10 minutes
In the high-stakes game to thrive in the world of financial services, the credit union service organization is a wild card that credit unions are playing with growing effectiveness. The CUSO “card” is wild and effective because it can become a lot of different cards as needed to make a winning hand.
Notably, it has become wild enough and effective enough that pit boss National Credit Union Administration is starting to pay attention to how it’s played. (See cues.org/072015risk and cues.org/nacusosummary for more about CUSO regs.)
Most CUSOs are set up as limited liability companies that pass through profits to the owners. Owners that are tax-paying entities pay taxes on the profits, but those that are not, like CUs, pay no income taxes, explains Guy Messick, general counsel of the National Association of Credit Union Service Organizations, Newport Beach, Calif., and a partner in the Media, Pa., law firm Messick & Lauer PC. The exception to this result is if the credit union is state-chartered and the CUSO’s activity is not related to the purpose of the credit union’s tax exemption.
For federally chartered CUs the investment limit in CUSOs is 1 percent of an owner-CU’s assets; the CU can lend another 1 percent of assets to CUSOs. For state-chartered CUs , the rules vary widely; investing up to 10 percent of assets is allowed in Texas, for example.
A Quick History of CUSOs
CUSO formations have come in waves, reflecting demand for financial services and restrictions on what CUs can offer within the CU, reports Jack Antonini, president/CEO of NACUSO. The first big wave of CUSO formation occurred in the mid-1980s, when they were the only way for CUs to offer wealth-management services. When restrictions were eased so CUs could offer such services directly, the need for CUSOs waned. But a second wave of CUSO formation occurred in the late 1990s as a way to gain operational efficiencies.
What started as a way to share commissions on the sale of securities and insurance has become an important source of interest and non-interest income and reduced operating costs for CUs, Messick adds. Without noninterest income from CUSOs, many would have operated in the red during the financial crisis following 2007, he says. The crisis stopped all innovation temporarily as financial institutions hunkered down, but now CUSOs are being formed again as spread income from loans continues to languish, he reports. Small CUs have the most to gain from CUSOs but are using them less than larger ones, he adds.
Among CUSOs that have had a big impact on the industry, Antonini cites CUES Supplier member CU Direct, which provides indirect auto loans from 12,000 dealerships to over 1,000 CU clients; CU Revest, which uses big data in sophisticated ways to deal with charged-off loans; CU Wallet, which has pooled investments from 80 CUs to develop a CU-branded digital wallet; and the now-defunct Member Gateways, formed expressly to investigate CUSO opportunities and launch CUSOs. Its efforts produced still-operating CU Realty and CU Financial Services, a broker-dealer.
Over time, two CUSO models have remained durable: aggregating back-office activities from multiple CUs to gain scale and efficiency, and offering popular financial products that CUs can’t offer directly.
Denver-based Open Technology Solutions is a good example of how CUs can save money with a CUSO. It’s a shared-services technology center for three CUs: $3.2 billion Bellco Credit Union, Greenwood, Colo.; $5.9 billion Bethpage Federal Credit Union, Bethpage, N.Y.; and $2.9 billion SECU of Maryland, Linthicum.
“We provide a full suite of technology services for our owners/partners,” says CEO Mike Atkins. “We combine the needs of two $3 billion CUs and a $6 billion CU to run the kind of efficient and robust tech center you expect in a $12 billion CU, with expertise that would be very expensive if any one of them were funding it on their own.” To make it all work, OTS “drives a lot of collaboration across our partners,” he explains.
OTS operates on a cost-sharing model, and contributes to the three CUs’ bottom lines. “It would cost each of our partners a couple million dollars a year to perform the same services in house,” Atkins says.
Gaining Scale
Aggregating operations activity from hundreds of CUs has built some of the biggest and oldest CUSOs like CUES Supplier members PSCU and CO-OP Financial Services.
For a large, 37-year-old CUSO with over 800 member-owners, St. Petersburg, Fla.-based PSCU has a simple mission: “We’re a scale play,” says Chuck Fagan, president/CEO. “Processors see us as a single big client with many sub-clients,” he explains. The typical CU has about 50,000 credit and debit cards, he says, while PSCU has 18 million.
“To our processor (First Data), we look like a single massive financial institution with over 800 end points,” he says. “We qualify for their best rates and pass them on to our owners. On their own, they’d have trouble even getting First Data’s attention.”
That scale play works for innovations like Apple Pay and EMV, Fagan says. “It would be a huge headache for Apple to try to deal with 6,000 end points. By consolidating them into a much smaller number, we make it feasible for Apple and CUs to work together. We have over 150 CUs signed up for Apple Pay and 70 already in production,” he says. And needing to convert 18 million plastic cards to EMV chip cards makes scale a tremendous positive factor, he adds.
CO-OP Financial Services, Rancho Cucamonga, Calif., has 3,500 CU clients and 1,200 owners, according to Caroline Willard, EVP/markets and strategy. She sees CUSO growth as part of an industry consolidation as it gets harder for small, independent CUs to survive. One of the first things CUs may try is sharing back-office operations and expenses with a neighbor or like-minded CU. It can be an alternative to merging, she notes.
