What's Our Role: Mergers & Acquisitions

What’s Our Role: Mergers & Acquisitions

Presented by: Stephen LaBarbera CPA, Manager

MichiganCharlotte  NorthTexas Carolina Florida Insight. Oversight. Foresight. SM1 Overview Financial Institutions Group

• Background & Industry Trends • Rationale • Digress: What’s Our Role Conversation • Merger Timeline • M&A Life Cycle From a Risk Professionals Perspective: • M&A Strategy • Integration • Due Diligence • Post Acquisition

2 Opening Inquires 3

1 – Hands up if your credit union pursuing mergers or acquisitions.

2 – Hands up if your credit union has been through a merger in past few years.

3 – Hands up if internal audit participated in the transaction.

4 Insight. Oversight. Foresight. SM Merger and Other Acquisition Activities Financial Institutions Group

• Types of Mergers • Voluntary – NCUA not involved • Unassisted supervisory merger – NCUA lightly involved • Assisted mergers – NCUA organized • Purchase & Assumption (P&A) – NCUA taken over

• Other Acquisition Activities • Bank Acquisitions • Purchasing individual branch

5 U.S. CU Trends 6

Change in # of Credit Unions 116,761,136 Members

88,513,329 Members Number of CU Members Number of of Unions Number Credit

Rate of Credit 4.5% Union 4.2% 4.0% 4.1% Mergers 4.0% 4.0% 3.8% 3.8% 3.5% 3.4% 3.5% 3.3% 3.2%

2.9% By 2038, CUNA predicts just 3,000 2.8% 2.7% credit unions will remain. A 3% 2.5% annual decline over the next 20 years 2.2%

331 333 306 302 295 275 281 265 265 255 261 252 245 252

Number of of Mergers Union Number Credit 233 236 215 212

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

NATIONAL CREDIT UNION GROWTH (INDEX 2001=100)

Peer 5

Peer 4

Peer 3 Peer 2

Peer 1

NATIONAL CREDIT UNION GROWTH (INDEX 2001=100)

2,400 LEGEND Peer 5 ($10B+) Peer 5 ($5B - $9.99B) Peer 5 ($2.5B - $4.99B) Peer 5 ($2B - $2.49B) Peer 5 ($1B - $1.99B)

957

900

468 311

100

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Peer 5 ($1B - $1.99B) Peer 5 ($2B - $2.49B) Peer 5 ($2.5B - $4.99B) Peer 5 ($5B - $9.99B) Peer 5 ($10B+)

1-10 50 - 100 Total Assets billion million Compare Net Interest Margin 2.91 3.28 0.37 Fee and Other Income 1.39 1.34 (0.05) Operating Expense (2.97) (3.72) (0.75) PLL Expense (0.34) (0.30) 0.04 Return on Assets (ROA) 0.99 0.60 (0.39)

Larger CUs offer better member rates Larger CUs have lower operating expense ratios Larger CUs have higher ROA Why it matters: Provides larger organizations certain competitive advantages such as the ability to invest in technology to attract millennial members, supply relationship pricing to loyal members, & minimize regulatory expense impact.

CU Industry Merger Rationale – Quantitative 12

Member Value Employee Value Credit Union Value

7.00% 0.93 0.88 0.93 Return of the Member* 86% 85% 6.00% 6.0% 83% 86% 87% 78% 88% 0.85 Loans / Shares Ratios 0.79 0.80 5.00% 73% 0.73 67.3% 67.3% 4.9% 60% 4.3% 4.6% 4.7% Comp & Bene’s (indexed) 0.66 4.5% 4.6% 4.00% 4.3% 4.0% 58.8% 47.9% 3.73% 3.72% 3.65% Yield on Loans 3.51% 3.50% 3.00% 0.41 46.5% 40.6% 3.16% 2.93% 31.1% 2.47% Operating Expense Ratio 2.00% 2.36% 22.3%

