Presented By: Jeffrey M. Cardone, Esq. Partner Luse Gorman, PC jcardone@luselaw

1. Presented By: Jeffrey M. Cardone, Esq. Partner Luse Gorman, PC jcardone@luselaw.com www.luselaw.com (202) 274-2033 Should Your Credit Union Consider Buying a Bank? NYCUA EXCEL 2019 June 13-16, 2019

2. Who We Are • Luse Gorman, PC is a law firm that specializes in representing Credit Unions and other financial institutions. • We are a national leader in representing financial institutions in mergers and acquisitions, charter expansions/conversions, capital raising transactions, corporate governance, executive compensation and regulatory and enforcement. • We represent approx. 300 financial institutions nationwide. Most are ranging from $100 million to $30 billion in assets. 1

3. Who We Are • Top 10 law firm in M&A every year since 2001 • No. 1 in 2009, 2011, 2012, 2015, 2016, 2017 and 2018 • Structured the first transaction of a Stock Bank by a Credit Union. • Largest practice group nationally dedicated exclusively to representing financial institutions • 25 Attorneys, including 5 attorneys specializing in executive compensation/employee benefits 2

4. Agenda for Discussion 1.Industry Update/Why are Credit Unions Buying Banks? • 2. Unique Considerations. • 3. Life Cycle of a Bank Acquisition 3

5. INDUSTRY UPDATE/WHY ARE CREDIT UNIONS BUYING BANKS? 4

6. Current Environment • Since Dodd-Frank, financial institutions are faced with: • Higher capital requirements (Basel III; risk-weighting of assets, which will apply to “complex” credit unions). • Additional consumer disclosure and compliance procedure. • Greater emphasis on corporate governance. • Dodd-Frank was nominally scaled back in 2018 with enactment of the Regulatory Relief Act (S.2155). • Overall effect – more costly to operate, more capital needed, more emphasis on economies of scale (the bigger the financial institution, the less that is being spent on regulatory compliance costs as a % of total noninterest expense). 5

7. Increased Consolidation • As a result, there is a strong perception that “bigger is better,” which has accelerated financial institution consolidations since Dodd-Frank, notwithstanding that financial institutions are healthier than ever from a capital standpoint. • Primary Drivers of Consolidation: • Increase scale/reduce regulatory costs/reduce efficiency ratio. • Limited sources of earnings and growth. • Older management teams/boards - lack of succession planning. • Securing low cost of funds/deposits. 6

8. Increased Consolidation • Credit Unions also have a need for scale to offset increased operating, regulatory and compliance costs. • “Complex Credit Unions” (>$500 million assets) will be subject to new risk-based capital ratio, which will be incorporated into the NCUA’s PCA Framework on January 1, 2020 (10% or greater ratio to be “well-capitalized”). • Limited organic growth opportunities due to field of membership restrictions and member business lending rules, notwithstanding more liberalize rules. • This has resulted in an increase of acquisitions by credit unions of other credit unions and, more recently, of banks, in order to accelerate growth/expand faster, particularly in member business lending and other commercial lending. 7

9. Current Environment – Credit Unions 8

10. Why the Increased Interest in Banks? 1. Accelerate the expansion into new business lines that are more closely associated with banks. • Diversifying loan and deposit products. • Expanding into desirable new markets. • Accelerate the infrastructure and talent needed to expand member business lending/commercial lending. • Acquire low cost of funds. Statistics from the FRB of St. Louis (recent credit union acquisition of banks: • Acquirer credit unions average total business loans to total loans ratio was 8.6%; • Selling banks average total business loans to total loans ratio was 33.8%. • Acquisitions of banks raised the acquiring credit union’s ratio of total business loans to total loans from 8.6% to 10.9%. 9

11. Why the Increased Interest in Banks? 2. “Easier” to acquire a bank than acquire another credit union • Since no “purchase price” involved, Credit Union-to-Credit Union mergers are heavily dependent on “social” issues (i.e., naming the surviving institution, determining key management positions, selecting board members/committees and employee retention). • Very easy for “social” issues to break down/prevent a deal from happening. • In contrast, bank acquisitions (i.e., cashing out all stockholders, which would occurs in all credit union acquisitions) will be driven by “who can pay the highest price.” • As a result “social issues” (while important) are not the “primary driver” and there is less of an expectation that a seller’s social concerns must be accommodated. 10