With its size and range of offerings, CO-OP Financial Services bears some resemblance to a commercial vendor. In fact, it often competes in RFPs with commercial vendors. Where it’s different, however, is its profit sharing.
“We pay out part of our retained earnings as patronage to our owners,” Willard explains. “They share in our success.” Earnings are not the primary measure of success, she notes, but CO-OP Financial Services provided its owners with a shareholder dividend pool of $29.2 million for 2014, bringing its total shareholder patronage amount to $314.1 million since it became a CU-owned cooperative in 1996.
Adding Products
If CUSOs can be useful for aggregation and cost-saving, they can also provide diversification and revenue generation. At $1.1 billion Allegacy Federal Credit Union, Winston-Salem, N.C., CUSOs are a strategic tool in the hands of Rick Leander, president/managing director of CUES Supplier member Allegacy Business Solutions.
In its Allegacy Business Solutions CUSO, Allegacy FCU has put together a portfolio of businesses designed to serve small and mid-sized businesses (as well as other CUs), and to boost the CU’s noninterest income and profitability. There’s a payroll business, an insurance brokerage, a real estate agency and, now coming online, a management consulting business and a media services business to help members use video well.
Most of the CUSOs are wholly owned by Allegacy FCU, which also owns a 40 percent stake in Advanced Fraud Solutions and also has investments in MBL LLC, and CFS, a broker-dealer.
“We decided to take the things we did well internally and monetize those capabilities as services we sell to our business members and other credit unions,” Leander says. “There are things CUSOs can do that credit unions can’t, but they all fit a coherent business footprint of skills we have or have acquired and services our clients need.”
And monetize, Allegacy FCU did. The CUSOs have contributed 20 to 30 percent of the organization’s net profits in the last three years. “In 2011, while we were still recovering from the financial crisis, we made a profit of $500,000,” Leander reports. “Last year, we made $8.3 million. This year we’re doing even better.”
If Leander doesn’t sound like a traditional CU executive, he’s not. As a commercial banker, he worked internationally for Citibank and Bank of America until switching to CUs in 2010.
Single-owner CUSOs generally rent CU employees, but it’s not unheard of for a CU to buy a local business like an insurance agency and turn it into a CUSO, perhaps with the top insurance agent running it, notes Messick. When CU talent gets involved in CUSOs, it expands their career opportunities and can improve morale, he adds.
Creating Technology
What’s new is the radical convergence of financial services and consumer technology, fertile ground for new CUSOs. CUs can partner with smart Silicon Valley financial technology startups and maybe end up with an ownership stake in something like the next PayPal, notes Matt Davis, founder of CUES Supplier member gameFI, Madison, Wis.
Financial technology entrepreneurs are good at the creative disruption that is changing the financial services marketplace, and CUs have members that could use the technology, he explains. Entrepreneurs generally like to work with CUs because they are nimble, don’t have balky shareholders to satisfy and enjoy tax-free status, he explains.
Davis knows what he is saying because gameFI is a tech start-up looking for a user base. The platform uses game thinking to transform the workplace experience of CU personnel in teller lines and call centers to drive employee engagement, member service levels, and business results. gameFI is currently a C corporation with two large CU clients, but Davis and his two partners, who together own the company now, are actively investigating forming a CUSO that would probably be a subsidiary of a holding company. CUs would have a significant ownership stake in the CUSO, he explains.
Traditionally, CUs have turned to tech vendors to provide the expertise and development budgets they can’t afford on their own, but multiple-owner CUSOs open up an alternative that puts the expertise and more of the revenue inside the CUs, Davis notes. And it lets them choose the projects.
Partnering with CUSOs may not be the most aggressive way for entrepreneurs to leverage their intellectual properties into lucrative IPOs, given the conservative culture of CUs, but Davis insists that getting rich doesn’t have to be the primary reason to form a CUSO. While CUSOs can drive significant noninterest revenue, Davis suggests that startups might be drawn to credit unions because of alignment with cooperative and not-for-profit ideals.
“Making a difference in people’s lives is pretty attractive to many young entrepreneurs,” Davis says. CU “philosophy provides us with the opportunity to do well and do good at the same time.”
While financial technology entrepreneurs and CU leaders working together through CUSOs can be a powerful engine for change, they may have different values and motivations, Messick cautions, so contracts that protect both parties are critical. “There need to be contractual ways for either party to leave the relationship in a reasonable and fair manner. We’ve seen situations where a breakup was difficult and the parties that ended up making the most money were the lawyers,” he observes.
The influx of technology ventures and entrepreneurs is affecting CUSO leadership, which traditionally came from CUs and often still does, but it’s becoming common to find a career banker, technical expert or financial entrepreneur taking the CEO spot or other leadership roles, Messick reports.
CU Revest was led by outsiders, and Paul Fiore of CU Wallet came from the technical world, Messick notes. A multiple-owner CUSO can afford to hire top talent that none of the individual CU owners could afford, and sometimes a big compensation package may be justified, he says.
Richard H. Gamble is a freelance writer based in Colorado.