1.02% 1.07% 1.05% ROA 0.84% 0.79% 1.00% 0.58% 0.67% 0.70% 0.39% 0.20% 0.71% 0.75% 0.0% 0.56% 0.63% 0.41% 0.46% 0.48% 0.48% 0.00% Annualized Dividends/Shares <$100M $100M-$249M $250M-$499M $500M-$749M $750M-$999M $1B-$2.5B $2.5B-$5B $5B-$9B >=$10B

*Callahan & Associates Return on Member represents "Return to Savers", "Return to Borrowers", "Member Service Usage" formulas. Credit unions with a score of 100 are considered leaders in providing services to their members

Regulatory Burden Financial Impact • 1 out of every 5 employee’s spend time on Depreciation of regulatory compliance Capitalized • Total credit union regulatory costs rose by Expenses 2% Including technology 800 million 15.1% between 2014 and 2016 rd 3 Party investments Expenses 23% • Total credit union regulatory costs translate to Including compliance, $115 per CU household technology, legal and training $6.1 BILLION Total Industry Regulatory Costs Small Credit Unions Bear the Brunt of Regulatory Burden 75%

Staff Costs Including risk management, 0.69% member-facing and support employees 0.46% 0.43%

Small Credit Unions Average Large Credit Unions (Under $115M) (Over $1B)

Member Benefits • Convenience: Increase member access points & extend geographical coverage • Price: Opportunity for competitive rates • Products & Services: Improved products and services • Familiarity: Same recognizable credit union experience

Credit Union Benefits • Operating efficiencies via combined systems and support networks • Greater presence • Increased lending opportunities • Further diversification of demand, product and services • Larger asset and capital base • Improved succession planning

• Credit unions saw a charter type shift over the past 15 years mainly due to merger activity and general credit union affinity of a community charter.

Credit Unions in 1990 Credit Unions in 2014

17%

43%

57%

83%

Why it matters : Single Common Bond Community & Other The conversion from a common bond charter to a community charter forced credit unions to compete with other types of financial institutions for members.

Why do smaller credit unions struggle? • Difficult to establish sustainability • Regulatory and compliance costs are much heavier burden for smaller organizations • Inability to offer and price competitive products and services • Less capital to invest in technology

“A good merger solves two problems. It puts a small credit union out of its pain, and it enables a larger credit union to grow by delivering members who are already sold on the credit union difference.” Robert McGarvey – Mergers Will Continue to Cull Small Credit Unions From Herd (2013)

• Economies of scale allow for improved technology to attract millennials. • Younger generations demand all modern delivery channels.

Examples: • Omnichannels • Mobile Banking • Remote Deposit Capture • P2P Payments According to a Deloitte • Biometric Authentication report, 72% of all consumers appreciate this security measure

18 What’s Our Role Conversation Financial Institutions Group

• Robin to help build section

19 WOR Guidelines - Partner Financial Institutions Group

Compliance Function Internal Audit Function • Strategic partner to senior • Audit Committee leadership and business

• Engaged upfront by business • Proactively provide input on risks unit leadership related to critical company initiatives

• Consulted by senior • Provide value by reporting on leadership in identified risk and controls by setting out opportunities the facts, risks and implications. • Collaborate with internal audit • Jointly with compliance assess to identify and cover risks group-level risk - Coordinate risk management plans/projects when possible.

20 What’s Our Role Conversation Financial Institutions Group

• No integrations/communication • Separate internal audit, compliance and risk management functions • Assumed responsibility for managing organization risk based on departmental objectives • No coordinating structure.

Managing Organizational Risk: The Mighty Triad of Internal Audit, Compliance, and Risk Management: https://www.slideshare.net/PYAPC/managing-organizational- risk-the-mighty-triad-of-internal-audit-compliance-and-risk-management

21 What’s Our Role Conversation Financial Institutions Group

• Informal Integration • Impromptu coordination - may work on some projects, but not for others • Dependent on relationships for working outside departmental boundaries

22 What’s Our Role Conversation Financial Institutions Group

• Official Integration • Departments that manage organization risk are in regular contact • Regular meetings with agendas, minutes, and action plans • Coordinated auditing, monitoring and reporting • The unity of the areas is understood by employees

23 WOR Guidelines - Audits and Reviews Financial Institutions Group

Compliance Function Internal Audit Function • Identify opportunities to perform • Look for opportunities to perform integrated assessments/audits integrated audits with IA

• Collaborate during development • Utilize compliance as resource of compliance and IA annual during fieldwork/planning audit/review work plans

• Develop and implement • Use compliance to develop a complimentary communications more holistic view of risk and when performing integrated increase audit efficiency audits.

