opportunity for community and regional banks to participate.

The act extends solar tax credits, or more broadly renewable energy investment tax credits, (REITCs) for at least 10 more years, until greenhouse gas emissions are reduced by 70%. It also retroactively increases the investment tax credit (ITC) rate from 26% to 30%, effective Jan. 1, 2022. This extension and expansion of ITCs, along with other meaningful incentives included in the act, should result in a significant increase in renewable energy projects that are developed and constructed over the next decade.

Community banks are a logical source of project loans and renewable energy tax credit investments, such as solar tax equity, in response to this expected flood of mid-size renewable projects. REITCs have a better return profile than other types of tax credit investments commonly made by banks. REITCs and the accelerated depreciation associated with a solar power project are fully recognized after it is built and begins producing power. This is notably different from other tax credit investments, such as new markets tax credits, low-income housing tax credits and historic rehabilitation tax credits, where credits are recognized over the holding period of the investment and can take 5, 7, 10 or 15 years.

Like other tax equity investments, renewable energy tax equity investments require complex deal structures, specialized project diligence and underwriting and active ongoing monitoring. Specialty investment management firms can provide support to community banks seeking to make renewable energy or solar tax credit investments by syndicating the investments across small groups of community banks. Without support, community banks may struggle to consistently identify suitable solar project investment opportunities built by qualified solar development partners.

Not all solar projects are created equally; and it is critical for a community bank to properly evaluate all aspects of a solar tax equity investment. Investment in particular types of solar projects, including utility, commercial and industrial, municipal and community solar projects, can provide stable and predictable returns. However, a community bank investor should perform considerable due diligence or partner with a firm to assist with the diligence. There are typically three stages of diligence:

  1. The bank should review the return profile and GAAP financial statement impact with their tax and audit firm to validate the benefits demonstrated by the solar developer and the anticipated impact of the investment on the bank’s earnings profile and capital.
  2. The bank should work with counsel to identify the path to approval for the investment. Solar tax equity investments are permissible for national banks under a 2021 OCC Rule (12 CFR 7.1025), and banks have been making solar tax equity investments based on OCC-published guidance for over a decade. In 2021, the new rule codified that guidance, providing a straightforward roadmap and encouraging community banks to consider solar tax equity investments. Alternatively, under Section 4(c)(6) of the Bank Holding Company Act, holding companies under $10 billion in assets may also invest in a properly structured solar tax equity fund managed by a professional asset manager.
  3. The bank must underwrite the solar developer and each individual solar project. Community banks should consider partnering with a firm that has experience evaluating and underwriting solar projects, and the bank’s due diligence should ensure that there are structural mitigants in place to fully address the unique risks associated with solar tax equity financings.

Solar tax credit investments can also be a key component to a bank’s broader environmental, social and governance, or ESG, strategy. The bank can monitor and report the amount of renewable energy generation produced by projects it has financed and include this information in an annual renewable energy finance impact report or a broader annual sustainability report.

The benefits of REITCs are hard to ignore. Achieving energy independence and reducing carbon emissions are critical goals in and of themselves. And tax credit investors that are funding renewable energy projects can significantly offset their federal tax liability and recognize a meaningful annual earnings benefit.

How Fifth Third Crafts Successful Bank-Fintech Partnerships

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From the start, Eric White anticipated the solar lender he launched in 2013 would eventually be owned by a bank. But it wasn’t until last fall that he settled on the $207 billion Fifth Third Bancorp in Cincinnati, Ohio.

The bank announced on Jan. 19 that it would acquire Dividend Finance for an undisclosed amount and closed the deal in May, with White, its founder and CEO, continuing to run the business.

White recalled two moments that made him feel certain his company had found its ideal buyer — the first was last fall when a group of Fifth Third’s top executives visited the fintech’s San Francisco’s headquarters for an initial meeting and the second was not much later when he met Ben Hoffman, Fifth Third’s chief strategy officer.

“It starts with people,” White says. “You have to like the people who are on the other side of the table from you before you get on the same side of the table as them.”

Hoffman echoed that, saying Fifth Third has come up with a couple of heuristics that help it determine whether it wants to pursue a partnership with a particular fintech. One is the way it assesses the entrepreneurs at the helm.

“We look at the leadership team and we ask, ‘Are these people that we could see filling other roles in the bank? Not because we intend to take them off mission — quite the opposite. When we bring these leaders in, it’s about empowering them to continue doing the thing that they’re incredibly passionate about and great at,” Hoffman says.

