How CUSOs Benefit Credit Unions

The following is an edited excerpt from the book CUSOs: How Credit Unions and Entrepreneurs Can Get Started (And Win!) with Credit Union Service Organizations by Brian Lauer.

CUSOs benefit credit unions by helping credit unions to expand services and increase efficiencies through economies of scale. In an ever more competitive financial marketplace, CUSOs are helping to level the playing field by giving credit unions a leg up to the competition. CUSOs aren’t governed by the same regulations as individual credit unions, so they offer credit unions access to a wider market of products and services.

In this chapter, we’ll take a deeper dive into the ways in which CUSOs benefit credit unions.

Benefits of CUSOs

There are four major reasons why credit unions actively seek to align themselves with CUSOs; each yields clear benefits to individual credit unions.

1. Income

Financial institutions used to flourish by making more in interest on loans than on the interest rates they paid to their depositors. However, as we saw in Chapter One, the traditional business model is no longer working. In our ever-expanding financial marketplace, the costs to credit unions for basic financial services, including compliance, technology, and specialized staff have driven up operating expenses.

Credit unions have therefore had to adapt to survive, and they’ve done this by finding opportunities to generate additional sources of income through CUSOs.

In this new model, there are basically two kinds of income available to credit unions: interest income and noninterest income.

Interest Income

Interest income is the traditional model, but now with an added twist. Credit unions traditionally made consumer loans, such as auto loans or unsecured signature loans for personal expenses, like Christmas loans. By partnering in CUSOs, credit unions can now extend their capacity to make more loans.

For example, a credit union that has traditionally made auto loans can partner with a CUSO that has wider access to auto dealerships. The credit union can now expand its auto loan volume by participating in an auto lending CUSO. In this model, it’s the dealer who actually initiates and makes the loan, then the credit union buys it from them. But in order to do this, the credit union needs to have a relationship with the dealer, and that relationship comes through the CUSO.

CU Direct is a CUSO in the auto loan sphere that has been in business since the 1980s. One of the earliest and largest CUSOs, CU Direct started as a way for credit unions to get access to auto lending opportunities and interest income. Credit unions historically got their start in consumer loans, and by the 1960s were doing a lot of business in auto loans. However, their market for auto loans began to shrink as auto dealers themselves began originating on-the-spot loans for car buyers. The dealers would then assign that financing to a lender. What CU Direct did was to create its own network with auto dealers to assign those loans to credit union lenders. Through CU Direct, credit unions get access to the dealer network, which is a conduit between dealers and credit unions. The network operates via software that originates and processes credit union loans directly at the auto dealers’ offices. The result has been more auto loans and interest income for credit unions.

CUSOs are also providing credit unions with the ability to expand their lending into the broader market of business and commercial loans. CUSOs offer the expertise credit unions need in commercial loan underwriting, processing, and servicing to book business loans. This is opening new opportunities for interest income on commercial lending that credit unions didn’t have before.

An example of a business lending CUSO is Member Business Financial Services (MBFS) LLC, originally formed by seven credit unions in eastern Pennsylvania. On their own, none of the credit unions had been able to offer their members business loans. So they decided to come together to form a CUSO and hired a specialized staff to originate, underwrite, and service business loans. Over time, MBFS merged with another CUSO doing exactly the same thing in western Pennsylvania, and together they expanded to serve credit unions across the entire state of Pennsylvania.

Noninterest Income

Noninterest income is earned on fees charged for products and services. Credit unions are traditionally community oriented and exist to provide their members with cost-effective financial products and services. Therefore, they’re not looking to generate noninterest income by charging fees. Instead, they look to CUSOs to provide access to financial services that members would traditionally find elsewhere.

The perfect example of this is insurance. A credit union can form a CUSO that is set up as its own insurance agency. The CUSO can sell property insurance, casualty insurance, homeowners, auto, and umbrella insurance to their members. The CUSO receives the customary commission typically generated on policies sold through an insurance carrier. The commissions are built into the cost of insurance. They aren’t the typically punitive, arbitrary charges for insufficient balance payments or bounced checks fees.

In addition to generating additional noninterest income from a credit union’s members, CUSOs, unlike credit unions, are permitted to serve people who are not credit union members. Therefore, by serving nonmembers, CUSOs can open doors to new revenue streams and broaden the market for credit unions to generate income.