24 Internal Audit Hurdles & Involvement

25 Perceptions of IA Related to Mergers Financial Institutions Group

• Observations from research published by the IIA • National and international organizations • Across various industries Perceptions of IA related to mergers: • IA participation in strategy will impair independence • IA is control focused and not strategically focused • Involvement in merger activity is time consuming and time sensitive • IA does not have the expertise and it is expensive for IA to obtain the skills

26 How Can IA’s Role be Expanded Financial Institutions Group

27 Value - Internal Audit Financial Institutions Group

28 What’s Our Role Conversation Financial Institutions Group

• What is your total asset size? • How big is your IA department? • Does IA get involved in strategic initiatives, such as merger transactions? • How is the interaction between IA and compliance? • Do you think there should be more interaction between the two groups at your credit union?

• Please feel free to bring any thoughts forward…

29 Merger Timeline

30 ‘Typical’ Merger Timeframe 31

Preliminary Member Vote Prospecting Merging CU Analysis Report results to Calls Member Vote [Due Diligence, Regulators 1-2 months & Approval Fair Valuation] 1-2 months 1-2 months 2-3 months Effective Regulatory Confidentiality Letter of Merger Date Merger Agreement Intent Merger Packet Final 1-2 months Planning Prep Analysis 1-2 months 1 month

Merger Operation CEO meetings & Integration & Education Strategic Joint BOD Implementation Planning meetings Appointment 9-12 months 2-4 months Merger of Merger Agreement Team 1-2 months Quantitative and 1-2 months Qualitative Measures Hart Scott Analysis Rodino Anti- Employment 1-2 months Trust Filing Agreement 2-3 months Modifications 1-2 months

Merger Strategic Prospecting Initiation/ Structure & Transaction Closing/Regulatory Integration/ Education Planning Analysis Introduction/ Negotiation Analysis Requirements Implementation Facilitation Strategy Transaction Integration Strategic Advisory Timeframe is for general reference only and © Doeren Mayhew. All rights reserved. may be materially different for each transaction Ranking Areas of Participation Financial Institutions Group

• Ranking of actual participation by IA in Merger by stages: 1. Post-merger audit of combined entity 2. Merger integration 3. Due diligence (may use third-party) 4. Deal approval and close (minimal) 5. Merger strategy (minimal)

32 Merger Strategy

33 Merger Strategy Financial Institutions Group

• IA’s role normally very limited • Stay appropriately informed about merger strategy and current activity • If management has a merger strategy, it may be reviewed for alignment with credit union goals • If business case is prepared (once target is identified), it may be reviewed. Should be: • Comprehensive & clear • Include synergies • Include dis-synergies

34 Merger Strategy - Risk Considerations

Governance/ Ineffective Mutual Collaboration Policy Communication

Culture/Human Organizational Regulatory Capital Development

Reputation Transaction Credit/Collateral

35 Merger Due Diligence

36 Due Diligence - Intro Financial Institutions Group

• The goal of due diligence in the M&A process is for the buyer to confirm seller’s financials and reach comfort level with closing deal. • Conduct due diligence as an organization: finance & accounting, operations, lending, human resources, risk & legal, internal audit, and outside consultants • Ensure weaknesses and risks are identified and considered in finalizing the deal

• Begin preplanning for integration

37 Due Diligence - Resource

CUESolutions: “Due Diligence Checklist” https://www.google.com/search?q=CUE S+due+diligence&rlz=1C1GCEU_enUS820 US820&oq=CUES+due+diligence&aqs=ch rome..69i57.6256j0j9&sourceid=chrome &ie=UTF-8 Click on Embedded Excel