Not all bank-fintech partnerships turn into acquisitions, nor does Hoffman intend them to. And not all acquisitions start out as partnerships. Fifth Third and Dividend Finance had not worked together prior to striking their deal.

But Fifth Third’s introspective question serves as “a real test for cultural fit,” Hoffman says. “If there isn’t another real job on the org chart that you think these individuals could do, how can you expect them to understand us, and how can you expect us to really understand them, and to appreciate each other?” 

Ensuring a Cultural Fit
In anticipation of rising interest rates, White began seeking prospective bank buyers for Dividend Finance late last year. His prerequisite was that the banks had to be experienced with indirect lending, as his company is a point-of-sale lender that partners with contractors nationwide to provide their customers with financing for solar and other home improvement projects.

White says Fifth Third’s long partnership with GreenSky – a point-of-sale lender that offers home improvement loans through merchants – gave him comfort. Fifth Third invested in and began collaborating with GreenSky starting in 2016. (Goldman Sachs acquired the fintech in March.)

“Indirect lending is a very different model than direct lending. Some banks just don’t get it, and Fifth Third did,” White says.

But it was in that first meeting with Fifth Third, as then-President Tim Spence talked about how he had previously worked at technology startups and as a strategy consultant, when White first felt a sense that this bank stood out from the other contenders. Spence had been lured away from Oliver Wyman, where he focused on helping banks — Fifth Third among them — with their digital roadmaps. (He succeeded Greg Carmichael as Fifth Third’s chief executive officer in July.)

“Hearing Tim introduce himself and give his background was an eyeopener in and itself. He doesn’t come from a traditional bank executive background,” White says. “So, it was a different and a very refreshing perspective. It was very exciting for us.”

Hoffman made just as strong an impression on White when they met later on, further reassuring him that Dividend Finance had found “a perfect cultural fit” in terms of management philosophy and the long-term goals of both sides.

Hoffman previously worked with Spence as part of the Oliver Wyman team that advised Fifth Third and other banks; he followed Spence to the bank side in 2016. Hoffman’s mandate has evolved over the years, but one facet of his duties is overseeing Fifth Third’s fintech activities. White gives Hoffman rave reviews, calling him “one of the most creative thinkers that I’ve come across in my entire career.”

With the people test passed, the most salient selling point for White was “how the bank thinks about technology and product.”

In his perspective, too many banks are stuck in “archaic approaches” to managing growth and innovation. But Spence’s answer when asked why he decided to work at a bank in Cincinnati “really stuck with me,” White says. “He viewed Fifth Third as a platform to combine the best elements of traditional banking along with the opportunity to infuse innovation and a technology-driven approach to product development and organizational management.”

It gave White confidence that Fifth Third would not make the mistake that he believes other banks sometimes do, which is “trying to make the fintechs conform to the way that the bank has operated historically and in doing so, stripping out the qualities that make that fintech successful.”

White says his confidence has only grown since the acquisition. At Fifth Third, his title is Dividend Finance president, and he operates the business with a comfortable level of autonomy, reporting to Howard Hammond, executive vice president and head of consumer banking.

Ensuring a Strategic Fit
Fifth Third has partnerships with about a dozen fintechs at any given time and, over the past year and a half, has acquired two niche digital lenders outright, Dividend Finance, in the ESG space, and Provide, in the healthcare space. (ESG stands for Environmental, Social and Governance, and is often used to refer to the components of a sustainability-minded business approach.)

ESG and healthcare are two categories that align with Fifth Third’s own areas of focus, in accordance with a rule Hoffman follows when choosing fintechs of interest, whether for partnerships or acquisitions. He considers this rule — the fintech must help the bank improve on its existing strategy — key to helping ensure a partnership will eventually produce enough of a return to make Fifth Third’s investment of time, effort and money worthwhile.

As a result of the Dividend Finance acquisition, Fifth Third is actively assessing whether to increase its sustainable finance target. The bank had set a goal two years ago that called for achieving $8 billion of lending for alternative energy like solar, wind and geothermal by 2025.

“The things that we do with fintech are things that we were going to do one way or another. We’re not taking on incremental missions. We’re just pursuing those missions in different form. So, that framing completely changes the analysis that we’re doing,” Hoffman says.

Other banks might have to look broadly at competing priorities to decide between partnering with a specific fintech or tackling some other important initiative. But Fifth Third engages in a different thought process.

