Heading into a merger? A loan portfolio review is a good idea

While credit union mergers and acquisitions (M&A) are relatively uncommon occurrences—in 2020 there were just 136 credit union mergers and just 5 bank acquisitions by credit unions—they are high-dollar agreements with a lot of room for ambiguity and interpretation. 

When credit unions are being merged and acquired, the terms are based on the value of the institution’s assets, including its loan portfolio. Collateral values and risk change over time, so during the M&A process, it’s important to get an accurate snapshot of the current state of the institution’s loan portfolio. Due diligence should involve making sure the assets are worth what the institution says they’re worth. 

2020 Analytics Started With a Merger

2020 Analytics wasn’t itself created by an actual merger, but it was a potential merger between two large credit unions that inspired the loan portfolio analysis offerings that became the basis for what we do. 

During the 2008 financial crisis, two credit unions in Florida were merging. At that point in time, risk mattered even more than usual—real estate values were in flux and borrowers were at risk of defaulting on their loans. 

As is customary in a merger process, CPA firms were engaged to perform the usual due diligence: reviewing contracts, making sure loan docs were signed, reviewing for fraud or regulatory issues, etc. But a board member at one of the institutions wondered, “How do we know if the other credit union didn’t make a bunch of bad loans?” 

Great question. The CPAs dug in to find out. They performed a multi-dimensional portfolio analysis (MDPA), looked at credit and collateral quality indicators, built the modeling, and presented it to the credit union board that requested it. The board was excited by the information, and the other credit union involved in the merger requested the same analysis. 

After seeing how vital the portfolio analysis was, and with models in hand, 2020 Analytics was formed as an entity. Our analysis now goes far beyond M&A activity—with that being a small portion of what we do—to help credit unions evaluate their portfolios on an ongoing basis as a proactive system of risk identification and mitigation.

What a Loan Portfolio Analysis Looks Like in M&A

The credit union industry is continuing to consolidate at a steady pace—about 3.5% per year. More and more mergers are happening between large credit unions, and smaller institutions continue to be acquired by larger ones. At larger sizes, operational costs become easier to manage, access to resources and technology grows, and economies of scale increase efficiency. 

As part of the due diligence process, it’s vital to analyze an institution’s loan portfolio for risk and to validate the sufficiency of loan loss reserves. By digging into collateral values, borrower credit scores, delinquency, and more, the acquiring credit union can make sure it has a realistic view of the portfolio risk of the institution being acquired. 

For example, if an institution being purchased reports a loan receivable value of $100M, a portfolio review helps the acquiring credit union understand the accuracy of that valuation by analyzing if the allowance for loan loss is appropriate, considering things like: 

• Whether borrower credit scores have changed since a loan was issued
• Changes in collateral valuation
• Delinquency and risk for future delinquency and default

If the expected portfolio valuation discovered in the review process doesn’t align with what the institution reported, the buyer has insight into the risk it’s taking on and has leverage to negotiate the terms. 

Benefits of Portfolio Review

The board in the Florida merger mentioned above was excited by the information revealed by the portfolio analysis because it was unlike anything they’d seen before. While the typical diligence process is robust, a detailed look into the loan portfolio is often overlooked. 

There are many purposes for adding a loan portfolio analysis in the M&A process. An MDPA brings peace of mind to the board, ensures the NCUA that diligence was done on the portfolio, and reinforces the purchase price. 

The analysis can also reveal synergy (or lack thereof) between merging institutions. For example, would borrowers at the institution being purchased be able to get loans at the buyer credit union using its existing requirements? This can reveal if members are inside the institution’s credit profile, which increases long-term membership opportunities. 

The acquiring credit union will also find value in a review of its own portfolio. With safety and soundness being a paramount concern from board members and regulators, demonstrating a deep understanding of your own portfolio relative to capital position will help make your case that you’re well-positioned to carry the risk of the absorbed financial institution. 

The benefits of a loan portfolio analysis in credit union M&As are visible immediately, before a merger is closed. If you’re going through a merger or acquisition, a multi-dimensional portfolio analysis (MDPA) is ideal in the weeks and months leading up to the closing.

Contact us to see why every credit union M&A should have a portfolio analysis.