38 Due Diligence - Takeaways Financial Institutions Group

• Unrecorded liabilities • IT vulnerabilities • Compliance issues and • Credit risk violations • IA may conduct targeted • Pending threating audits litigation • Key control structure • Employee benefits understanding • Contract review • Integration preplanning

39 Deal Approval and Close

40 Merger Approval and Close Financial Institutions Group

Section Description Member 1 Detailed explanation of the reason for the merger. Vote

2 Proposed effective date of the merger. NCUA/ FTC State 3 Current financial statements for both credit unions.

Section Description Section Contents

Process and project plan Notification and Report Form 1 1

Merger Documentation Message and methods of communication 2 o Explanation and value proposition of the merger 2 o Merger agreement Executive biographies o Member vote packet 3 Market Share Information o MarketConcentration—Deposit Analysis 3 o Market Concentration—Loan Analysis Meetingagenda and logistics o Market Concentration by County 4 o Bank and Credit Union Market Share Analysis Financial Information 5 Member vote tabulation and results submission o Fair Valuation of Combined Entities as of 3/31/09 4 o Call reports as of 12/31/09 o Combined forecast 2010 o 5-year historical financial performance ratios

5 Legal Information 41 Merger Approval and Close Financial Institutions Group

• IA participation in this phase may be limited • Focus on legal documents and regulatory approval • Keep apprised of progress • During this phase, IA can continue to monitor the merging CU’s performance • Any deterioration or activity increasing risk

42 Merger Approval and Close Financial Institutions Group

• Merger Application with NCUA • Excellent item to review before the integration stage begins. Click on PDF Embedded

43 Merger Integration

44 Merger Integration Merger Considerations

BDO: “Internal Audit’s role in highly acquisitive organizations” https://www.bdo.com/BDO/media/Webinar-Handouts/IAs-Role-in-Highly-Acquisitive- Organizations_062717.pdf Merger Integration Merger Considerations

Project Management Group Structure

Executive Team/Sponsor

Performance Group Leaders

Performance Groups Merger Integration Merger Considerations

• Participate in critical meetings • Understand integration timelines • Play advisory role to performance groups • Monitor progress or lack of progress • Highlight potential gaps in the internal control structure

48 Post-Merger Audits

49 Post-Merger Audit Financial Institutions Group

• Risk-based audit plan of combined entity • Audit significant changes • Perform targeted monitoring • Prepare lessons learned observations about the integration process maybe in coordination with a survey or interview process: • Significant integration challenges noted • Most apparent culture diversity noted • Other observations from due diligence follow up and monitoring

50 Merger Integration Audit/Survey Financial Institutions Group

• A Post-Merger Integration Audit answers key questions about the last acquisition: • How were projects, difficulties, communications, and actions surrounding the merger handled? • What could have been done differently to make the integration more efficient? • What actions remain unfinished? • How have members and employees perceived merger? • If the company were to merge/acquire again, what should be done differently?

• Audit Approach: • Determine the depth of review required • Interview or conduct written surveys with executives, managers, employees, and if appropriate, members and board members • Combine the qualitative and quantitative data (turn responses to specific questions into graphs) to provide feedback and recommendations

• Audit Deliverables: Source: Merger Integration: Post-Acquisition • Summary report with recommendations Employee Survey Questions: https://www.mergerintegration.com/post- • Compiled interview notes acquisition-employee-survey Click on PDF Embedded • Analyzed survey/interview results • Presentation summary

51 Questions?

52 Insight. Oversight. Foresight. SM Thank you

Stephen LaBarbera, CPA, Manager Cell: (908) 268-1344 Email: [email protected] Services

• Audit • Commercial loan • Mergers & consulting consolidations • Internal audit co- • IT assurance sourcing • Vulnerability • Loan loss & delinquency assessments control systems • Penetration testing • CUSO consulting • Member business • Regulatory compliance loan reviews Compliance

55 Due Diligence – Lending Compliance Financial Institutions Group

• Determine whether loan product features will change Truth in Lending – in a manner that adversely affects consumers Regulations Z • Ensure proper notification for variable-rate (VR) adjustments on VR mortgages