12. Why are Banks willing to sell to Credit Unions? 1. Credit Unions have a stronger ability to pay than a bank (particularly if capital is strong) - Can pay a higher price/take on a “riskier” target bank (i.e., not a profitable) because (1) no stockholders/not under the same pressures as to the pro forma impact of the transaction; and (2) more favorable tax treatment (no corporate taxes paid by a Credit Union). 2. Culture Alignment - Selling bank may be more aligned with the “culture” of a credit union and prefer to “sell” to a non-profit entity rather than a distant large bank. 3. Less Execution Risk – it has been demonstrated that a credit union can successfully bid on a bank, obtain the required regulatory approvals and integrate a bank charter into its operations. 11

13. UNIQUE CONSIDERATIONS 12

14. 1. Deal Structure – P&A Transaction • Purchase and Assumption (“P&A”) – Credit union acquisitions of banks are generally structured as a purchase of assets and an assumption liabilities (i.e., deposits) transaction rather than as a “merger” or “stock purchase” transaction. • Federal law and most state laws do not allow for a direct merger of a bank into a credit union or for a credit union to purchase directly all of the stock of a bank and hold as a subsidiary. • “All Cash” Deal – The only consideration that a credit union can offer the stockholders of a target bank is “cash.” In contrast, a stock bank could offer stock, cash or a combination of both to the target bank stockholders. 13

15. 1. Deal Structure – P&A Transaction (cont’d) • Steps to Consummate P&A Transaction: • Credit Union makes a cash payment to the Target Bank (the “transaction consideration”). • The Target Bank’s assets are transferred to, and liabilities are assumed by, the Credit Union. • Following payment of any taxes/expenses, the remaining transaction consideration is paid as a capital distribution to the Target Bank’s holding company (if applicable) and the Target Bank dissolves. • The Target Bank’s stock holding company pays out all remaining assets, including the cash consideration received, to the stock holding company’s stockholders and stock holding company dissolves. 14

16. 2. P&A Transaction – Dissolving the Bank • In P&A Transaction – (1) the target bank (and its holding company, if has one) will need to be dissolved; and (2) the credit union will not be a “successor in interest” by operation of law applicable to a merger. • As a result: • (1) target bank will have to go through a process to dissolve (including paying out obligations, terminating contracts and tax-qualified plans, etc.) before transaction consideration is paid to its stockholders (which can be time consuming/expensive to target bank); and • (2) Credit Union will have to make sure the transfer of assets and liabilities of the target bank are completed in accordance with applicable law or assigned in accordance with applicable contracts, etc. 15

17. 3. P&A Transaction - “Double Taxation” • P&A Transaction will result in a “double taxation” to the stockholders of the selling bank: (1) taxes paid on any net gain from the sale of assets being paid by the target bank at the corporate level (unless S-Corp); and (2) taxes being by stockholders when cash consideration is distributed to them. • In contrast, a bank-to-bank merger generally will not result in double taxation (no tax at the corporate and taxes would only be paid by stockholders if receiving cash). • As a result, a credit union bidder is at a “disadvantage” compared to a bank bidder (if the deal consideration is the same, less of the net proceeds would be paid to stockholders in a P&A transaction because of the “double taxation”). 16

18. 4. Potential Target Banks - Expectations • Target banks for credit unions have been historically small (<$400 million in assets, with most common asset size between $50 million and $250 million in assets). • The size ratio of target bank to credit union has been generally 5% to 15% (based on asset size). • Important for credit unions pursuing a bank acquisition strategy to have realistic expectations of the size of the bank that will likely be acquired. 17

19. 5. How Bank Deals are Evaluated • Price to Tangible Book Value (TBV) is the driving metric for bank merger pricing for stockholders. • Price to TBV – what is it? • Cash/Invest. $ 25 Deposits $200 • Loans 190 Borrowings 15 • Allowance (5) Other Liab. 10 • Intangibles 5 Total Liab. 225 • Other Assets 35 Equity 25 • $250 $250 • Shares outstanding = 1,250,000 • $2.0 million in earnings in 2018 • $25M Equity/1,250,000 = $20 book value per share. • $25M Equity (less $5M in intangibles)/1,250,000 = $16 TBV per share 18

20. 5. How Bank Deals are Evaluated (cont’d) • Now assume a buyer offers $30 million. • Cash/Invest. $ 25 Deposits $200 • Loans 190 Borrowings 15 • Allowance (5) Other Liab. 10 • Intangibles 5 Total Liab. 225 • Other Assets 35 Equity 25 • $250 $250 • Shares outstanding = 1,250,000 • $2.0 million in earnings in 2018 • A $30 million offer equals: • $24 per share ($30 million/1.25M shares) • 120% of “book” ($24/$20 = 130%) • 150% of “tangible book” ($24/$16 = 150%) • 15 times 2018 earnings ($2.0M/1.25M shares) = $1.60 EPS • $24/$1.60 = 15x earnings. 19