“It’s not, if we decide to partner with Provide, or should we acquire Dividend Finance, what will we not do?” Hoffman says.

Instead, Fifth Third asks, does this accelerate the timeframe for achieving a goal the bank has already set for itself?

“These partnerships are successful when they are aligned to our strategy and they accelerate, or de-risk, the execution of that strategy, as opposed to being separate and apart from the core ambitions of the franchise,” Hoffman says.

Assessing the Priority Level of Partnering — for Both Sides
Beyond that, any proposed partnership also needs to be “a top five priority” for both the fintech’s leadership and the relevant Fifth Third business line.

Hoffman advises other banks against the common approach of setting up a “tiny” partnership for the two sides to get to know each other with the idea of taking things to the next level when the time is right. “The likelihood of the timing ever being right, is very, very low,” he says. Those relationships often end up as distracting “hobbies” rather than ever escalating to the priority level necessary to add value for both sides and pay off in a meaningful way.

His insight is informed by experience. Hoffman leads Fifth Third’s corporate venture capital arm, which makes direct minority investments in fintechs. Given recent regulatory changes, it also participates as limited partners in several fintech-oriented venture capital funds.

His team is responsible for nurturing Fifth Third’s fintech partnerships, offering strategic insight and facilitating access to resources within the bank.

“As you can imagine, with some of the early-stage companies that we invest in, it’s six partners and an idea. Meanwhile, we have 20,000 people and branches and a half-dozen regulators and all of that. So, we provide a single point of contact to help sort of incubate and nurture the partnership until it reaches a level of stability and becomes a larger business,” Hoffman says.

“We work hard, as the partnerships mature, to stabilize the operating model such that the handholding, the single point of contact, becomes less necessary.”

That transition typically happens as the fintech gets better integrated into the day-to-day operations of the core business with which it is partnering, whether consumer banking, wealth management or another area in the bank.

Delivering Above and Beyond
With Provide, a digital lending financial platform for healthcare practices, the bank was an early investor, taking a lead role in a $12 million funding round with the venture capital firm QED Investors in 2018.

Fifth Third began funding loans made on the platform about two years later, with the amount increasing over time to the point where it was taking about half of Provide’s overall loan volume, the largest share among the five participating banks.

Through the Fifth Third partnership, Provide also expanded its offerings to include core banking and payments services, which are now used by more than 70% of the doctors for whom the fintech provides acquisition financing nationwide.

In announcing the agreement to buy Provide in June 2021, Fifth Third says the fintech would maintain its brand identity and operate as an independent business line.

Daniel Titcomb oversees Provide as its president and reports to Kala Gibson, executive vice president and chief corporate responsibility officer. (Gibson had oversight of business banking when Titcomb came on board and, though he’s in a new role as of March, continues to work with Provide.) Under Fifth Third’s ownership, Titcomb, who co-founded the fintech with James Bachmeier III in 2013, envisions being able to fuel loan growth and offer expanded services that help make starting and running a healthcare practice easier for doctors.

Since its launch, Provide has originated more than $1 billion in loans, largely through “practice lending,” which enables healthcare providers to start, buy or expand their practices. Its average loan size is $750,000.

Titcomb cited “a shared belief” in bank-fintech partnerships as one reason the early relationship with Fifth Third proved to be a success. “We both had a view of the future that didn’t include one destroying the other,” he says.

Years ago, fintechs and banks were often wary of each other — even adversarial — with banks being labeled by some as “dumb pipes,” the implication being that they were unable to keep up with nimble and innovative startups and were useful merely for product distribution to a larger customer base, Titcomb says. But he always found Fifth Third to be thoughtful and strategic, defying those stereotypes.

Though selling his business was scary, he says, “it was a lot less scary than it could’ve been,” given the established relationship.

Still, “we had to get comfortable and confident that they weren’t going to encourage us to spend less on technology,” he added. “Any time you enter into an agreement like that, you hope, but you don’t know.”

Titcomb says he is thrilled that the consistent feedback from Fifth Third since he joined has been: “You run this business the way you think it should be run.”

“It’s a relief,” he says.

Given outcomes like those experienced by White and Titcomb, Fifth Third has become known in fintech circles as a strong partner that delivers on its promises. Hoffman works hard to maintain that reputation—a competitive advantage.

