Consolidation among American Credit Unions: Taming the Urge to Merge

Historical Perspective

Cooperative credit took many years to take hold in the United States. The inspiration came from the Raiffeisen or Schulze-Delitzsch cooperative banks of Germany. And although Raiffeisen style agricultural financial cooperatives were tried in the United States around the turn of the twentieth century, they didn’t catch on. Even with the personal involvement of the very successful Alphonse Desjardin from Canada, these not-as-foreign cooperative banks also could not seem to catch on in the United States.

Finally in 1921, after experimenting with credit unions in Massachusetts, Edward Filene hired Roy Bergengren to work full-time to promote cooperative lending in the United States. Filene created an organization that would support the development of legislation and organization of credit cooperatives throughout the country; it was called the Credit Union National Extension Bureau. By then, cooperative lending institutions had developed a stable name, the credit union – a literal translation of Raiffeisen’s term for his cooperative lending institution. They had also developed a focus, consumer savings and lending.

From 1921 to 1934 the Credit Union National Extension Bureau successfully supported and/or sponsored enabling legislation in 39 states and the District of Columbia. In 1934, congress passed federal legislation that authorized the organization of federally chartered credit unions throughout the United States. In 1937, Credit Union National Extension Bureau was retired, and replaced by a national credit union organization run by credit union members themselves, Credit Union National Association (CUNA). Its first executive was Roy Bergengren, with Filene serving as a permanent member of its board. At the establishment of CUNA, the United States had around 5,800 credit unions. Bergengren saw this as merely the tip of the iceberg. Looking back to Germany where credit cooperatives originated, and assuming that these institutions would always remain rather small and responsive to their members, he saw the need in 1937 for more than 100,000 credit unions in the United States[i].

Bergengren would probably be pleasantly surprise at the market share held by credit unions today, but may have problems with the number of institutions it takes to hold that market share. The graph below shows the number of credit unions who were members of CUNA from 1945 through 2009. The post-war years saw the number of credit unions grow rapidly, topping out in 1969, with 23,866 credit unions.

Economies of Scale

Since the 1960s financial institutions have been encouraged to become more competitive. In the 1960s and 1970s all financial institutions began to be more conscious of efficiencies. Whenever possible, mergers were encouraged to make institutions more viable. At the end of the 1970s, the United States saw high inflation, and a banking failure – taking down a large portion of the savings and loan industry. Many of the weaker capitalized institutions were again encouraged to merge. And with a wave of re-regulation in the 1980s and 1990s, consolidation took hold in both the banking and credit union industries. As a result, by the end of 2009, there were fewer credit unions than there had been since the late 1930s.

In recent years mounting evidence has suggested that credit unions are competing against banks, and that there are some economies of scale. James Wilcox estimates that these scale economies do not begin until the institution has at least $100 million in total assets. In the past two decades, the average credit union size has grown from $19.6 million in 1990 (in constant 2009 dollars) to $92.6 million in 2009.

These trends can be seen in the average assets per credit union. First note that all of these figures are per institution, and adjusted for inflation. Over much of the history of credit unions in the United States, the average assets per credit union has remained fairly constant – until recently. In recent years, the pressure to become more competitive and more efficient has pushed credit unions to consolidate. In recent years, the average credit union has assets of around $90 million dollars – short of the $100 million needed to achieve economies of scale. No wonder Federal Reserve researchers David C. Wheelock and Paul W. Wilson think that credit unions are probably too small.

In the case of credit unions (and banks too for that matter), the average is far higher than most institutions. The graph below shows the trends in total assets, share & deposits, and loans & leases for the median institution over time. First note that the median institution is far below the average. But even then, the trend is upward sloping (after adjusting for inflation). Over a sixteen year period, the median sized credit union has more than doubled, but remains far below the $100 million necessary to reach competitive efficiency.

