Beyond liquidity

Corporate CUs are at the forefront of product development

It's getting so credit union members can go online the day their checks clear and retrieve images of cancelled checks as proof of payment. That's because of services like those from Southwest Corporate Federal Credit Union in Dallas: digital check imaging and a home banking product to access that check image.

Corporate credit unions-commonly referred to as "corporates"-initially were formed to provide credit unions with liquidity services and transaction settlement. Now they offer a wide array of offerings, including Internet-based home banking and bill payment solutions-programs that reach credit union members (consumers).

Francis Lee, president/CEO of the $9.7 billion asset institution, is quick to point out that the check image file isn't available exclusively to Southwest Corporate's home banking customers. It's available to customers using other home banking programs as well. Lee views those Internet-based products as natural extensions of the transactions corporates have processed for decades: share drafts, automated teller machines, and debit cards.

Joe Herbst agrees with Lee. "We're heading away from paper and toward electronic transactions," says the president/CEO of $5.1 billion-asset Empire Corporate Federal Credit Union in Albany, N.Y.

"Consumers determine what they need, and it's up to credit unions to see how they can offer those services," says Lee. What individual credit unions lack is "volume and expertise," he adds. Through their corporates, credit unions aggregate volume to achieve economies of scale.

"And when they do that, we're able to acquire the necessary expertise to manage the new service. That's how the corporate network works," Lee says.

Recently, Southwest Corporate helped its members manage a Federal Reserve System change. The Fed began delivering automated clearinghouse (ACH) items four times a day in September. Some credit unions can't process them that often, so Southwest Corporate captures the ACH transactions, stores them, and forwards them once a day to those credit unions.

Corporate credit unions are positioning themselves for passage of the Check Clearing for the 21st Century Act (Check 21), expected to pass this year. It will allow financial institutions to present the image of a check for payment in place of the paper check.

Credit unions are well-positioned for this service because more than 90% "truncate" members' share drafts and have done so since share drafts were introduced in the 1970s, notes Dan Kampen, president/CEO of U.S. Central Credit Union, Lenexa, Kan.

As Check 21 evolves, Kampen says there will be a "grand opportunity" to present "out of area" items through the corporate credit union system. Currently, a California check captured in New York, for example, would be presented to the New York Fed. The New York Fed would settle it with the Los Angeles Fed, which would send it to the respondent financial institution listed on the check. Under Check 21, the paper check doesn't have to move anymore, Kampen explains.

If the corporates can route those check images, he contends, it will be a much more efficient process and might produce some new fee income. "We send electronic files and [payments] all day long. Now we can just attach a file of those images. That's the strategic part of Check 21," he says.

There will be an immediate benefit to Check 21. When checks bounce now, it means sorting a full day's file of paper checks to retrieve and return those that bounced. Check 21 will let processors retrieve and return digital images of checks instead of paper checks, notes Herbst.

Corporates also are linking with third-party providers to provide a variety of offerings beyond investments and transaction processing. Mid-Atlantic Corporate Federal Credit Union in Middletown, Pa., for example, links with Coast to Coast Financial Services, Inc., Richboro, Pa., to help credit unions reduce instances of fraud.

The company accesses multiple up-to-date public information databases to ensure the accuracy of potential members' names, ages, and current and previous addresses.

Services provided include fraud scoring and Social Security number, Office of Foreign Assets Control, interactive fraud database, mail drop, and cell phone database searches.

San Dimas, Calif.-based WesCorp partners with Sheshunoff Information Services in Austin, Texas, to deliver Internet-based asset/liability management (ALM) training. For an annual fee, credit unions gain access to more than 25 online courses that cover major developments in ALM.

NEW INVESTMENTS

Member needs produce new services on corporates' investment side, too. Credit unions are awash in liquidity. That's one reason corporate credit union assets have doubled during the past five years to more than $80 billion (Table I). Credit unions invest about 30% of their excess funds at corporates.