“These companies have options, and some of those options are very compelling,” Hoffman says, adding that his goal is to make sure Fifth Third is “the partner of choice” for the fintechs it targets. That only happens, he says, if their experience after signing a deal aligns with what he says beforehand.

Count an enthusiastic Titcomb among those who attest that it has. “They have delivered above and beyond,” Titcomb says.

Trends in Corporate Leadership

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In this episode of Looking Ahead, David Ingles and Stephen Amdur, partners at Pillsbury Winthrop Shaw Pittman, focus on the rapidly evolving financial industry. Some of this technological shift, they explain, has been propelled by declining development costs and greater access to capital —and they point out where private equity investors are seeing opportunities. They also explore how large regional and national banks have shifted their M&A strategies to acquiring technology platforms.

The Emerging Impacts of Covid Stimulus on Bank Balance Sheets

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In the middle of 2020, while some consumers were stockpiling essentials like water and hand sanitizer, many businesses were shoring up their cash reserves. Companies across the country were scrambling to build their war chests by cutting back on expenses, drawing from lines of credit and tapping into the Small Business Administration’s massive new Paycheck Protection Program credit facility.

The prevailing wisdom at the time was that the Covid-19 pandemic was going to be a long and painful journey, and that businesses would need cash in order to remain solvent and survive. Though this was true for some firms, 2020 was a year of record growth and profitability for many others. Further, as the SBA began forgiving PPP loans in 2021, many companies experienced a financial windfall. The result for community banks, though, has been a surplus of deposits on their balance sheets that bankers are struggling to deploy.

This issue is exacerbated by a decrease in loan demand. Prior to the pandemic, community banks could generally count on loan growth keeping up with deposit growth; for many banks, deposits were historically the primary bottleneck to their loan production. At the start of 2020, deposit growth began to rapidly outpace loans. By the second quarter of 2021, loan levels were nearly stagnant compared to the same quarter last year.

Another way to think about this dynamic is through the lens of loan-to-deposit (LTD) ratios. The sector historically maintained LTDs in the mid-1980s, but has recently seen a highly unusual dip under 75%.

While these LTDs are reassuring for regulators from a safety and soundness perspective, underpinning the increased liquidity at banks, they also present a challenge. If bankers can’t deploy these deposits into interest-generating loans, what other options exist to offset their cost of funds?

The unfortunate reality for banks is that most of these new deposits came in the form of demand accounts, which require such a high degree of liquidity that they can’t be invested for any meaningful level of yield. And, if these asset and liability challenges weren’t enough, this surge in demand deposits effectively replaced a stalled demand for more desirable timed deposits.

Banks have approached these challenges from both sides of the balance sheet. On the asset side, it is not surprising that banks have been stuck parking an increasing portion of the sector’s investment assets in low-yield interest-bearing bank accounts.

On the liabilities side, community banks that are flush with cash have prudently trimmed their more expensive sources of funds, including reducing Federal Home Loan Banks short-term borrowings by 53%. This also may be partially attributable to the unusual housing market of high prices and low volumes that stemmed from the pandemic.

As the pandemic subsides and SBA origination fees become a thing of the past, shareholders will be looking for interest income to rebound, while regulators keep a close eye on risk profiles at an institutional level. Though it’s too soon to know how this will all shake out, it’s encouraging to remember that we’re largely looking at a profile of conservative community banks. For every Treasury department at a mega bank that is aggressively chasing yield, there are hundreds of community bank CEOs that are strategically addressing these challenges with their boards as rational and responsible fiduciaries.

Visit https://www.otcmarkets.com/market-data/qaravan-bank-data to learn more about how Qaravan can help banks understand their balance sheets relative to peers and benchmarks.

What 2022 Could Hold for Bank M&A

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Pent-up deal demand will define 2022, continuing this year’s momentum as pandemic-related credit concerns recede. Stinson LLP Partner Adam Maier believes banks can expect to see a high volume of deals in the space but anticipate approval slowdowns from regulatory scrutiny. He also shares his top advice for directors as their banks prepare for growth next year. Topics include:

  • Deal Demand
  • Regulatory Considerations
  • Advice for Growth

PayPal Is Not a Bank. Or Is It?

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Last Tuesday, payment company PayPal Holdings’ market capitalization of $277 billion was higher than the entire KBW regional bank index of $213.5 billion. This has been true for months now.

Tom Michaud, CEO of Keefe, Bruyette & Woods, noted PayPal’s valuation in a February presentation for Bank Director. “They can really afford to invest in ways a typical community bank can’t,” he said at the time.

