A wholly owned subsidiary offers credit unions relief from the chokehold that today’s tight interest rate margins and slow loan growth have on revenue by adding an additional source of income. But as attractive as subsidiaries are, even the savviest of credit unions can be tripped up by the rules restricting these investments — with considerable money at stake. As of September 2012, $2.3 billion was invested in subsidiaries, an 11% increase compared to the same period the previous year.
Known as credit union service organizations or CUSOs, these subsidiaries are governed by federal regulations (Code of Federal Regulations, Title 12, Part 712), with some states imposing different requirements on the investments that state-chartered credit unions make. The National Credit Union Administration monitors investments in CUSOs, but no single entity regulates these subsidiaries, which instead answer to the regulators of whichever industry the CUSO is in, such as securities regulators for investment brokerages. Federal regulations have changed little over the years, and a recent proposal that would have required CUSOs to file annual financial reports with the NCUA, which already reserves the right to review a CUSO’s books at any time, has stalled for lack of support, says Jack Antonini, president and CEO of the National Association of Credit Union Service Organizations. Although practically anyone can own a CUSO and some credit unions co-own these businesses with other credit unions or companies, the majority — 606 of 750 CUSOs — are wholly owned.
The federal code lists 20 categories of businesses that credit unions may own, including insurance agencies, leasing companies, and services for record retention, security, and recovery. Nevertheless, those categories could just as easily be divided into two broad groups: back-office services that support and streamline the credit union’s operations or financial services that allow the credit union to expand its expertise and product line. The first category generally offers the potential for cost savings while the second provides a diversified revenue stream, with insurance and real estate agencies an especially good fit because they naturally extend and complement the credit union’s mortgage and auto loan business.
Still, credit unions need considerable capital to buy another company. Under federal law, a credit union can’t spend more than 1% of assets, excluding reserves, to purchase one or more CUSOs, although it can lend an additional 1%, excluding reserves, to its subsidiaries. In theory, that means a credit union must have $200 million in assets to buy a company with a $2 million price tag. In practice, fluctuating assets require that figure to be higher. Because those percentages are recalculated annually, a credit union that barely met the federal standard in the first year could find itself having to divest if its assets decline. Tom Linn, executive vice president for consulting firm Marsh Berry, has brokered deals for credit unions acquiring insurance agencies that cost $2 million or $3 million. For a deal that size, he says, “Credit unions generally need $750 million in assets to become qualified buyers.”
Other requirements also make purchasing subsidiaries a tricky proposition. At least 51% of the subsidiary’s customer base must be credit union members, and the business must have its own distinct leadership.
“There can be some overlap with the credit union, but the management team can’t be 100% the same,” says Guy Messick, an attorney with Messick & Lauer and general counsel to NACUSO. And although cross-selling is permitted, credit unions can’t make buying the subsidiary’s product a condition for approving a loan or conducting other financial business with the credit union.
Even when CUSOs meet all federal requirements, they can damage a credit union’s reputation if they engage in unethical or sloppy business dealings. In cases like this, credit unions run the risk of being drawn into a lawsuit or losing their entire investment if the CUSO goes bankrupt.
“A CUSO that performs badly can be a real big black eye for the credit union,” Antonini says. “There have only been a handful, and they have generally been lending CUSOs that were wholly owned.”
According to Antonini, CUSOs owned by multiple credit unions have more eyes looking over the books so any difficulties come to light before they become a serious threat.
Despite the risks, the rewards of owning a CUSO are considerable, and the revenue from a single auto insurance policy compared to an auto loan illustrates why.
“The average auto loan has a three-year term, a $15,000 balance, and a margin of half a percent, generating just $75 in revenue each year,” Linn says. By contrast, “the average car insurance policy generates $150 per year, and the average policyholder stays for nine years. The difference in total revenue over the full term: $225 for the car loan versus $1,350 for the car insurance policy.