With high liquidity, low loan demand, and low interest rates, credit union spreads are very thin, Lee explains. "Those of us with expanded investment authorities have structured certificates that mimic collateralized mortgage obligation [CMO] returns but without the CMO complexities."

Structured certificates are on corporate credit unions' product lists as "callables," "step-ups," or "floating-rate" certificates. But more often than not, those products come from U.S. Central.

Empire Corporate uses U.S. Central for its structured products. However, the corporate now has authority to purchase derivatives, such as CMOs, so it may structure its own certificates in the future.

Most investments Midwest Corporate Federal Credit Union, Bismarck, N.D., offers originate at U.S. Central. "We pass through U.S. Central's products with a small margin," says president/CEO Doug Wolf.

The $210 million asset corporate provides an impressive lineup of services for an institution with just two full- and three part-time employees. The lineup is possible because of relationships with U.S. Central, other corporates, and other companies.

For instance, Midwest Corporate is a stockholder in Corporate Network Brokerage Services Inc. (CNBS), Overland Park, Kan., which provides wholesale and retail brokerage services. With CNBS, Midwest Corporate doesn't need to hire a licensed broker. Larger corporates, such as Empire and Southwest, have their own brokerage firms with licensed brokers on staff to do trades and provide investment advisory and management services.

Midwest offers "SimpliCD," a certificate of deposit (CD) locater program, through the Corporate Exchange, a credit union service organization (CUSO) 28 corporate credit unions own. Corporate One Federal Credit Union in Columbus, Ohio, invented the CD "finder" service.

For electronic bill payment, Midwest Corporate offers a package from U.S. Central and one from Mid-Atlantic Corporate Federal.

And Midwest Corporate acts like a clearinghouse for some ancillary services: financial planning, Web design, and board meeting reports. The latter two programs, "Website Without a Webmaster (W3)" and "CU Boardroom," come from Smart Source Solutions, a CUSO owned by Constitution State Corporate Credit Union in Wallingford, Conn.

Wolf believes products and services will be developed by one or a handful of corporates through corporate-owned CUSOs. Some products might be retained for competitive advantage, while others will be offered to other corporates to gain market share.

That means there will be a certain degree of both competition and cooperation among the corporates. Corporates with recently minted national fields of membership look forward to expanding their memberships, but there are a finite number of credit unions.

However, credit unions are beginning to join more than one corporate for certain features. For example, Midwest Corporate has 65 credit union members. One is from New Jersey and another is from New York. "They're credit unions with large balances looking to diversify some of their overnight money," Wolf explains.

COOPERATION VS. COMPETITION

Have national charters and competition strained relationships among corporates? Is trademark cooperation in danger of becoming a casualty of competition?

"Competition is away of life. It's better for credit unions to have choices. It makes us do a better job," says Herbst. "Yet cooperation is alive and well. We teamed up with two other corporates to provide business services. We partnered with Southwest Corporate to deliver bill payment and home banking."

Kampen points out Kathy Garner, president/CEO of Northwest Corporate Credit Union in Portland, Ore., took the lead in business lending services. Now U.S. Central is looking at taking her product set nationally.

"That's a quick-to-market way to look at it," Kampen says. "Sometimes U.S. Central takes the leadership role. Other times a corporate does."

Herbst believes such cooperation is essential to credit unions and corporates. "This system is so small that we need to work together. That's what made us what we are today."

Cooperating while maintaining independence requires a high level of trust, says Kampen, with "active involvement from the management of both corporates and U.S. Central."

Herbst admits competition has strained relationships among corporates. "That's something we'll manage. The more you get used to it, the easier it is to deal with. It's not a personal thing."

Wolf believes corporates are beginning to accept membership overlaps as a fact of life, just as natural-person credit unions did. "Credit unions have had overlapping fields of membership for as long as I've been involved with them. They still talk to each other and share policies."

The National Credit Union Administration (NCUA) permitted corporates to seek national charters beginning in December 1997. At first, cooperation suffered because people didn't know where things were headed, Wolf explains. "But now we're seeing cooperation return in the form of strategic partnerships."