An example of a CUSO that earns noninterest income is CUSO Financial Services (CFS). CFS is one of the premier broker-dealers serving the credit union marketplace. It had its inception when several vendors in the financial services industry realized that most broker-dealer arrangements weren’t cost-effective for credit unions. They reached out to several credit union leaders who agreed and formed CFS as a broker-dealer company. CFS is owned by its credit union founders and operated by the vendors who helped conceive it. Over ten years or so, CFS has generated more than $50 million in dividends for its equity owners. It serves the broader credit union community that uses CFS’s financial services as clients.

2. Expertise

When a credit union works with a CUSO to expand its service offerings into the broader market, the credit union benefits from the CUSO’s expertise. Several credit unions that want to offer new services could come together to form a CUSO to provide that service. This is both highly efficient and effective because it leads to superior expertise shared by several credit unions. There’s power in numbers. As a collaboration of several credit unions, the CUSO can share expenses to hire the best employees for a fraction of the cost.

The CUSO can also provide those services to other credit unions that are not part of the collaborative CUSO. This increases the earning power of the credit unions that formed the CUSO. Now that they are up and operating, they can use their excess capacity to serve other credit unions and collect the fees. A single, highly expert and shared department can serve a credit union much more efficiently than a small department contained within one credit union. It affords the hiring of talented people who can drive income for the participating credit unions.

For example, a dozen or so credit unions came together in the southwest United States, forming a CUSO called Credit Union Financial Network (CUFN), to manage securities investment for their members. Investment services require expertise and specialized skills to manage relationships with Securities and Exchange Commission (SEC)-licensed brokers, dealers, and registered representatives who sell securities. Some credit unions can do this on their own, but others don’t have the skills on staff. CUFN provides the service and assists credit unions in generating income. Financial services CUSOs of this type also exist in the investment, commercial lending, and mortgage arenas, as well as in the indirect lending space.

Another example of using collaboration to maximize expertise and minimize costs is Business Alliance Financial Services (BAFS) in Louisiana. BAFS is a business lending CUSO that helps credit unions pool their resources so that each doesn’t have to support its own commercial lending department. Eleven credit unions support one business lending department that provides superior underwriting and loan processing expertise. BAFS brings together a great deal of knowledge and experience in providing US Department of Agriculture loans prevalent in that region of the country. They bring a high level of service to their rural community membership in Louisiana and parts of Arkansas and Texas. BAFS does all the underwriting, analysis, and processing of loans for its credit union partners and other credit unions who participate as clients.

Commercial lending CUSOs, such as BAFS, build a network of trust among participating credit unions that makes it possible for credit unions to sell loans or pieces of loans to other credit unions. This helps credit unions spread their risk. Consider the example of a small rural credit union that has an opportunity to make a $5 million loan that would be great for their community, but they don’t have the funds to do it. A commercial lending CUSO can provide the expertise to underwrite and analyze a loan of that size and caliber. It can also provide a network of participating credit unions that can collaborate to hold a piece of the loan. In this way, smaller credit unions can better serve their communities while sharing loan ownership, risk, and income.

3. Innovation

Service delivery channels are extremely important to the credit union industry. These include everything from payment services and remote check deposit services to online banking. These digital platforms are always evolving with more efficient and innovative technologies. So there’s a constant stream of innovation in software products for generating and modifying loans and better ways to provide mobile and online access to financial products and services. CUSOs are helping credit unions access these new delivery channels and are opening doors for credit unions to invest in new financial products.

To do this, CUSOs partner with technology entrepreneurs to develop innovative financial technologies, often called fintech. These are typically startup companies that develop products and services, such as lending platforms and loan application processes. The startups that develop these products need access to financial institutions and their customers. They also need certain required licenses and authorizations. CUSOs have the licenses, or aren’t required to have them, so they are attractive business partners for tech entrepreneurs. They are also more accessible than global banks, so tech entrepreneurs seek partnerships with credit unions. At the same time, fintech entrepreneurs are frequently looking for investors. They need development money and strategic partners.

For credit unions, it’s an opportunity to earn income on a good investment. By investing in fintech through CUSOs, they gain a stake in a third-party company that’s providing a product to their members. This kind of strategic investment comes with a degree of control over delivery channels. In this way, a credit union becomes both a customer and a stakeholder with more influence over the strategic vision of a new service platform. It’s a win-win scenario for credit unions, which are member-driven organizations with a service-oriented philosophy.

