CUSOs can help you build full-service success

Here's a fresh perspective: credit union service oraganizations (CUSOs) occupying the top spot on the organizational chart, with credit unions as the supporting base. That might soond like the tail wagging the dog to you, but it's not that farfetched in the minds of CUSO proponents.

After all, CUSOs provide sophisticated financial services credit unions can't. They literally put the "full" into full-service credit union. Credit unions can use CUSOs to create economies of scale (shared branching, employee leasing, and data processing) ... to give members more sophisticated financial services (mortgage originations and servicing) ... and to provide a complete array of sophisticated investment options (insurance, stocks, bonds, and mutual funds).

What's more, CUSOs can serve nonmembers-provided the aggregate amount of income from nonmembers doesn't exceed 49% of CUSO income-and expand credit union market potential. CUSOs offer potential, plenty of potential. That's how Bob Dorsa would see it. He's the head of a 200-member trade association for CUSOs-the National Association of Credit Union Service Organizations (NACUSO) in Newport Beach, Calif.

To hear Dorsa tell it, the nearly 2,000 credit unions that have ownership investments in about 600 CUSOs nationwide are well-positioned for the 21st century. "Loyalty, affinity, common bond-those things that got us through the latter part of the 20th century-are going to be mitigating factors in the future," Dorsa proclaims. "Consumers now want quality, pricing, delivery, professionalism. And they're not going to settle for less."

To Dorsa's way of thinking, a CUSO provides the best opportunity to satisfy those consumers. CUSOs aren't new. They've been around since the early '80s and credit unions have used them to offer a variety of services. They help achieve back-office economies of scale in shared branching networks (as in the case of Service Centers Corp. in Michigan, with nearly 300 credit union investors) and in data processing (Users Inc., Valley Forge, Pa.). And they provide sophisticated investment and insurance services to give members a full range of financial service options.

Why, then, haven't more credit unions embraced CUSOs?

First, they're largely unknown, and there's a natural fear of the unknown, Dorsa says. He points out, for example, that credit unions make only 2% of the mortgage originations in the United States. "And we know even less about the insurance and investment business than we do about the real estate origination and servicing business," which are natural extensions of services credit unions do offer.

Second, many credit unions take the wrong approach to managing CUSOs, claims Dorsa. A lot of people who manage CUSOs already have full-time jobs at credit unions. "So we're talking about diminishing returns-CUSO managers use most of their resources and energy dealing with credit union products and services, so there's not much enthusiasm left to give to the CUSO."

Third, the CUSO profit motive seems to butt heads with credit unions' not-for-profit philosophy. "God bless the volunteers," says Dorsa. "They've gotten us to where we are now. But some of them just don't understand how a for-profit subsidiary is necessary to compete today. People who believe profitmaking is sacrilegious are missing the boat."

Fourth, credit union cooperation oftentimes breaks down. "Our industry, apart from the concerted effort on H.R. 1151, doesn't have the greatest track record for working together on an ongoing basis."

Dorsa envisions 200 to 300 CUSOs serving credit unions nationwide. They'd be the creme de la creme. Credit unions, for example, would tap the expertise of the best credit union mortgage lendersNavy Federal, San Antonio Federal, Xerox Federal, or Hughes Aircraft Employees Federal-and build topflight mortgage origination and servicing CUSOs, like CUMANET in West Patterson, N.J.

"If we did it right and approached it the way Dave Thomas [Wendy's], Ray Krock [McDonaids], or Col. Sanders [Kentucky Fried Chicken] did," says Dorsa, "we'd be in fat city. But we try to do it with credit union resources that are already overwhelmed."

Like Dorsa, Guy Messick has been hawking CUSOs from coast to coast for years. He sees CUSOs as linking credit unions to virtually any financial service and cutting operating costs to serve members more efficiently. In particular, Messick and Dorsa see CUSOs as a way to keep members from going elsewhere for more sophisticated services.

Messick, an attorney in Media, Pa., specializes in helping credit unions set up CUSOs. He's also NACUSO's legal counsel. While Dorsa and Messick acknowledge that credit unions can't be all things to all people, CUSOs can help them come close.

Why consider a CUSO?

It's apparent that Dorsa, Messick, and other CUSO proponents see CUSOs as a way of rounding out member services. Why?

First, the 1,891 credit unions that have ownership interests in CUSOs serve more than 40 million members and represent more than 50% of the movement's assets, according to midyear call report data from the National Credit Union Administration (NCUA).

