$40 Million Transfer Of Member Capital Shows Need For New Merger Rule

The merger of Belvoir Federal Credit Union into Pentagon Federal Credit Union in early 2016 seemed to come out of nowhere, at least to members and movement stakeholders who weren’t the senior managers receiving golden parachutes for handing over seven decades of building goodwill and cooperative capital.

A day before the merger was announced, the credit union was ballyhooing a new branch serving the Northern Virginia community, but that announcement made no mention of the merger notice coming out the next day.

It also took months of asking and Freedom of Information filings to pry loose what really happened. Here’s the story, a cautionary tale why more transparency is desperately needed, something the NCUA is now proposing to add to the merger process.

Speak Up

Trhough Aug. 8, the NCUA is accepting comments on its new merger rule. The NCUA says the new rule would:

• Increase the required time for notice to members before a merger vote to at least 45 days.
• Require the merging credit unions to disclose all merger-related compensation for certain employees and officials of the merging credit union.
• Clarify the contents and format of the members’ notice to provide better information.
• Create a member-to-member communications process similar that found in NCUA’s regulations covering credit union conversions to or mergers with banks.

The February 2016 Special Membership Meeting Notice sent by Belvoir FCU’s board chair announcing the credit union’s intent to merge with PenFed included a combined statement of the two credit unions’ financial condition as of June 2015.It included an entry for negative goodwill totaling $40.7 million that would be added to PenFed’s balance sheet.

This amount was the total of Belvoir’s book capital plus additional gains from the estimated market value of its assets and liabilities. This is what Belvoir FCU members paid PenFed to have PenFed take control of their credit union in this voluntarymerger.

Unlike the sale of a bank where the owners are paid for their ownership plus estimates of future earnings valuethe 27,458 reported Belvoir members at March 31, 2016, paid an average of $1,482 to join PenFed. That despite the factthey could have joined PenFed anytime they wanted prior to that for free.

PenFed recognized this negative goodwill or extraordinary gainas non-operating income in 2016 and used it to pay its operating expenses, support the dividend, and add to retained earnings.

Credit unions have shown they can survive adversity. But the real test of their character is how they use their success.

How Did Such A One-Sided Deal Go Down?

How could such a transfer of member wealth from a sound, successful credit union with a 70-year operating history occur? What did the board tell its members? Was the NCUA involved? Are there lessons for other credit unions from this transaction?

A review of the public record and the FOIA file for the merger shows Belvoir’s board did not consult or request member input. Itoperated completely in secret from board approval in August 2015 until it sent out its required notice to members of a special meeting to vote on the merger. That notice was dated Feb. 24, 2016, but not mailed until March 11.

On Feb. 23, 2016, the day before the date of the Chairman’s Notice, Belvoir issued a press release announcing its new, modern branch at Fort Belvoir. The CEO is quoted, We always look to bring the latest technology to our members… this helps to bring an exemplary member experience.

Not a mention of the merger that would be announced the next day.

It would have been difficult if not impossible for members to have time to analyze or learn about other options.

By keeping the entire plan secret and limiting member notice to a period of just two weeks, it would have been difficult if not impossible for members to have time to analyze or learn about other options.

The member notice, while lacking specifics, was clear in its recommendation: I am pleased to inform you that we are proposing to merge Belvoir FCU into Pentagon FCU (PenFed). In today’s ever-changing economy, our Board of Directors evaluatedstrategic possibilities to assure you, our member, receive the full range of products and services you deserve. After considering alternatives, we determined that a merger with PenFed is in the best interest of the members.

No specifics, no mention of alternatives, no recognition of the market niche and three generations of member loyalty since its doors opened 72 years earlier.

Moreover, the FOIA merger file shows only a two-sentence merger agreement and a merger plan that recites the general capabilities and history of PenFed.

There is no documentation of either the board’s or managers’ due diligence in this exercise of their fiduciary duties.

So, what was the driving force behind this merger?

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NCUA Forces Disclosure Of Payments To Senior Staff

Reinforcing this insider-arranged sale: The CEO would receive a bonus of $250,000; the CFO and COO payments of $125,000 each, upon the merger’s approval. These disclosures were added to the official notice only after the NCUA required they be putin the requirement mailing.

Read more about PenFed’s merger strategies in this look at its takeover of Miramar Federal Credit Union in California.

Managing The Vote

By keeping the process secret, Belvoir’s board and senior managers were able to control the discussion and messages sent to members. Nowhere in the announcement was a comparison of rates, products, or services provided. The notice gave lists ofgeneral PenFed services and its low loan rates and a description of PenFed’s distribution system including its 36 worldwide branches.

There was no description of PenFed’s business model and how PenFed’s products and services would compare with Belvoir’s five-branch, locally focused, high personal service approach.

Nowhere was there a description of what might be lost in the merger. For example, Belvoir offered member business loans, which PenFed does not offer and required Belvoir to sell prior to the merger. Belvoir offered courtesy pay and a much-broader creditunderwriting approach. PenFed’s policies and business strategy are much different than Belvoir’s, which listed 189 local businesses and employee groups in its FOM.

