The Hidden Value(s)

Unseen 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.

 
 

''Unseen 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.''

Credit unions 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.

The absence 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?

The Market Values A Credit Union Franchise

Recently some of the potential ''unseen value'' of credit unions was revealed when a former credit union agreed to be acquired by a bank holding company.

IGA Federal 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.

On November 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''?

Worth More Than Book

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.

The analysis of the price paid for Jade Financial in the announcement of the merger included the following ratios:

Price/Latest 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.

An Indicator 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.

This reality 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 value.

The True 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 wealth'' important?

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 being.

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.

 

 

 

March 26, 2001


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