Real Estate • Provide the appropriate Servicing Transfer Settlement notice Procedures (RESPA) – • Maintain escrow account administration Regulation X

Home Mortgage Disclosure Act • Determine the impact on HMDA reporting for (HMDA) – the surviving institution. Regulation C

56 Due Diligence – Lending Compliance Financial Institutions Group

Secure and Fair Enforcement for • Identify Mortgage Loan Originators. • Update employer/employee information in Mortgage Licensing registry within 60 days of change. (SAFE ACT)

• Conduct a comprehensive Fair Lending review to Fair Lending ensure the acquired loans reflect: consistency in Regulations pricing and underwriting; no impermissible steering practices;

Fair Credit Reporting • Provide updated Negative Information notice Act (FCRA) disclosures, when necessary.

57 Due Diligence – Lending Compliance Financial Institutions Group

• Identify covered loans and ensure adequate insurance coverage. Flood Insurance • Notify the Federal Emergency Management Agency (FEMA) of change in servicer.

Homeowners • Provide the appropriate Servicing Transfer notice. Protection Act (Private • Maintain escrow account administration, including Mortgage Insurance) annual analysis and notification(s).

• Determine if any foreclosure proceedings are in Protecting Tenants at process, or if foreclosure is necessary after the Foreclosure Act transaction. Provide required notices to “qualified tenants.”

58 Due Diligence – Deposit Compliance Financial Institutions Group

• Determine whether terms / features will change Truth in Savings – and provide applicable Change in Terms notices Regulation DD • Continue to provide periodic statements with accurate customized information (if applicable).

Electronic Fund • Identify changes in terms and provide notification within regulatory timeframes. Transfer – • Consider overdraft payment opt-in requirements Regulation E for newly acquired customers.

Expedited Funds • Identify changes in funds availability policies and ensure compliance with Regulation CC. Availability Act (EFAA) • Ensure transaction processing cut-off timeframes – Regulation CC are coordinated and properly disclosed

59 Due Diligence – Other Compliance Financial Institutions Group

Bank Secrecy Act • What credit union wide system will be used? (BSA) • Money services business

Unfair or Deceptive • Consider the adequacy of disclosures to consumers regarding changes to account terms. Acts or Practices • Consider potential impacts on customer accounts (UDAP) converted to accounts without the same benefits

Fair Debt Collection • Determine if the acquired bank collects debt for third practices parties and the scope of that function.

60 Due Diligence – Compliance Resource Financial Institutions Group

Source for compliance slides: “Mergers and Acquisitions: A Compliance Perspective”

Click on Embedded PDF

61 What’s our Role Guidelines

62 WOR Guidelines Financial Institutions Group •Guidelines may need to be appropriately paired back for credit unions below 1 billion in total assets

63 WOR Guidelines - Partner Financial Institutions Group

Compliance Function Internal Audit Function • Strategic partner to senior • Audit Committee leadership and business • Engaged upfront by business • Proactively provide input on risks unit leadership related to critical company initiatives

• Consulted by senior leadership in identified • Provide value by reporting on risk and controls by setting out opportunities the facts, risks and implications. • Collaborate with internal audit • Jointly with compliance assess to identify and cover risks group-level risk - Coordinate risk management plans/projects when possible.

64 WOR Guidelines - Risk Assessment Financial Institutions Group

Compliance Function Internal Audit Function • Coordinate compliance risk • Include compliance function as assessment processes with part of annual risk assessment internal audit risk assessment • Discuss key areas of risk where possible assessment with compliance • Review “hot topic” risks together to determine whether • Share and obtain feedback on in compliance or internal audit assessments of risk scope

• Work together across ERM, • Reduce the risk of duplication of other “lines of defense”, and efforts internal audit to build common risk framework.