Second, CUSOs give credit unions an opportunity to serve up a full platter of more than 50 financial services to members. But more important, CUSOs give credit unions an entree into credit union members' investment portfolios via investment and trust services that heavyweight competitors provide.

What CUSO proponents contend is that the environment is ideal for credit unions to consider forming CUSOs, or at least using their services. That's because today's environment shows a wholesale shift of investments from traditional financial institutions to mutual funds and high-end investment options, a regulatory climate that encourages rather than discourages CUSO operation, and the constant battle to keep expenses under control.

Take the stock market, for example. For now, at least, the longest bull market in history has changed the way consumers invest. Consumers are moving their investments away from traditional financial institutions. Credit unions, banks, and savings and loans held 90% of consumers' assets in 1980. Today, that share is 56% and shrinking.

"Credit unions have one-third of members' deposit and loan business but only about 9% of their investment business," noted Tom Davis, a Highlands Ranch, Colo., consultant who spoke to about 150 attendees at CUNA's inaugural CUSO Institute last fall.

It's estimated 42 million households own mutual funds, and that number will climb nearly 12% to 47 million by the year 2000. Likewise, the greater the household income, the greater the likelihood of mutual fund ownership, which climbs from 18% among households with less than $35,000 in annual income to 73% of households earning $75,000 or more in annual income.

CUNA's National Member Survey, sponsored by Credit Union Magazine, shows 34% of members own stock or bond mutual funds, 26% own publicly traded stocks or corporate bonds, 22% own money market mutual funds, 19% annuities, and 7% government securities. In the life cycle of mutual fund ownership, peak ownership years are between ages 35 and 54, which coincidentally mirrors the penetration peak for credit union membership. With the stock market booming, is it any wonder members' use of stock and bond mutual funds and money market mutual funds increased 21% and 47%, respectively, between 1996 and 1998?

These trends suggest credit unions must address members' changing investment demands. Larry Sharp, president/chief executive officer (CEO) of Arrowhead Central Credit Union, San Bernardino, Calif., addressed this issue recently in CUNA's Credit Union Executive Journal. Sharp pointed out that CUSOs would allow credit unions to become gatekeepers for members' financial relationships. Using a CUSO to provide brokerage and trust services helps credit unions help members looking for financial solutions. It keeps the member in touch with the credit union.

Most important, Sharp noted, credit unions can access pretax retirement dollars and help members get higher yields, tax advantages, payroll deduction convenience, selfdirection, and borrowing provisions. In short, CUSOs can elevate credit unions to a level above the traditional savings and lending function. Advocates like Sharp believe credit unions need to become retailers of traditional and nontraditional financial services.

What is a CUSO?

CUSOs are limited partnerships, corporations, or limited liability companies in which a credit union has made an investment and/or a loan. NCUA regulations regarding CUSOs limit a credit union's financial risk, define the services CUSOs can offer and whom they can serve, and protect against conflicts of interest between the CUSO and the credit union's officers and directors.

Essentially there are two types of CUSOs:

1. Those set up to perform back-shop operations for credit unions, such as accounting or processing operations. An example of this is Credit Union Services of Montana, Inc. (CUMONT), formed by Billings Federal, Laurel Federal, Livingston Federal, and Yellowstone Teachers credit unions in 1991 to provide data processing, electronic tax filing, mortgage processing, marketing, collections, and other services for shareholders and credit union clients.

Each shareholder-credit union owns equal shares in CUMONT and has two voting representatives on the CUSO board. The CUSO has a break-even philosophy, having been established to take advantage of economies of scale by outsourcing back-office functions. Shareholders must unanimously agree to issue additional stock or add a new shareholder, assess additional capital contributions, change the fee schedule, change the location of CUMONT offices, borrow money, modify the original corporate agreement, or distribute profits.

2. Those that offer financial services to members, such as discount brokerage, trust services, or insurance. Purdue Employees Federal Credit Union, West Lafayette, Ind., established its CUSO in 1995 to provide a variety of products for members. Among the services it offers are investments, auto purchasing, mortgage origination and servicing, property and casualty insurance, and trusts. (The CUSO also provides some back-office services for credit unions.)

Where appropriate, Purdue Employees Federal's CUSO has formed a strategic alliance with vendors such as CUNA Mutual Group's Plan America. The end result is literally a shopping mall where members can get everything from investments to insurance to travel and cell phone services.