To characterize a more typical credit union from the members’ standpoint, we consider the median asset dollar. If all credit unions were sorted according to size, then the asset dollar that is right in the middle of all assets could be called the median asset dollar. For members, roughly half of all asset dollars are in institutions larger than this institution, and half are in smaller institutions. When we graph these “median asset dollar” institutions, the size is rather impressive. Again these figures are adjusted for inflation. Note how all of these institutions are large enough to experience economies of scale. Also note the rapid growth on this end of the institution. About than 83% of all credit union assets were held by the larges 15% of credit unions. Ten percent of all credit union assets were held by the five largest credit unions at the end of third quarter 2010. If the current trend continues, the median asset dollar will be held in a credit union with more than $1 billion in assets in just two years.

Mergers among Credit Unions

Unlike banks, credit unions cannot raise equity through the equity markets. Instead they have to retain undistributed profit, and use it as capital to fuel their growth. Credit unions tend to face a dilemma. To get larger, they must pay competitive rates to their members on deposits, charge competitive rates on their loans, and still be able to grow their capital (undistributed profit) enough to so that their capital ratios are above that required by the regulators. Growing the institution through increased efficiencies and market forces can take time.

An alternative method is merging. If two $50 million dollar credit unions were to merge, they would (at least in theory) be able to benefit from increased economies of scale. From January of 1994 through November of 2010, there were over 4,500 credit union mergers announced in the NCUA Monthly Activity Report. The graph below shows the merger announcements by quarter for those same years. If anything, the merger activities have calmed down somewhat since the financial crisis of 2008. Note that fourth quarter of 2010 is not included in the data because at posting the December Monthly Activity Report was unavailable.

But merging is not a panacea. Research conducted on mergers concludes that mergers tend to benefit the target (acquired) institution and their members, while generally providing little benefit to the acquiring (or surviving) institution. These findings are consistent regardless of performance measure used or whether the credit unions were American or Australian. The biggest reason for lack of performance improvement on the part of the surviving firm appears to be two-fold: size, and motivation.

The first reason mergers don’t tend to benefit the acquiring institution is that the targets have traditionally been tiny. The change in size is usually quite small. With very little change in overall size, little can be expected in economies of scale. As an added problem, most acquiring institutions are equally small. Of all of the 4,500 mergers in the past seventeen years, very few have produced a combined institution with more than $100 million in assets and a vast change in size from the acquiring firm pre-merger.

The second reason mergers don’t tend to benefit the acquiring institution is that the target institution tends to be financially distressed. Most mergers resulted in vast improvements in CAMEL ratios for target firms. It appears that even when “financial stability” is not specifically listed as the reason for the merger by the NCUA it usually was the motivator. The NCUA can twist the arms of credit unions to merge with troubled institutions because the insurance fund is a cooperative fund, and if an institution fails, all participants may be charged higher premiums.

But even among merger participants not brought together by NCUA, it is more likely that an institution that is looking for a merger partner was motivated to look by their own financial realities. The CEO of the target firm would have to take a “demotion”, and may lose her job entirely if acquired.

When all the right conditions fall into place, mergers have been shown that they can improve performance for both the target and acquiring institutions. It is just a matter of taking the time to find the right merger partner and putting together the right agreement to benefit the members of both institutions in the end.

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[i] Bergengren, Roy F. (1937). “Consumers' Coöperation” Annals of the American Academy of Political and Social Science, Vol. 191, pp. 144-148.

For my academic research on this subject, see:

•"The Effect of Mergers on Credit Union Performance", co-authored by Linda L. Miles and Takeshi Nishikawa. Presented at Financial Management Association Annual Meeting, Reno Nevada, October 2009. Published in Journal of Banking and Finance, vol (33), issue (12 - December), pp. 2267-2274.

•"Can Credit Union Performance Improve Through Mergers? the Case of State Farm Credit Union Consolidation", co-authored by Linda L. Miles. Presented at Financial Management Association Annual Meeting, New York City, New York, October 2010.