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To The Next Level
CUSOs build cooperation on cooperation by dismantling silos and merging or partnering with other CUSOs to leverage fixed costs or expand services.

By Richard H. Gamble

Editor's note: The following first appeared in the February 2009 issue of Credit Union Management.

When Hurricane Ike devastated parts of the Gulf Coast around Galveston, Texas, two credit union service organizations found they were involved in helping many of the same CUs. Ongoing Operations, a CUES Supplier member based in Hagerstown, Md., was helping them maintain business continuity with offsite systems. In turn, DigitalMailer, based in Herndon, Va., was helping them get messages through to employees and members. The two CUSOs decided to work together as strategic partners and provide their services as an integrated package. Now CUs can tap both in a single process, reports Ron Daly, president of DigitalMailer, also a CUES Supplier member.

"One service agreement ties us together," Daly says. "And our systems are integrated (DigitalMailer's bulk e-mailer and Ongoing Operations' database of who should be notified).

"It's all set up so you can just hit one notification button instead of searching through files to see who needs to be notified" of a disruption of operations and what should be done about it.

A common CUSO owner, $1.6 billion Northwest Federal Credit Union, Herndon, Va., and a common board member helped get the negotiations started. Services like DigitalMailer are available commercially but at a higher price. Forging a strategic partnership and packaging the two CUSO services together made operational and economic sense, says Kirk Drake, president/CEO of Ongoing Operations.

Super CUSOs Evolving
Multiple CUs getting together to form a CUSO has long been the key to broader service and greater operational efficiency for credit unions, many of which remain small and local. Now a trend toward cooperation among CUSOs, sometimes even merging to form "super CUSOs," is beginning to reshape the service landscape and perhaps expand what CUs are able to do cost-effectively.

"We're seeing more and more discussions about how CUSOs can work together to leverage resources and upgrade or extend services," says Tony Boutelle, president/CEO of CUDL, a CUES Supplier member and CUSO based in Ontario, Calif., that provides indirect and point-of-sale auto lending. "It's giving CUs a chance to expand their delivery channels at an affordable price and become more competitive."

There's not much better evidence of CUSO-to-CUSO interaction than CU Holding Company, formed by $333 million Mazuma Credit Union in Kansas City in 2003. It now has stakes in four CUSOs, which specialize in marketing services, mortgage origination, payday lending and payroll services. The four for-profit CUSOs, all limited liability corporations, can upstream pre-tax profits as dividends to their owners, including the holding company, also an LLC CUSO, and the holding company can upstream pre-tax profits to Mazuma CU. (Read more on this in the last section of this article, "Ownership Structures.")

CU Holding Company's sub-CUSOs embrace collaboration whenever they can, notes Lisa Renner, CEO. "We try to be a family of CUSOs and always look for ways we can share resources and improve efficiencies."

For Mazuma CU and CU Holding Company, CUSOs clearly are an attractive line of business. "Traditionally, credit unions made money on the spread between deposits and loans, but that spread has shrunk to almost nothing, so we have to find additional sources of revenue," explains Renner. "The credit unions have a great business model, but it has been replicated over and over and has saturated the market. The CUSO offers a different business model, one well suited to collaboration. It's an easy way for credit unions to plug in and work together for their competitive advantage."

Mergers Make Sense
A merger made sense for CUsource and UniPro, two Montana CUSOs that frequently passed files back and forth as they performed complementary roles in processing share drafts and doing data processing. And CUsource was one of four owners of UniPro. Because maintaining two separate CUSOs meant two boards of directors, two sets of IT and financial audits, and two bond and professional liability insurance policies, the two CUSOs merged in October to form one larger CUSO. They expect to save 30 to 40 percent of the costs in areas where duplication can be eliminated, reports Shirley Bailey, president/CEO of the surviving CUSO, CUsource, based in Great Falls, Mont.

Another example of convergence among CUSOs will be the first combined auto lending and mortgage lending symposium scheduled for Las Vegas in May. CUDL and Prime Alliance Solutions, Seattle, a CUSO that provides mortgage lending services, historically have held separate annual meetings. Now CU lenders can cover both bases in one trip, Boutelle explains.

Both Prime Alliance and CUDL are success stories in the area of CUSOs providing services to CUSOs. Prime Alliance was created in January 2000 when groups of CUs saw that residential mortgage origination was an attractive line of business for CUs, but that doing it well would require a degree of automation and scale beyond most CUs. These CUs banded together and formed CUSOs to help originate and process mortgages.