Today, three of every four CUSOs being formed provide member services, such as selling securities or various types of insurancelife, disability, long-term care, casualty, homeowners, property, and auto. Estate planning can generate revenues without a lot of upfront investment or administrative costs, Dorsa says. The key is getting good market penetration.

Credit unions staff about four of 10 CUSOs, Dorsa estimates. The rest are "pass throughs"-staffed by vendors with whom the credit union has a contract. In some cases, revenues come from product sales. In other cases, where regulatory restrictions exist, revenues come from renting space to the vendor. Dorsa says the average credit union invests about 2% of assets in a CUSO. Twenty-eight credit unions have more than $1 million invested in CUSOs.

Getting started

With 600 CUSOs already in existence, credit unions might look first at joining one already in existence-either on an ownership basis or as a customer. Should you choose to start your own CUSO, there are a number of resources available (see Resources).

You could start with Messick, author of numerous CUSO articles, an organizational manual, and a directors' guide. He maintains a Web site (www.cu-cafe.com) for attorneys and senior credit union staff to discuss issues and concerns. You could tap NACUSO's resources, attend CUNA's next CUSO Institute this fall, or contact credit unions already in the business and learn from them ("CUSO makers and shakers," p. 58).

Credit unions considering starting or participating in a CUSO need to develop a business and capitalization plan, conduct market research to determine need, get legal help, develop an action plan, and maximize liability protection. It all starts with having a concrete purpose or objective, and developing a vision or mission statement.

What difficulties can you expect?

Starting a CUSO requires intensive planning. Consultant Tom Davis notes it took one of his clients two and a half years from its first CUSO meeting before it had completed its business plan. He cautions that many credit unions starting out have a tendency to overestimate the income a CUSO can generate in its first three years. Dorsa cautions not to underestimate the human resources such a project demands.

A CUSO often requires developing or hiring new management expertise. After all, depending on the services being offered, a CUSO might need expertise in a variety of services-insurance, trusts, investments, financial planning, and securities.

Regulatory oversight is a major consideration, with (potentially) a variety of regulators-NCUA's oversight of the credit union's investment and involvement, the state department of insurance, state department of banking regulations for trust operations, the federal Securities and Exchange Commission, and, if successful in this for-profit venture, the Internal Revenue Service.

See why some credit unions might be hesitant to start down the CUSO route?

"There's a natural hesitancy when it comes to getting involved with something you don't know," Messick notes. The rules are different from running not-for-profit credit unions.

Of course, you'll have to determine the degree, if any, of overlap, between the credit union and the CUSO. Should your credit union's board and employees also serve the CUSO? While that's a natural desire, Messick warns that the greater the overlap, the greater the likelihood regulators will treat the CUSO like a division of the credit union. Too much overlap significantly increases liability exposure.

And when it comes to sharing employees, the rules are strict. The credit union CEO cannot serve as CUSO CEO nor receive pay from the CUSO. The CUSO, however, can reimburse the credit union for services, provided payments are made within 90 days.

CUSOs differ significantly from credit unions. There will be cultural differences that management should address. Credit unions are not-forprofit entities; CUSOs, most likely, are for-profit.

Consider the compensation issue. The overall compensation packages at each entity will be different, as they should be. At the Air Academy Service Corp.-the CUSO for Air Academy Federal Credit Union in Colorado Springs, Colo.-the compensation structure for CUSO employees is nontraditional. Financial planners and mortgage originators are on commission, earning market-based pay. Financial planners and mortgage originators earn more than credit union employees, and more than their supervisors during boom markets.

"You get what you pay for," says Air Academy Federal CEO Glenn Strebe. "If you want topquality employees, you pay topquality salaries."

Address the issue head-on, advises Strebe. Credit union employees will find out what CUSO staff earn when CUSO staff apply for loans. Explain what credit union staff have to do to earn those financial rewards and how you'll help them.

But tell them the downside, too. For example, there's a reason why mortgage originators are called "mortgage gypsies": When the market goes into a slump, layoffs often result.

You have to manage cultural and service differences as well as the CUSO's support needs, Strebe says. Flexibility is the key because CUSOs are offering more than 50 different services to credit unions and their members.

Credit unions shouldn't think in terms of CUSOs, says Dorsa, but in terms of service organizations. "This is about making the credit union stronger and helping your members."

Copyright Credit Union National Association, Inc. Feb 1999
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