Wealth'' is the title of a recent Brookings Institution task
force report. It describes the difficulties in recording intangible
assets on the balance sheets of public companies. The report states,
''As the United States moves into the 21st Century, the factors
that have become more important to economic growth and societal
wealth are ''intangible'' or ''non-physical'' such
as intellectual capital, research and development, brand names and
human capital. . . intangibles are harder to measure, harder to
quantify, often harder to manage and harder to define than tangibles.''
as economic entities have a double intangible challenge. First is
the difficulty faced by all business organizations of measuring
intangible assets. But the second factor is that there is no market
information or pricing mechanisms attempting to continuously appraise
a credit union's value. All publicly traded companies confront the
''invisible hand'' of the market. A firm's stock price constantly
provides a best estimate at a point in time of a firm's future value.
of this market-based information on credit union's performance is
both a blessing and a challenge. Recently several major banks have
reported increases in loan loss reserves and the marketplace has
marked down their stock accordingly. Credit unions are not pressured
to make decisions, short-term or strategic, with an eye on what
the market will do to the price of stock. There is no stock price.
On the other
hand, in a period of rapid change where competitive forces, technology
and deregulation are changing the nature of the business credit
unions are in, the lack of market feedback on credit union strategy
may lead to a false sense of security. Although credit unions report
sound earnings today in their call reports, does this mean that
their long-term member relationships are not in play?
Values A Credit Union Franchise
of the potential ''unseen value'' of credit unions was revealed
when a former credit union agreed to be acquired by a bank holding
Credit Union was founded in 1975 for the employees of Philadelphia
Electric Company. In 1998 when the credit union converted to a mutual
savings bank, it was the 16th largest credit union in Pennsylvania
with assets of $160 million, capital of 10.1%, an ROA of .12, and
with negative loan and share growth for the 12 months ending June
30, 1998. The credit union had 22,300 members and a loan-to-share
ratio of 69%.
In October 1999
the company converted from a mutual to stock from of organization
at a price of $8 per share. Soon thereafter professional investors
began buying blocks of the former credit union's shares speculating
on the potential for takeover by another financial firm.
3, 2000 an agreement was announced between the holding company for
the former IGA FCU, Jade Financial Corp, and PSBI, a bank holding
company, to complete a merger of the two firms' subsidiary banks.
The price for each share of stock in Jade Financial was $13.55.
In less than
two years, a federal credit union has gone from a cooperative to
a fully priced and sold public company. What can we learn from this
transaction about the potential ''market'' value of credit
unions, or their ''unseen wealth''?
At the time
of the transaction the following were the major financial facts
about Jade Financial. Total assets at September 30, 2000 were $214.9
million, deposits-$166 million, loans-$127.3 million, borrowings
of $20 million, and total equity of $27.7 million. The equity-to-asset
ratio was 12.9% and the allowance for loan loss was 1.28%. ROA,
measured by yhe latest 12 months earnings, was 45 basis points using
September month end assets.
of the price paid for Jade Financial in the announcement of the
merger included the following ratios:
12 month earnings: 26.2 times
Price/Tangible Book value: 140.7%
Price over Tangible Book value
As a % of deposits: 6.42%
Thus this firm,
which had been a credit union barely two years earlier, obtained
a premium of 40% over the book net worth. This premium was 6% higher
than the book value of the $166 million in deposits.
The press announcements
talked about why this was a reasonable price. Some of the rationale
included complementary product lines, geographic extension into
a familiar market by the acquirer, the ability to evolve the new
organization faster into a full service community banking franchise,
and positioning the new organization for immediate improvement on
equity by leveraging the capital base.
This last statement
is illuminating. The funding of the merger is from the investment
securities of both organizations. Prior to the merger PSBI, the
acquirer, had an equity ratio of 14.1% and IGA/Jade, 12.9%. The
new combined entity will have a ratio of only 7.8%, which means
the owners have used the capital of the organizations to pay for
the transaction. This lower capital ratio will give the new entity
a higher return on equity according to the proforma projections
of 9.5% versus the 5.8% of the higher capitalized IGA/Jade.
for Credit Unions?
IGA both as
a credit union and as a mutual savings bank was not reporting growth
or earnings in the leading percentiles; however, when the firm's
business was opened up to bids, a substantial premium was paid over
book value. While there is probably some financial alchemy in the
transaction since the purchase was paid solely from the assets of
the two organizations, nonetheless the transaction suggests the
hidden value that exists for many credit union franchises.
places a very different light on the continual regulatory focus
on capital ratios, NEV calculations and ALM shocks as indicators
of a credit union's strength. All of these efforts at tangible measures
miss many of the elements that are at the core of a credit union's
Credit Union Value
But what is
this value? Is it solely the business franchise that a credit union
has created from loyal members and core deposits? Is there something
deeper that needs to be recognized? Why is recognizing this ''unseen
I believe the
strength of the credit union is much more than its on going business
franchise. The organizational advantage of the owner-user cooperative
represents a different way for members to achieve financial solutions.
A credit union is a ''community of interest'' in which the
individuals search together for both individual and collective well
While the Jade
financial transaction might tempt other credit unions to also seek
out the tangible elements of business value, the real difference
is that credit unions are built on values. Credit unions were founded
on principles of cooperation that are more enduring than an objective
analysis of a business' worth. That's the message more and more
members are responding to. It is an advantage none of our competitors
can ever match.