21. 6. Credit Union Bid v. Bank Bid Understand that a “credit union bid” will be assessed differently than a “bank bid” by a target bank. • Because of the P&A structure - a “credit union bid” will be an amount for the asset and liabilities of a target bank. • Because of the merger structure - a “bank bid” will be an amount for all the stock of the target bank. • As a result, a target bank in comparing a credit union bid to a bank bid will want to understand how taxes, costs, transaction expenses will affect the “net amount” eventually received by stockholders. • EX) $30 million offer ($24 per share) for target bank in earlier hypothetical. The $30 million amount paid by a credit union for the assets and liabilities of the target bank may not (unlike a bank bid) result in the target bank stockholders receiving $24 per share because the $30 million of transaction consideration may be reduced by corporate taxes paid by target and other transaction expenses. 20

22. 7. Credit Union Offer Will Likely Be “Shopped” Understand that a target bank considering a cash offer from a Credit Union will likely “shop” the bank to several bidders • If there is a “sale of control” of a bank (i.e., a cash offer, which would be the case for a “Credit Union Bid”), the board of target bank must exercise its fiduciary duty to obtain the best price reasonably available for its stockholders (“Revlon duties” – Delaware case law followed by most states). • As a result, a Credit Union should expect that its offer will be tested against other offers (i.e., a market check). • The foregoing solicitation process, along with taxes, costs, transaction expenses that may affect the “net amount” received by target bank stockholders will be factors in determining whether the “Credit Union Bid” is acceptable. 21

23. 8. Credit Union Has Advantage of Being “Member Owned” Credit Unions competing in the bank M&A arena have an advantage over other banks bidding for a target bank because the Credit Union is “member owned” and has “no stockholders.” • Credit Unions can “pay more” (i.e., credit union bid can be higher) because (1) they do not have to worry about the effect on stockholders; and (2) they have a more favorable tax treatment. • A stock bank making a competing bid may be more limited because the bid may be criticized by stockholders if its pay too much (e.g., the offer may be too dilutive to the stock bank’s stockholders). While Credit Union can “pay more,” it’s important not to bid more than necessary. Discipline is important. 22

24. 9. Credit Union Has A Disadvantage Due to Only Paying Cash/P&A Structure. • Credit Unions can only pay cash, which if a competing bank bidder is offering stock, it may have an advantage if stock is viewed as having the potential for growth value (unlike cash, a stock deal does not have to be the “highest bid” because of the potential growth and target bank is making an “investment into the buyer bank”). • P&A Structure may have negative tax consequences to the target bank and its stockholders (unlike a P&A transaction, a “merger” is generally tax free at the corporate level and a “merger” with stock consideration is tax-free at the shareholder level). • Higher fiduciary standards/likely for deal to be shopped for a Credit Union bid since it will be “all cash” (“sale of control,” (i.e., all cash) triggers Revlon Duties – board of stock bank has fiduciary duty to get the “best price reasonably available.”) 23

25. 10. “Memberizing” customers of Target Bank • Credit Unions should plan early in the process in terms of how it will “memberize” customers of the Target Bank. Considerations: • Field of Membership Expansion - Would Credit Union have to expand field of membership to cover the customers of the Target Bank/would this be permissible by NCUA/state regulator? (e.g., expand the communities that credit unions service or additional select employee groups (“SEGs”)). Good news – regulators receptive for FOM expansions in business transactions. • Membership of Target Bank Customers - Since P&A transaction, most likely that Target Bank customers would have to take “affirmative action” to join the Credit Union (required if federal or federally insured), which means that no deposits may be transferred from Target Bank to Credit Union unless potential members affirmatively subscribe to membership in the Credit Union. • Borrower Customers of Target Bank w/o Deposit Accounts – To assume the loan relationship, the customer must have an “account” with the Credit Union. 24

26. 11. Impermissible Assets/Activities of Target Bank • Important for Credit Union to evaluate the Target Bank’s activities and balance sheet composition for impermissible activities and assets and liabilities. • Examples: • Commercial loans with original maturities that exceed 15 years. • Commercial loans cause member business loan balances to exceed statutory limits. • Municipal Deposits and Brokered Deposits that may not be permissible for the Credit Union to hold. • Good news – NCUA generally gives a post-transaction period (up to 6 months) to bring into compliance (or sell into the secondary market) non-conforming loans. 25

