March 23, 2010
Read part two of this article series.
In the current economic environment and with 16 federally insured credit unions having failed since the beginning of 2009 (and with others being merged away more quietly), many credit unions have questions about purchase and assumption agreements, or P&As. When the National Credit Union Administration is faced with a troubled credit union, it is often forced to close the institution. One way to do so while insulating the Credit Union Share Insurance Fund from losses and maintaining service to the troubled credit union’s members is an emergency merger (a topic for a future article).
Another method is a P&A, an often-misunderstood way of controlling risk. A P&A differs from a merger in that the bidding credit union can exclude assets and liabilities from the transaction while still obtaining the disappearing credit union’s field of membership. Mechanically, in a P&A the NCUA takes a troubled institution into conservatorship and then sells it (or parts of it) to the highest bidder.
The NCUA and credit unions bidding in P&A scenarios are focused on controlling risk in the transaction. As noted above, the bidding credit union can exclude assets and liabilities from its bid. If the acquiring credit union excludes some parts of the disappearing credit union, the NCUA retains those assets and liabilities and oversees them from a central facility. This ability to “strip away” assets and liabilities makes a P&A attractive for an acquiring credit union that might want a desirable FOM, shares and certain assets, but might not want to inherit all the business decisions of the troubled credit union.
Additionally, the NCUA has certain powers in a P&A that allow even greater freedom to exclude risk. One such power is the NCUA’s ability to repudiate contracts for credit unions in conservatorship. This power allows the NCUA to make an ailing credit union more attractive to potential partners by “busting” unfavorable leases, data processing contracts, vendor relationships or other similar agreements. While a merger partner would have to extricate itself from these relationships, a P&A bidder can instead request that the NCUA use its repudiation powers.
NCUA can also offer “208 assistance” to a continuing credit union as another incentive to take on a troubled institution. Federal Credit Union Act Section 208 allows the NCUA to provide assistance to credit unions if it would facilitate a consolidation and reduce the risk of a loss to the NCUSIF. Often the NCUA provides either cash or a guarantee of assets to “backstop” potential losses. In the current environment, however, the NCUA is not granting stop-losses or guarantees, more often opting to give cash to the acquiring credit union. To do otherwise would place open-ended liabilities on the NCUSIF balance sheet. Cash assistance is often calculated to make up for the difference between the value of the purchased assets and FOM of the acquired credit union and the value of its shares (minus a premium).
Beyond the risk-mitigating aspects of P&As, bidding credit unions are often motivated because of the FOM benefits—the acquiring credit union is able to retain the disappearing credit union’s FOM without regard to FOM restrictions. For example, a multiple common bond FCU could obtain a community group in a P&A. Also, a federal credit union could obtain an otherwise impermissible FOM of a state-chartered credit union. P&As that cross state lines allow credit unions to diversify geographically and obtain valuable FOM segments that would otherwise be impermissible.
With the expansive options to control risk and still obtain merger benefits, it is little wonder that a P&A might be attractive to a well-capitalized credit union. A well-crafted bid can provide a continuing credit union with significant opportunities. However, this does not mean credit unions should abandon actual mergers: With a merger you are in the driver’s seat; with a P&A the regulator retains a great deal of control.
In Part II of this series, I will discuss some considerations your credit union might want to take into account if it is considering participating in a P&A as a bidding credit union.
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.