Small L.A. credit union tries to foil merger.

It claims deal would result in loss of customers

The merger agreement reached earlier this year between two federal credit unions in L.A. County seemed at the time a fairly innocuous, voluntary absorption of a small institution by a much larger one. But the deal has sparked a legal battle that for the first time challenges the way federal regulators handle credit union mergers.

At issue is whether federal credit unions, as fundamentally different entities than commercial banks, should be allowed to enter into arrangements that might endanger the viability of other credit unions. In short, should regulators force credit unions to cooperate rather than compete?

Members of Alhambra-based Engineers Federal Credit Union agreed to merge with the much larger Lockheed Employees Federal Credit Union early this year, and the deal was approved on May 18 by the National Credit Union Administration, the agency that regulates federal credit unions.

Although the merger was consummated June 30, a complaint filed in federal court could eventually tear it apart, forcing both parties to perform a costly unwinding of their accounts.

Engineers Federal Credit Union was a fairly small institution, with approximately $40 million in assets, serving employees of the L.A. County Department of Public Works, along with workers at small engineering companies in the county. Burbank-based Lockheed Employees Federal Credit Union, on the other hand, is the second-biggest credit union in L.A. County, with nearly $1 billion in assets and 100,000 members.

Competitive threat

The dispute arose because Engineers Federal Credit Union competed with another small credit union for the same limited customer base - namely, employees of the Public Works Department. Public Works Employees Credit Union, a $28 million-in-asset institution that serves exclusively the 3,800 county public works employees, objected to the deal because it allows Lockheed to accept Public Works Department employees as members for the first time.

Fearing the merger would damage its membership base, Public Works Employees filed a complaint in U.S. District Court in San Francisco four days before the merger would be consummated, requesting a restraining order to block the deal.

The restraining order was rejected by the court, but attorneys for the Public Works Employees Credit Union responded by filing a request for a preliminary injunction that could still dissolve the merger. The case is scheduled to be heard Sept. 6 in the same San Francisco courtroom where the restraining order was rejected.

As a result of the court action, the NCUA has not closed Engineers Federal Credit Union's charter, normally the final step in a merger agreement. The charter is being kept alive until the matter is decided, according to an NCUA attorney, even though the two credit unions have already merged their accounts and memberships.

The court action - filed against the NCUA and not Lockheed or Engineers - claims that the agency did not follow federal regulations in approving the merger between the two credit unions. It was filed in San Francisco because the merger was approved by Daniel Murphy, the director of the NCUA's Pacific region, whose office is in the Bay Area city of Concord.

Joseph Melchione, a partner with the Glendale law firm of Styskal, Wiese & Melchione who represents Public Works Employees Credit Union, said the NCUA is obligated to study the economic impact of a proposed credit union merger on other credit unions whose memberships overlap. Although Public Works Employees repeatedly requested information and expressed its opposition to the merger to Murphy, its concerns were ignored, Melchione said.

Vague rules

Because credit unions are allowed to restrict their memberships - for example, they can legally cater strictly to certain ethnic or religious groups as well as certain employers - they are forced to follow specific rules restricting competition that don't apply to other banking institutions, Melchione said.

But the specifics of those rules are somewhat vague. The Federal Credit Union Act mandates that the NCUA consider "the economic advisability of the transaction" when deciding on mergers. In a policy manual for the NCUA, this phrase is defined to mean that the merged entity "will be a viable institution and its chartering will not materially affect the interests of the other credit unions or the credit union system," according to the complaint.

Nonetheless, an attorney with the NCUA who asked not to be identified said that doesn't mean all credit unions with an overlapping customer base have to be consulted before a merger is approved.

"The practice that has been in place for some time was followed here," said the attorney, who works in the NCUA headquarters in Washington, D.C. "This is a suit that wants to test the limits of our authority, and test the system in which the NCUA makes its decisions."

The case is to be determined based on the judge's interpretation of NCUA regulations and policies on mergers, which have never before been challenged in court, both parties agreed.

Melchione said the merger jeopardizes his client's future. Before the merger, Public Works Employees was competing against Engineers Federal Credit Union, another relatively small credit union that could offer similar services and rates to its own, he said. But when Engineers was absorbed by Lockheed, Public Works Employees found itself up against a giant with superior resources that could potentially sweep away its membership.

"We think the members (of Public Works Employees) lose in the long run because they lose a credit union that is dedicated to their interests and their interests alone," Melchione said.

"It's not just who offers the best loan rate today, it's who's going to be there in the long haul."