PayPal’s market value is richer than several large banks, including PNC Financial Services Group, Citigroup and Truist Financial Corp.

But how can that be? When you compare the earnings reports of PayPal to the banks, you can see the companies’ focuses are entirely different. PayPal promotes its growth: growth in payment volume, growth in accounts and growth in revenue. Truist and PNC are more inclined to highlight their profitability, which is typical of well established, legacy financial companies.

Source: Paypal

Source: PayPal. Total payment volume is the value of payments, net of payment reversals, successfully completed on PayPal’s platform or enabled by PayPal on a partner platform, not including gateway exclusive transactions.

PNC reported net income of $7.5 billion, an increase of 40% from the year before, on total revenue of $13.7 billion in 2020. PayPal reported earnings of $4.2 billion in 2020, nearly double what the company had earned the year prior.

PayPal was trading at about 67 times earnings last Wednesday, while Truist was trading at about 19 and PNC at 28, according to the research firm Morningstar.

Of course, it’s silly to compare PayPal to banks. PayPal isn’t a bank, nor does it want to be, says Wedbush Securities managing director and equity analyst Moshe Katri. “It’s better than a bank,” he says. “What you’re getting from PayPal is a host of products and services that are more economical.”

Katri says PayPal, which owns the person-to-person payments platform Venmo, offers transaction fees that are lower than competitors. For example, PayPal advertises fees to merchants for online transactions for a flat 2.9% plus 30 cents. Card associations such as Visa and Mastercard offer a variety of pricing options for credit and debit cards.

Katri says PayPal’s valuation is related to its platform and its earnings power. PayPal has roughly 350 million consumers and about 29 million merchants using its platform, with potential to grow. Not only could PayPal expand its customer base, but it could also grow its transactions and fees per customer.

“It allows you to do multiple things: shop online, transfer funds, transfer funds globally, bill pay,” Katri says. “They offer other products and services that look and feel like you’re dealing with a bank.”

PayPal also offers small business loans, often for as little $5,000. It uses transaction data to underwrite loans to merchants that may appear unattractive to many banks.

But PayPal is more often compared to competitors Mastercard and Visa than to banks. Both Mastercard and Visa saw a decline in payment volume during the pandemic after losing some in-person merchant business, according to the publication Barron’s. In contrast, PayPal did especially well during 2020, when the pandemic forced more purchases to move online.

PayPal’s size and strength have helped it invest, including recent initiatives like an option to pay via cryptocurrency, a touchless QR-code payment option and a “buy now, pay later” interest-free loan for consumers.

PayPal CEO Dan Schulman said on a fourth-quarter earnings call that the company plans to enhance bill pay options this year and launch budgeting and savings tools. “We all know the current financial system is antiquated,” he said.

But the juggernaut that is PayPal may not ride so high a few years from now. Shortly after a February investor presentation where the company projected a compound annual growth rate of 20% in revenue, reaching $50 billion by 2025, the stock price skyrocketed to $305 per share.

It has come down considerably since then, along with many high-flying technology companies. PayPal’s stock sunk 20% to $242.8 per share at market close last Wednesday, according to Morningstar. Katri has a buy rating on the stock, assuming a price of $330 per share.

Morningstar analyst Brett Horn thinks PayPal’s long term prospects are less certain, even though few payments companies are as well positioned as PayPal right now. Competitors are active in mergers and acquisitions, getting stronger to go up against PayPal’s business model. Apple Pay remains a formidable threat.

On the merchant processing side, Stripe and Square are among the players growing considerably, too. What’s clear is that giant payments platforms may continue to erode interchange fees and other income streams for banks.

“The digital first world is no longer our future,” Schulman said in February. “It is our current reality and it will forever change how we interact in almost all elements of our lives.”

How Credit Unions Pursue Growth

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The nationwide pandemic and persistent economic uncertainty hasn’t slowed the growth of Idaho Central Credit Union.

The credit union is located in Chubbuck, Idaho, a town of 15,600 near the southeast corner, and is one of the fastest growing in the nation. It has nearly tripled in size over the last five years, mostly from organic growth, according to an analysis by CEO Advisory Group of the 50 fastest growing credit unions. It also has some of the highest earnings among credit unions — with a return on average assets of 1.6% last year — an enviable figure, even among banks.

“This is an example of a credit union that is large enough, [say] $6 billion in assets, that they can be dominant in their state and in a lot of small- and medium-sized markets,” says Glenn Christensen, president of CEO Advisory Group, which advises credit unions.