27. 12. Compensation/Severance Costs and Personnel Issues • Need to assess additional deal costs of severance benefits payable under employment and change in control agreements (which many banks maintain). • Key personnel/lenders of target bank for new line of business – how will credit union ensure their continued employment (or protect their interests to the extent the key personnel/lenders do not want to remain employed). • Need to assess the tax-qualified retirement plans and SERPs of the target bank and how they will be treated in a transaction. • The termination and liquidation ESOPs (which many banks maintain) may present tricky issues and may add deal costs in connection with the termination/liquidation of an ESOP (shares must be liquidated based on an appraised value which may exceed the per share consideration received by other stockholders). 26

28. 13. Converted Thrifts and Liquidation Accounts • If Target Bank is a converted thrift (i.e., federal or state savings bank converted from mutual form of ownership), the institution will likely have a “liquidation account.” • A converted thrift is required to establish a liquidation account (which is an “accounting entry” equal to thrift’s “equity” ) at the time of the conversion that represents the ownership interest in the mutual bank by depositors just prior to the conversion and the balance of the liquidation account must be paid to depositors in the event of a “liquidation.” • An acquisition by a Credit Union of a converted thrift is now considered a “liquidation” by the Federal Reserve and therefore would require the payout of the liquidation account balance in effect to depositors of the converted thrift (which this is another deal consideration, potential cost). 27

29. LIFE CYCLE OF A BANK ACQUISITION 28

30. Life Cycle of a Bank Acquisition • Planning phase. • Due diligence of potential target bank. • Negotiating/executing a definitive P&A Agreement. • Required regulatory and/or stockholder/depositor approvals, depending on type of transaction. • Closing of the transaction/integration of target bank/employees/customers. 29

31. Consider possible acquisition targets and market areas for expansion. Consider who your M&A competitors are and their ability to pay, particularly since you can only pay cash. Pricing analyses by investment banker enable management and the board to be informed and make informed decisions (how much can you pay/do you have the necessary net worth/how would a potential deal impact regulatory capital?) Should you have a relationship with an investment banker/should your business plan be updated? Understand/take into consideration additional potential “costs” in determining how much you can pay (i.e., taxable transaction and other potential considerations that could impact the net consideration received by the target bank stockholders). Planning Phase 30

32. Planning Phase • Buyer needs to address any unresolved supervisory issues and communicate with your regulator regarding your strategic plans • Have all MRAs in most recent ROE been addressed? • Any outstanding regulatory action, whether a formal action or MOU, may be a bar to regulatory approval. • A less than satisfactory compliance or management rating may prevent a Buyer from obtaining approval, even if overall CAMEL rating is “2” or better. • Need to discuss with NCUA/state regulator plan for FOM expansion/plan to address non-conforming assets/activities. 31

33. Planning Phase Selecting a merger partner and having the “right fit.” • Corporate culture synergies? – Important for transitioning customer relationship. • Asset quality – due diligence very important. • Integration of bank and their customer markets into the Credit Union. • “Memberizing” customers and Field of Membership Issues. 32

34. Planning Phase – Social Issues • Branch Closings and Business Line Consolidations/Expansions • Compensation and Benefits: • Employee and directors plans and payments. • Pre - and post merger arrangements. • How will you incentivize key target employees to remain employed until closing/systems conversion date? 33

35. Typical Solicitation Process – Target Bank • Board approves parties to contact (parties selected are based on 1) ability to pay; 2) prior acquisition activity; 3) ability to execute; and 4) prior expressed interest). • Investment banker contacts parties and requests each to enter into confidentiality agreement. • Parties are provided with a “solicitation book” or confidential information memorandum about the target bank. • If interested, Buyer provides a “non-binding indication of interest” or letter of intent. • Sets forth key business terms (price, structure, etc.) • Sets forth key social issues (board seats, officers) 34

36. Planning Phase/Next Steps Next Steps Once You Find a Potential Target: • Preliminary meetings – senior management/board. • Engage advisors to prepare pro formas, costs and terms. • Negotiate/enter into letter of intent (i.e., term sheet). • Sets forth key business terms (compensation, deal costs). • Assess how taxes, costs of liquidations and other expenses will impact the transaction/net amount received by target bank stockholders (very important). • Sets forth key social issues (board seats, officers). • Letter of intent is non-binding; however – important to address key issues upfront to avoid “wasting everyone’s time.” • Meet/have discussions with the regulators. 35