One example of these policy differences is that Belvoir’s mortgage loan portfolio as reported in the HMDA data had twice the level of CRA qualified loans (income at 80% or lower of the median income in the MSA) than did PenFed’s. For the mostrecent year’s data, 2015, 18% of Belvoir’s mortgages were CRA eligible versus 9% for PenFed.

Further there was no explanation of why PenFed at $21 billion, or 63 times larger than Belvoir would be able to provide better personal service. On Jan. 29, 2016, one month prior to the merger announcement, Belvoir was named one of thebest places to work in Virginia for the third consecutive year.

Even with this one-sided, time-restricted process, the members voted against the merger at the required special meeting. Unfortunately, that result was overwhelmed by the ballots submitted where members relied on the notice information.If a member trusts the credit union enough to send their money to it, why should they not rely on this same instinct if the recommendation is to close up the shop?

You Might Also Enjoy

• Credit Unions As A Cornerstone Of Freedom
• Why A Stronger Voluntary Merger Rule Is Necessary
• Credit Unions For Sale?
• Credit Union Sales Use Secrecy To Undermine The Movement
• How To Stop Exploiting Members In Mergers

What PenFed Gained

In the March 31, 2016, press release announcing the merger, PenFed made clear what it was gaining in this transaction:

PenFed expands its field of membership to include the Fort Belvoir military community which … is home to some of the top national defense organizations. … The largest employer in Fairfax County, Virginia, Belvoir boasts twice as many employeesas the Pentagon. PenFed also gains an employee team that is dedicated to member service, five convenient branch locations, and an outstanding membership base focused on America’s national security.

Belvoir’s board and management, while negotiating for their members’ best interests, transferred $41 million in collective book and market value in addition to the opportunities described above.

How did such a transaction ever get past the NCUA and its oversight of member interests and consumer rights? How could this event pass any description of fiduciary duty by either party?

A Blind Eye or Benign Neglect?

When a member who received the FOIA merger file (after nine months and multiple requests) and wrote a request that the transaction be reviewed, the NCUA replied:

(We have) reviewed the materials submitted … and determined that the merger’s disclosures and procedures complied with applicable NCUA regulations.

In other words, the transaction was legal.

In prior opinions NCUA has been explicit in some of its statements of fiduciary duty by directors and senior managers. Two such statements are especially relevant in this context:

1. In a February 2011 letter to federal credit unions (11-FCU-02), the NCUA stated what the duties of directors’ entails:
   ^ Directors must always focus on the best interest of the membership as a whole.
   ^ The requirementfor ‘reasonable inquiry’ means that the more complex a decision, and the more important the decision is to the financial interests of the members, the more due diligence the directors need to do in an attempt to make a good decision. (emphasisadded)
2. The General Counsel letter of March 15, 2011, directly addresses the central issue of fiduciary responsibility in Belvoir’s board’s merger recommendation: We believe that fiduciary duties are properly owed to people and not to entities… the danger is that, if the directors are allowed to focus only on the credit union when making a decision ? without regard to how the members are affected ? the directors can justify making self-serving decisions, or decisions that serve primarily the FCU’s insiders, under the guise that the directors are simply doing what is best for the credit union.(emphasis added)

Making A New Rule Matter

The difficulty of a new, more transparent rule is that for those who want to game the system, the new regulation can just become a more involved roadmap. The maneuvering outlined above undermines both the values and principles that cooperatives dependupon for stewardship of common wealth.

It’s Not Too Late To Make Your Voice Heard

• Click here for the new merger rule as published in the Federal Register on June 8, 2017. (11 pages)
• Click here for the full text of the proposed changes to 12 CFR Parts 701, 708a, and 708b. (52 pages)
• Click here to submit comments directly to the NCUA, due by Aug. 8, 2017.
• Click here to submit comments through NAFCU, due by July 19, 2017.
• Submit comments through CUNA, due by Aug. 7, 2017.

Credit unions are designed to be an alternative to the profit-driven ambitions of other financial institutions. Member-owner interest must be the dominant consideration if credit unions want to continue to claim a special role in the marketplace.

If the new rule merely provides boards and CEOs better guidelines for self-dealing, then no rule is going to eliminate greed. Boards, senior managers, and the NCUA need to recognize that fiduciary duties are meaningful even if they can never be fullycodified by rule.

Just as terms like democracy, justice, and freedom are always being reviewed against events, so, too, must the cooperative structure be constantly defined and defended.

The credit union system is a powerful and successful one that operates alongside the market economy. It is free from some threats because of its cooperative design and mission; however, even with good intentions, credit unions are always at risk of betrayingtheir mission by seeking the rewards of the for-profit sector.

Credit unions have shown they can survive adversity. But the real test of their character is how they use their success. Will it be to seek institutional glory and personal gain or to further the member-owners’ well-being?