Unsurprisingly, growth and earnings often go hand in hand. Many of the nation’s fastest growing credit unions are also high earners. Size and strength matter in the world of credit unions, as larger credit unions are able to afford the technology that attract and keep members, just like banks need technology to keep customers. These institutions also are able to offer competitive rates and convenience over smaller or less-efficient institutions.

“Economies of scale are real in our industry, and required for credit unions to continue to compete,” says Christensen.

The largest credit unions, indeed, have been taking an ever-larger share of the industry. Deposits at the top 20 credit unions increased 9.5% over the last five years; institutions with below $1 billion in assets grew deposits at 2.4% on average,” says Peter Duffy, managing director at Piper Sandler & Co. who focuses on credit unions.

As of the end of 2019, only 6% of credit unions had more than $1 billion in assets, or 332 out of about 5,200. That 6% represented 70% of the industry’s total deposit shares, Duffy says. Members gravitate to these institutions because they offer what members want: digital banking, convenience and better rates on deposits and loans.

“The only ones that can consistently deliver the best rates, as well as the best technology suites, are the ones with scale,” Duffy says.

Duffy doesn’t think there’s a fixed optimal size for all credit unions. It depends on the market: A credit union in Los Angeles might need $5 billion in assets to compete effectively, while one in Nashville, Tennessee, might need $2 billion.

There are a lot of obstacles to building size and scale in the credit union industry, however. Large mergers in the space are relatively rare compared to banks — and they became even rarer during the coronavirus pandemic. Part of it is a lack of urgency around growth.

“For credit unions, since they don’t have shareholders, they aren’t looking to provide liquidity for shareholders or to get a good price,” says Christensen.

Prospective merger partners face a host of sensitive, difficult questions: Who will be in charge? Which board members will remain? What happens to the staff? What are the goals of the combined organization? What kind of change-in-control agreements are there for executives who lose their jobs?

These social issues can make deals fall apart. Perhaps the sheer difficulty of navigating credit union mergers is one contributor to the nascent trend of credit unions buying banks. A full $6.2 billion of the $27.7 billion in merged credit union assets in the last five years came from banks, Christensen says.

Institutions such as Lakeland, Florida-based MIDFLORIDA Credit Union are buying banks. In 2019, MIDFLORIDA purchased Ocala, Florida-based Community Bank & Trust of Florida, with $743 million in assets, and the Florida assets of $675 million First American Bank. The Fort Dodge, Iowa-based bank was later acquired by GreenState Credit Union in early 2020.

The $5 billion asset MIDFLORIDA was interested in an acquisition to gain more branches, as well as Community Bank & Trust’s treasury management department, which provides financial services to commercial customers.

MIDFLORIDA President Steve Moseley says it’s probably easier to buy a healthy bank than a healthy credit union. “The old saying is, ‘Everything is for sale [for the right price],’” he says. “Credit unions are not for sale.”

Still, despite the difficulties of completing mergers, the most-significant trend shaping the credit union landscape is that the nation’s numerous small institutions are going away. About 3% of credit unions disappear every year, mostly as a result of a merger, says Christensen. He projects that the current level of 5,271 credit unions with an average asset size of $335.6 million will drop to 3,903 credit unions by 2030 — with an average asset size of $1.1 billion.

CEO Advisory Credit Union Industry Consolidation Forecast

The pandemic’s economic uncertainty dropped deal-making activity down to 65 in the first half of 2020, compared to 72 during the same period in 2019 and 90 in the first half of 2018, according to S&P Global Market Intelligence. Still, Christensen and Duffy expect that figure to pick up as credit unions become more comfortable figuring out potential partners’ credit risks.

In the last five years, the fastest growing credit unions that have more than $500 million in assets have been acquirers. Based on deposits, Vibe Credit Union in Novi, Michigan, ranked the fastest growing acquirer above $500 million in assets between 2015 and 2020, according to the analysis by CEO Advisory Group. The $1 billion institution merged with Oakland County Credit Union in 2019.

Gurnee, Illinois-based Consumers Cooperative Credit Union ranked second. The $2.6 billion Consumers has done four mergers in that time, including the 2019 marriage to Andigo Credit Union in Schaumberg, Illinois. Still, much of its growth has been organic.