Wolf says Midwest Corporate will need partners. "We offer market share to the corporates that have the ability to create new things."

Lee turns the question around. "The question is, 'Does competition help our members?' The answer is yes. We have to sharpen our pencils. Credit unions benefit from that."

Competition exists and it's likely to grow, in Lee's view. "But we also look for ways to cooperate, like we did in the SimpliCD product."

Kampen calls cooperation a hallmark of the credit union community and a business necessity. "We as corporates make sure we stay connected with the trade associations, Filene Research Institute, and major credit union vendors. We do joint ventures between U.S. Central and its members and others. It's about making sure you have people with the right core competencies and who share common values. That makes it easy to cooperate."

VALUE-ADDED PHILOSOPHY

Corporates see themselves as value-added partners of credit unions. One way they add value is by aggregating credit union transactions to create volume efficiencies. But volume isn't the only value they offer.

Empire Corporate, for example, made its bill payment service into a consumer-friendly model. Bills paid via ACH aren't dispatched until two days before they're due. If checks need to be cut, they're sent a week before the bill's due date. "That way members get the float," Herbst explains.

Empire also opened Member Trade, a broker-dealer that sells securities, and Member Trade Advisory Services. The advisory service will help member credit unions set investment policies, perform shock tests on securities, and validate shock-test models.

Even though credit unions are awash in liquidity, corporates are testing the waters in loan participations. Southwest Corporate has taken part in two participations and Empire plans to broker loan participations and participate in them.

Loan participations are new for corporates. Most participations are traded between credit unions. Because his member credit unions already have established loan-participation networks, Wolf isn't sure Midwest Corporate can add value by brokering or taking part in them.

Also, Wolf explains, corporates are allowed only to do "recourse" participations. That means the issuing credit union has to take back any loans that go bad. The credit union can't treat the participation as a sale. Therefore, the loan continues to be carried as an asset and the participation doesn't lower capital and allowance-for-loan-loss reserve requirements.

"Corporates were put on earth to add value to member credit unions. We'll offer any financial product if we can add value," says Herbst. "If our members can get it directly without us adding any value, then it doesn't make any sense for us to offer it."

"I try to keep in mind that corporates are co-ops," Wolf adds. "I remind NCUA of that from time to time. As a co-op, not everything is driven by profitability. It's what we can do on behalf of the majority of member credit unions."

CORPORATES MATURE

Corporate credit unions have been temper-hardened by a turbulent decade that recast their structures and further defined their roles. Following the failure and subsequent liquidation of Capital Corporate (CapCorp) Federal Credit Union in 1995, NCUA issued a sweeping revision to its corporate credit union regulation in 1996.

NCUA's regulation required corporates to increase capital ratios to 5% or 6%, depending on powers exercised. It tightened lending limits to any one credit union and required "shock tests" on investments. CapCorp failed in large part because it was overly invested in derivatives of long-term mortgage-backed securities.

Subsequently, NCUA required the corporates and U.S. Central Credit Union to end interlocking board and management relationships with leagues and CUNA & Affiliates. Those interlocks existed from the time the leagues and CUNA built U.S. Central and the corporate network.

Wolf says the corporate network matured following that separation, and he believes there's more innovation among the corporates because of it.

These regulatory and competitive adjustments produced a number of corporate credit union mergers. A few are pending. Midwest Corporate recently considered but declined a merger opportunity. Its members preferred Midwest's pricing structure and the corporate's local presence. "It's a relationship business, but you still have to be competitive," says Wolf.

Although there are fewer corporate credit unions than there used to be, the corporate network is larger and stronger today in terms of product and service portfolios, assets, and capital ratios. No one will predict where the mergers will end, but corporate officials agree there will be more.

"Things will happen naturally," Wolf says. "Member credit unions will decide. Size won't be the issue, rates and services will be. So as long as our members are happy with what we're doing, we'll exist."

Copyright Credit Union National Association, Inc. Nov 2003
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