An example of this kind of tech innovation in member services is CU Realty Services, which is a CUSO partnership of credit unions and the real estate industry. CU Realty Services provides specialized internal software that gives credit union members access to multiple listing services for homes. These home listing services are an inside track to home buying and selling. The partnership also provides members with access to affiliated real estate agents and brokers to help them in the buying and selling process. The arrangement operates as an affinity program offering buyers and sellers rebates of 20 percent on real estate commissions. The program is available in states where regulations permit such discounts. It’s a boon to credit unions, because members who use the service are more likely to apply for a mortgage through their credit union, though they aren’t required to do so. The service deepens the relationship of trust and affinity between credit unions and their members.

4. Savings

The fourth reason credit unions actively seek to align themselves with CUSOs is savings. CUSOs provide credit unions with tangible cost savings through economy of scale. As we discussed in Chapter One, credit union operating expenses keep going up, while income in the traditional model keeps going down. But when credit unions come together collaboratively in CUSOs, they can consolidate shared services more economically.

An example of this is the use of core processing systems. Core processors are essential for the full range of financial accounting; they are the backbone of the entire operation and are very expensive to purchase, run, and maintain. Yet when several credit unions join together to form a CUSO, they are able to share the expense of core processing. They essentially have one IT department running the core processing system.

This results in big savings for the credit unions involved. They have better aggregate buying power to negotiate for additional products and services as well. Through their association in a CUSO, they are seen as a much larger institution in the marketplace and reap the savings.

For example, consider a CUSO formed by Franklin Mint Federal Credit Union in the Philadelphia area. The credit union found that it had become too costly to maintain their own mortgage department and all the incurred expenses of software, services, and staff. What they decided to do was move their mortgage department into a CUSO called State Financial Network and sell those mortgage services to other credit unions as well, which made the operation more economical.

By moving their mortgage operation into a CUSO and providing those services to other credit unions, they could offset the cost of providing mortgage services to their own members. Also, by increasing their volume, they were able to get better pricing on the sale of their mortgages on the secondary market. Basically, they took the fixed cost of providing mortgage services to their own members and leveraged it into a CUSO that saved money by providing those services to other credit unions as well.

In a similar vein, some credit unions have moved their indirect lending resources into CUSOs. Lending resources, such as auto dealer networks, have maintenance costs. By forming an indirect lending CUSO and opening their dealer network to other credit unions, a credit union can offset their costs and reap savings.

Staying Alive

In addition to the four reasons just discussed — income, expertise, innovation, and savings — there’s one more reason credit unions align themselves with CUSOs. And the reason is simple: staying alive.

As we’ve seen, credit unions trying to survive have had to improve on the traditional banking model. CUSOs open doors to credit unions for opportunities to invest in more dynamic financial models that stimulate earnings. In this way, CUSOs help credit unions compete with for-profit financial institutions on more equal footing. By aligning in CUSOs, credit unions can offer their members more services while increasing income and maintaining their independence.

Two of the oldest and largest CUSOs in the industry are CO-OP Financial Services in California and PSCU in Florida. Both were early players in providing credit unions with access to products and services that helped credit unions compete in the changing financial services marketplace.

CO-OP started as a partnership of credit unions that weren’t large enough on their own to gain access to automated teller machines. As a new customer convenience, ATMs were all the rage in the early 1980s, and credit unions needed to get on board. CO-OP offered credit unions their own ATM network, which started in 1981 with twenty ATMs. Over the years, CO-OP has grown in products and services to include processing and payment tools, consulting, and shared branching networks, along with upward of 30,000 surcharge-free ATMs.

PSCU began in the late 1970s with a mission of providing credit unions with sorely needed access to credit card networks. What began as a partnership of five credit unions quickly grew to thirty-six within one year, and to 275 credit unions five years later. By 1991, PSCU was also servicing debit card programs. During their long history, PSCU has provided credit unions with early access to leading-edge financial technologies, including data analytics, digital payments, call center support, and digital wallets. They are a quintessential example of a well-connected industry player that gives credit unions a competitive edge to compete in the evolving financial landscape.

CUSOs such as CO-OP and PSCU are driving down operating costs and helping credit unions increase their income, which is a powerful combination. In this way, CUSOs continue to accelerate the growth of credit unions through a financial technology infrastructure and services.

For more on the benefits of CUSOs, check out CUSOs: How Credit Unions and Entrepreneurs Can Get Started (And Win!) with Credit Union Service Organizations by Brian Lauer.