NCUA Response to Congressman French Hill Questions on Credit Union Bank Transactions

E&I/ASW:ASW
SSIC 12320

SENT BY EMAIL

TO: NCUA Board Chairman Todd M. Harper

FROM: Director Kelly Lay

SUBJ: NCUA Response to Congressman French Hill Questions on Credit Union Bank Transactions

DATE: December 14, 2023

This memorandum responds to a request from Congressman French Hill in reference to the U.S. House of Representatives' Committee on Financial Services "Oversight of Prudential Regulators" hearing on November 15, 2023. Congressman Hill requested more transparency on how credit union bank purchase transactions work; the issue of banks moving from a tax to non-tax status; and how deposits are insured.

The Federal Credit Union Act (FCU Act) explicitly permits these transactions.¹ Federally insured credit unions, however, cannot acquire a bank charter. Instead, federally insured credit unions may purchase assets and assume liabilities (including deposits) of a bank that chooses to sell its assets and liabilities (bank-to-credit union transactions). In instances where a substantial portion of the assets are purchased and liabilities assumed, the bank charter may be terminated. These bank-to-credit union transactions are arms-length, market-driven transactions sought by the management of the bank and credit union. The transactions must comply with legal, regulatory, and safety and soundness requirements, among others, to be approved by the applicable state and federal regulators and insurers.

Bank transactions with credit unions are a small proportion of the overall consolidation occurring in the financial services marketplace. From 2011 to September 30, 2023, the NCUA has approved 64 purchases and assumptions of banks' assets and liabilities by credit unions.² By comparison, in the first nine months of 2023 alone, there have been 90 bank-to-bank transactions and 108 credit union-to-credit union mergers. Most of the bank-to credit union transactions (54 of 64, or 84.4 percent) consummated from 2011 through the third quarter of 2023 have been by federally insured, state-chartered credit unions due to the broader authority and flexibility in their field of membership requirements.

The NCUA has approved six bank-to-credit union transactions in the first nine months of 2023 (b)(4); (b)(8). It should be noted that not all announced deals are completed. Since 2011, the NCUA and/or the state regulatory agency have denied four transactions and in nine other instances, acknowledged the credit union's withdrawal of applications.

The structure of credit unions is fundamentally different from that of banks, with credit unions being not-for-profit member-owned cooperatives generally subject to field of membership restraints. Specifically, the FCU Act limits credit union growth in multiple ways, including by limiting their customer base (field of membership); imposing a cap on the amount of member business loans most federally insured credit unions may make; preventing credit unions from issuing common stock and other equity instruments; imposing an interest rate ceiling and prohibiting certain fees (like prepayment penalties) on federal credit union lending; and imposing a variety of restrictions on the types of investments federal credit unions may make.

In these transactions, the former bank customers will continue to receive the services of a federally insured financial institution. The former bank customers may have different levels of consumer financial protection supervision upon becoming members of a credit union. In some instances, they will receive additional protections in the form of pre-payment penalties or loan interest rate caps.

Unlike the federal banking agencies, the NCUA does not conduct separate periodic compliance examinations, nor does it assign a separate consumer compliance rating pursuant to the Uniform Interagency Consumer Compliance Rating System approved by the FFIEC in 2016. Therefore, the former bank customers that are now credit union members may have less consumer financial protection oversight after the bank-to-credit union transaction.

The NCUA has been working steadily to address this imbalance and to fulfill the FFIEC's statutory mandate to promote uniformity in supervision across regulators. The NCUA has recently begun to incorporate consumer compliance examination specialists focused solely on evaluating credit unions' adherence to consumer compliance requirements. In addition, the NCUA's 2024 budget contains funding to start building out a consumer compliance exam function for credit unions nearing $10 billion in assets that emphasizes compliance risk management practices designed to manage consumer compliance risk, support compliance, and prevent consumer harm.