65 WOR Guidelines - Monitoring Financial Institutions Group

Compliance Function Internal Audit Function • Identify overlap with IA and • Coordinate with Compliance to: areas that are more • Identify new areas of risk appropriate for continuous monitoring • Discuss issues and concerns • Collaborate with IA to develop • Discuss upcoming reviews to metrics/reports for monitoring ensure efficiencies deficiencies identified. • Formalize process of • Meet with IA to review metrics, communicating compliance to find areas that may require issues with compliance, so that “deeper dive” audit. compliance can assist in root cause analysis and corrective action.

66 WOR Guidelines - Audits and Reviews Financial Institutions Group

Compliance Function Internal Audit Function • Identify opportunities to • Look for opportunities to perform perform integrated integrated audits assessments/audits with IA • Collaborate during • Utilize compliance as resourced development of compliance during fieldwork/planning and IA annual audit/review work plans • Develop and implement • Use compliance to develop a complimentary more holistic view of risk and communications when increase audit efficiency performing integrated audits.

67 WOR Guidelines - Reporting Financial Institutions Group

Compliance Function Internal Audit Function • Align more closely with • Navigate the audit committee by internal audit to drive a providing understanding of common definition of risk and sources and coverage of risk use similar risk language with leadership • Conduct routine coordination • Include IA in meetings to and communication between facilitate information sharing legal, compliance, ERM and a coordinated approach • In order to appropriately and • Coordinate with IA when proactively navigate the audit needed for meetings/reporting committee by providing understanding of sources and coverage of risk

68 What’s our role - Source Financial Institutions Group

PWC: “Intersection of Internal Audit and Click on Embedded Link Compliance (2018 Compliance Institute 708)”:https://www.slideshare.net/theHCCA/i ntersection-of-internal-audit-and- compliance-2018-compliance-institute-708”

69 What’s Our Role Conversation Financial Institutions Group

Internal Audit Compliance Risk Management • Improve business and • Identify risks and • Helps set financial controls, deploy resources organizational recommendations to accordingly strategy to mitigate drive change loss • Reviews risk • Protects institution • Promote acting management, and from legal liability, legally and control and by serving to ethically, mitigate governances processes protect the member compliance risks • Provide unbiased and • Global objective view

70 U.S. Bank Trends 71

310

Change 267 248 in # of 244 240 Banks 225 228 202 203 194

118 126

7,523 7,397 7,279 7,077 6,829 6,519 6,275 6,072 5,847 5,607 5,340 5,112 4,918 Number of of Number Banks

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

NATIONAL BANK GROWTH (INDEX 2005=100) 273 Peer 5

211 Peer 4

119 Peer 3

100

6363 Peer 2

24 Peer 1

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Peer 1 ($0-$49.9M) Peer 2 ($50M-$99.9M) Peer 3 ($100M-499.9M) Peer 4 ($500M-$1B) Peer 5 ($1B+) Note Omits banks over 10 Billion in Assets

From 1990 and Q1 2015:

28% 80% 50%

U.S. Population Number of Credit Unions Credit Union Membership

Why it matters: This data strongly suggests that by creating economies of scale within the industry, Fewer credit unions were able to do a better job in the areas of service, branding, and generating public awareness than was the case during the segmented history of the industry’s past.

Summary Components • Accounting and reconciliation • Assess current contracts (liability and escape clauses – IT & Debit Card) • Human resource policies, staffing, • Review legal to determine potential compensation structure and litigation or contingent liabilities unrecorded benefit plans • Loan evaluation focused on credit, • Allowance for loan loss analysis and collateral, concentration, and interest delinquency, charge-off patterns rate risk • Cash and liquidity • Investments-credit & Interest rate risk • Fixed assets and market value • Other assets and liabilities • Members shares and certificates • Equity levels • Fair value of balance sheet • Projected synergies

74 Merger Integration Merger Considerations

Project Management Group Process

Use Tools

Decision

Group Decision Communication Leaders Meetings

Executive Team Decision Meetings

Update Project Plan Merger Integration Merger Considerations

• Four Key Areas of M&A Life Cycle

3. Deal 2. Due 4. 1. Strategy approval Diligence Integration and close

• IA should be involved throughout the M&A process to monitor management activities and offer key insights.