Canyon State Credit Union in Phoenix, which subsequently changed its name to Copper State Credit Union, and Community First Credit Union in Santa Rosa, California, were the third and fourth fastest growing acquirers in the last five years. Copper State, which has $520 million in assets, recorded a deposit growth rate of 225%. Community First , with $622 million in assets, notched 206%. The average deposit growth rate for all credit unions above $500 million in assets was 57.9%.

CEO Advisory Group Top 50 Fastest Growing Credit Unions

“A number of organizations look to build membership to build scale, so they can continue to invest,” says Rick Childs, a partner in the public accounting and consulting firm Crowe LLP.

Idaho Central is trying to do that mostly organically, becoming the sixth-fastest growing credit union above $500 million in assets. Instead of losing business during a pandemic, loans are growing — particularly mortgages and refinances — as well as auto loans.

“It’s almost counterintuitive,” says Mark Willden, the chief information officer. “Are we apprehensive? Of course we are.”

He points out that unemployment remained relatively low in Idaho, at 6.1% in September, compared to 7.9% nationally. The credit union also participated in the Small Business Administration’s Paycheck Protection Program, lending out about $200 million, which helped grow loans.

Idaho Central is also investing in technology to improve customer service. It launched a new digital account opening platform in January 2020, which allows for automated approvals and offers a way for new members to fund their accounts right away. The credit union also purchased the platform from Temenos and customized the software using an in-house team of developers, software architects and user experience designers. It purchased Salesforce.com customer relationship management software, which gives employees a full view of each member they are serving, reducing wait times and providing better service.

But like Idaho Central, many of the fastest growing institutions aren’t growing through mergers, but organically. And boy, are they growing.

Latino Community Credit Union in Durham, North Carolina, grew assets 178% over the last five years by catering to Spanish-language and immigrant communities. It funds much of that growth with grants and subordinated debt, says Christensen.

Currently, only designated low-income credit unions such as the $536.5 million asset Latino Community can raise secondary capital, such as subordinated debt. But the National Credit Union Administration finalized a rule that goes into effect January 1, 2022, permiting non-low income credit unions to issue subordinated debt to comply with another set of rules. NCUA’s impending risk-based capital requirement would require credit unions to hold total capital equal to 10% of their risk-weighted assets, according to Richard Garabedian, an attorney at Hunton Andrews Kurth. He expects that the proposed rule likely will go into effect in 2021.

Unlike banks, credit unions can’t issue stock to investors. Many institutions use earnings to fuel their growth, and the two measures are closely linked. Easing the restrictions will give them a way to raise secondary capital.

A separate analysis by Piper Sandler’s Duffy of the top 263 credit unions based on share growth, membership growth and return on average assets found that the average top performer grew members by 54% in the last six years, while all other credit unions had an average growth rate of less than 1%.

Many of the fastest growing credit unions also happen to be among the top 25 highest earners, according to a list compiled by Piper Sandler. Among them: Burton, Michigan-based ELGA Credit Union, MIDFLORIDA Credit Union, Vibe and Idaho Central. All of them had a return on average assets of more than 1.5%. That’s no accident.

Top 25 High Performing Credit Unions

Credit unions above $1 billion in assets have a median return on average assets of 0.94%, compared to 0.49% for those below $1 billion in assets. Of the top 25 credit unions with the highest return on average assets in 2019, only a handful were below $1 billion in assets, according to Duffy.

Duffy frequently talks about the divide between credit unions that have forward momentum on growth and earnings and those who do not. Those who do not are “not going to be able, and have not been able, to keep up.”

Adding Value With Merchant Services

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Leading with merchant services can help a bank acquire new customers, according to a recent Accenture study commissioned by Fiserv. On average, these accounts are more profitable: Compared to other business accounts, merchant account holders generate 2.6 times more revenue. In this video, Michael Rogers of Fiserv explains how these accounts help banks grow and offers considerations for how bank leaders can enrich this valuable product.

  • Leading With Payments
  • Building Relationships
  • Strengthening Your Offering

To access Fiserv’s study, “From Revenue to Retention: Growing Your Deposits With Merchant Services,” click HERE.

Finding Opportunities in 2021

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Will deal volume pick up pace in 2021? Despite credit concerns and negotiation hurdles, Stinson LLP Partner Adam Maier predicts a stronger appetite for deals — but adds that potential acquirers will have to be aggressive in pursuing targets that align with their strategic goals.

  • Predictions for 2021
  • Capital Considerations
  • Regulatory Hurdles to Growth