Approval Process

All bank-to-credit union transactions must be approved by the NCUA, the Federal Deposit Insurance Corporation (FDIC), and other applicable state and federal bank and credit union regulators. Federally insured credit unions file an application with the NCUA. The bank simultaneously files a Bank Merger Act application with the FDIC.

The FCU Act includes the following list of factors the NCUA must consider in determining whether to approve or deny a transaction with a bank:³

1. The history, financial condition, and management policies of the credit union;
2. The adequacy of the credit union's reserves;
3. The economic advisability of the transaction;
4. The general character and fitness of the credit union's management;
5. The convenience and needs of the members to be served by the credit union; and
6. Whether the credit union is a cooperative association organized for the purpose of promoting thrift among its members and creating a source of credit for provident or productive purposes.

The NCUA reviews these factors along with a third-party fair valuation analysis included with each application to assess the continued safety and soundness of the consolidated entity and the economic advisability of the transaction.

When a federal credit union purchases the assets and assumes the liabilities of a bank, the NCUA requires a two-step process to establish the membership status of the former bank's customers. First, the federal credit union must confirm that the bank customers are within the credit union's field of membership. Second, the former bank customers must become full members of the federal credit union.⁴ In instances of federally insured, state-chartered credit unions, which make up most of these transactions, the state regulatory agency must also approve the transaction prior to consummation.

Tax to Non-Tax Status

Bank trade groups contend that these transactions reflect an economic advantage to the credit union due to their tax-exempt status. The facts do not bear this out. As noted previously, credit unions are subject to substantial growth, investment, and other restrictions that do not apply to banks.

Bank trade groups also argue credit unions can afford to pay more than banks to purchase and assume bank assets and liabilities because credit unions do not pay taxes. The fair valuation analyses reviewed typically include an assessment of the market rates banks have historically paid to acquire another bank @rice-to-book value of the transaction). The NCUA uses this market analysis to assess the reasonableness of the price-to-book value of the transaction between the credit union and the bank.

A credit union's purchase of a bank is typically a strategic action to expand its geographic footprint or to grow a loan program with seasoned loans and to supplement its oversight of the loan program with the knowledge and expertise of the bank employees. A credit union's only source of capital is retained earnings, which limits the number and amount of acquisitions it can make and remain well-capitalized.⁵ Credit unions do not have access to the capital markets to fund aggressive growth strategies.

Deposit Insurance

The National Credit Union Share Insurance Fund (Share Insurance Fund), operated by the NCUA, insures member shares (deposits) in accordance with the minimum statutory limits (currently $250,000), like the FDIC's Deposit Insurance Fund. As noted above, due to field of membership requirements, the bank's customers are required to become members of the credit union before their deposits can be insured. The NCUA, FDIC, and the relevant state regulatory agency, in the case of state-chartered credit unions, ensure the bank depositors are members of the acquiring credit union or are otherwise eligible for insurance at consummation of the transaction so their accounts have continuous insurance coverage in all circumstances.

Approvals vs. Denials

While it is a market-driven decision for a credit union and a bank to pair in a transaction, and the NCUA makes every effort not to interfere with strategic market activity, the NCUA must review the transaction for continued safety and soundness of the acquiring credit union and risk to the credit union, credit union members, and the Share Insurance Fund.

With each transaction, the NCUA works with the credit union to ensure it has appropriate risk controls in place to mitigate and manage the additional operational, including compliance, and financial risk. Credit unions that are unable to provide the necessary controls to support the additional risk may choose to withdraw their applications until such time that their financial and operational condition and controls can support the transaction.

Conclusion

In conclusion, the number of credit union purchases of bank assets and certain liabilities is relatively small compared to the overall level of financial institution mergers and more likely to be pursued by federally insured, state-chartered credit unions. All purchases must meet the FCU Act criteria for NCUA to approve, and the transactions provide former bank customers with continued federal insurance coverage on their funds. Additionally, credit unions are limited in how they can fund and account for these transactions, as they must rely on retained earnings instead of accessing equity through capital markets available to banks.

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