37. Due Diligence • Generally there is an “exclusivity period” to “look under the hood” and conduct due diligence of target bank before signing merger agreement. • Review loan portfolio/asset quality. Important to understand impermissible assets/activities (could reduce the franchise value of target bank). • Understand adverse regulatory issues of target bank. • Review board/key committee minutes. • Management interviews of target bank (i.e., ask questions about business, reports of examination and CAMELs ratings). • Vendor agreements/termination fees. • Understand costs of liquidation of target bank (potential tax impact and final costs/steps to liquidate target bank) – Will target bank have enough remaining assets after transaction consideration is paid to stockholders to pay remaining expenses? If not, how will this be addressed? 36

38. Due Diligence - Compensation • Quantification costs/dealing with compensation issues are critically important. • Buyer should focus on aggregate potential costs, including: • Payments triggered on change in control (i.e., single trigger). • Payments triggered on termination of employment (i.e., double trigger). • Review all “good reason” provisions under target employment/change in control agreements, particularly in “merger of equals” transactions. • SERP and other benefit plan termination costs could be greater than reflected on balance sheet, e.g., discount rate for early termination of SERP could be greater than that used for accruals. • ESOPs (tax-qualified plan invested primarily in shares of employer stock) could add additional costs in terms of liquidating the plan. 37

39. Negotiating/Entering into P&A Agreement • Key provisions of a typical P&A Agreement: • Price/deal consideration. • “Walk” provisions. • Social issues – board of directors; senior management; employee benefits; severance payments; etc. • Due diligence protection provisions – representations and warranties; material adverse effect. • Restrictive covenants (i.e., restrictions after signing). • Termination fees and “no-shop” provisions. • Understand the regulatory/shareholder/depositor approval requirements of the transaction. 38

40. Regulatory Approvals – Credit Union Regulatory approval of transaction/potential Field of Membership Expansion is needed from primary federal regulator (NCUA) and state regulator. Member vote is generally not required. NCUA/state regulators generally consider: • Impact on members. • Financial impact (pro forma net worth) • Field of membership/impermissible assets and activities (what is the plan to deal with these issues)? 39

41. Regulatory Approval – Target Bank • Approval of Primary Federal Regulator or State Banking Department regarding the liquidation of the bank and transferring the transaction consideration to the holding company/stockholders, as applicable. • FDIC approval of transfer of assets and deposits and the termination of deposit insurance. • Federal Reserve approval/non-objection (if target bank has a holding company) to pay transaction consideration as a dividend to stockholders. 40

42. Depositor/Stockholder Approval • Target Bank stockholders will need to vote to approve: (1) the P&A transaction; and (2) the liquidation of the bank/bank holding company pursuant to a plan of dissolution. • Target Bank depositor vote to approve the transaction may be required to avoid NCUA requirement that each member must take an affirmative action to become a member of the Credit Union (per agreement with NCUA/OCC in GFA/Monadnock transaction, each depositor had one vote and a special meeting was called within 60 days of NCUA approval of the transaction). 41

43. Closing/Post-Closing of the Transaction • Complete all closing items required to consummate the P&A transaction. • Dissolve the target bank/holding company, as applicable and payout transaction consideration (and any other remaining assets) to the target stock holders. • Take all final actions re: dissolutions (final tax return, file required dissolution documents with state of incorporation, as required). • Payout of change in control benefits, as required by contracts and arrangements of Target Bank. • Terminate Target Bank employee benefit plans • Integration/”memberizing Target Bank customers. • Address non-conforming assets/activities per discussions/agreement with NCUA/state regulator. 42

44. Getting The Deal Done – Take-Aways • Current banking landscape offers Credit Unions opportunities to expand their franchise and enhance value through acquisitions. • Lack of succession planning, regulatory/compliance costs, and the impact of technology will continue to generate consolidation, particularly for community banks. • Planning is essential and consider having discussions with an investment banker/reaching out to banks in target market areas to see if there would be an interest to a strategic partnership. • Work with legal counsel/financial advisors that have an understanding of both sides of the acquisition (i.e., the legal and regulatory framework of and the differences between credit unions and banks), which increases the likelihood that a Credit Union will be a successful bidder/reduces execution risk. 43

45. LUSE GORMAN, PC ATTORNEYS AT LAW TELEPHONE (202) 274-2000 FACSIMILE (202) 362-2902 www.luselaw.com Jeff Cardone, Partner (202) 274-2033 (direct) jcardone@luselaw.com 44