Soon it also became clear that technology and secondary market size would be critical to staying competitive with the big players starting to dominate the mortgage market. So, Seattle-based BECU organized Prime Alliance Solutions to be a CUSO to CUSOs, explains CUES member Joe Brancucci, executive vice president of the $8 billion CU and CEO and chairman of Prime Alliance.

Award-winning technology links the 17 CUSOs that are the primary owners of Prime Alliance, 68 other large CUs that are direct members and 1,500 CUs that participate indirectly through their CUSOs in a soup-to-nuts process that is all electronic, automated and Internet based. It allows CU members to apply on line from their homes and get a decision within minutes.

CUDL, formed in 1994 and owned by 79 CUs and six other CU organizations, is now working with FSCC (Financial Service Centers Cooperative), a shared branch network CUSO and a CUES Supplier member based in San Dimas, Calif. In 2009, the two will introduce a product using FSCC's member verification features to support a CUDL Internet lending offering.

The logic of cooperation and current trends in the CUSO marketplace suggest that CUSOs will continue to merge and expand, leveraging their economies of scale or extending geographic coverage, suggests CUES member Gordon Dames, who recently retired as president/CEO of $2.8 billion Mountain America Credit Union, Salt Lake City, and still is active in managing the Members Business Lending CUSO the CU organized. These more expansive CUSOs may keep regional offices to retain a local feel and responsiveness, adds Dames.

Maintaining Specialization
The prevailing CUSO expansion pattern is that CUSOs form in market niches and specialize in doing one thing well and efficiently-data processing, Small Business Administration lending, ATM networks, etc. CUs get the services they need by joining a variety of specialized CUSOs, not, for the most part, by joining a CUSO of CUSOs that packages a variety of services from a single source, Dames explains. But CUSO expansion and consolidation is a strong trend and just where it will go remains to be seen, he says.

While it is possible for one CUSO to acquire another CUSO in a different line of business and have the consolidated CUSO offer a broader package of services, the marketplace is not driving such consolidation, notes CUES member Stan Hollen, CEO of CO-OP Financial Services, Rancho Cucamonga, Calif., a CUES Supplier member. What the marketplace is driving is a tight focus on doing one thing well. And that has meant consolidation among CUSOs in the same line of business.

The consolidation of CUSOs is meeting some resistance, Dames says, from pride among people who started their own CUSOs. "These managers think they can go it alone. They all want to be the surviving CUSO," he says. But that attitude is softening as the need to cut costs or expand service drives consolidation, he notes. "The ATM networks used to be regional, but they saw the need to merge and create a national network. We can only hope that CUSOs in other lines of business [recognize the value] and consolidate," he observes.

Not everyone thinks consolidation is so important. CUs cooperating to form and support CUSOs is critical, but CUSOs cooperating with each other is much less important, Hollen suggests. "CUSOs do a lot for credit unions," he says. "They are critical to many of the services we offer and depend on. They're built around a common need of a group of credit unions, but CUSOs don't often need each other, so the level of cooperation and communication is not particularly high and not particularly important."

Ownership Structures
CUSO leaders also disagree about the best legal structure to use for CUSOs. They can be set up as for-profit C corporations owned by nonprofit CUs, Dames explains. In that case, the C corp makes profits, pays taxes on those profits and then pays out after-tax profits as dividends to its owners. Or they can be set up as LLCs, which means that if there is sufficient net income, an LLC CUSO can pay a patronage dividend that is taxed at the rate of its owners. CUs as nonprofits are not taxed.

As a practical matter, CUSOs are likely to pay their owners largely in services. While patronage dividends paid out in cash can be substantial, large amounts of cash generally are not booked at the CUSO and then paid out, free from taxes, to CU owners, Dames explains.

While it's fashionable now for new CUSOs to choose the LLC structure so dividends can be passed pre-tax to CU owners, not everyone approves. "The National Association of Credit Union Service Organizations doesn't recommend LLCs," Boutelle reports, noting that CUDL is a C corp. "It hasn't happened yet, but they think the IRS might invalidate some of those organizations as tax avoidance schemes. Many of the older and largest CUSOs are organized as co-ops under co-op law."

Richard H. Gamble is a free-lance writer based in Colorado.

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