Pass-Through Corporates Take a Pass at Consolidation Recommendations
Despite recommendations by CUNA and others that call for significant corporate consolidation, three executives of small corporates said they are not in merger discussions and are unlikely to merge.
Dennis DeGroot, president/CEO of the $864 million Missouri Corporate CU, said his cooperative will need to raise some new capital to meet proposed NCUA benchmarks and is still considering its options. However, a merger is not among them.
"I feel strongly that we can survive," he said. "We'll have to raise some capital, but we're not in bad shape."
Jeff Merry, chief financial officer of the $1.34 billion Volunteer Corporate CU, said his cooperative isn't in merger discussions, either. In fact, he said VolCorp could meet new corporate regulations as currently proposed, although he's "cautiously optimistic" the NCUA will make some adjustments in final Part 704 regs that will put it in "a good position to continue to exist as VolCorp, serve our members in the way they are accustomed to and still meet retained earnings and capital requirements."
Larry Eisenhauer, president/CEO of the $340 million Kansas Corporate CU, said he wouldn't stand in the way of a merger opportunity that would provide his members with cheaper rates and better products and services. But, KCCU isn't in merger discussions with anyone, and Einsenhauer added his members would be less likely to recapitalize a merged entity than Kansas Corp. Eighty percent of KCCU members would not have to contribute new funds to meet proposed capital requirements, he said.
Members of the Wichita, Kans.-based cooperative have told Eisenhauer they want the corporate to remain a separate entity. However, the CEO said he and his board won't make any final decisions about KCCU's future until they see the legacy assets plan, final corporate regulations and know which products and services they will continue to receive from U.S. Central.
"The regulations as proposed would make it difficult for any entity to generate the earnings necessary to meet new capital goals," he said. "And, if a couple of changes aren't made, I would have a hard time asking members to commit to perpetual capital accounts if I didn't think we could hit those goals. I wouldn't want to, two and a half years from now, go back to our members and say, 'I'm sorry, we didn't do as well as we thought we would, and we're going to get merged, along with your capital.' We're taking a wait-and-see position."
Merry said the proposed corporate regulations that need adjusting are no secret, because objections in comment letters are so consistent.
"NCUA appears to be listening to industry feedback," he said. "It's not just a formality, they appear to be sincerely taking the feedback they receive and applying to the proposed rule to make it better."
What about economies of scale and the potential for changes at U.S. Central?
DeGroot said he'd have to replace three key services should U.S. Central cease to exist: automated settlement, an overnight account and a line of credit. He called U.S. Central's auto settlement the spine that supports the credit union payments system and said he hopes it can be preserved in some form.
However, he said he could replace the overnight account, even though U.S. Central's product allows Missouri Corp to "pay a nice spread to members." And although the St. Louis institution's current capital ratio makes it difficult to gain new lines of credit, DeGroot said he is optimistic he could replace his U.S. Central line.
Eisenhower said Kansas Corp already has a relationship with the Kansas City Federal Reserve Bank and Kansas City-based Federal Home Loan Bank, which he said will "become more of a liquidity provider to us." KCCU also was recently approved to be a third-party safekeeping agent for the FHLB.
"We've been actively looking for alternatives to all services, whether it's through U.S. Central or another vendor, and we know what our alternative preference is," he said.
Merry called pass-through corporates a dying breed, saying most corporates have made adjustments to their business plans in the last two years. He called VolCorp a "hybrid corporate," part U.S. Central pass-through and part stand alone corporate.
VolCorp has brought some U.S. Central services in house, like its core processing system and bond accounting, he said. While the Memphis based corporate still offers U.S. Central investments to members, it's not with the same emphasis as years past.
Although some U.S. Central pricing is difficult to find elsewhere, Merry said other service providers are "more willing to work with you on pricing in order to gain your business" thanks to uncertainty about U.S. Central's future. He called some of U.S. Central's competitors somewhat more competitive.
CUNA's Bill Hampel, who was a member of the trade's Corporate Credit Union Task Force, said the differences between the task force recommendations and small corporates aren't as large as they seem.
"All corporates recognize their historical business models will no longer work, and they will have to come up with something really different," he said.
He also dismissed reports corporates aren't discussing mergers, saying, "if they were in merger negotiations, they probably wouldn't talk to the press about it."
The main message of the corporate task force wasn't that corporates need to consolidate, but rather that credit unions told the group they aren't willing to capitalize large balance sheets, he said.
"You can operate with a small balance sheet and still offer core services without requiring much capital if you don't have a lot of investments on your books," Hampel said.
Small credit unions didn't have large investment portfolios, but they will miss the revenue U.S. Central's aggressive investment portfolio brought them, he said.
"In the past they earned a high enough return from U.S. Central to do two things: pay attractive rates to their members and pay for the other costs of being a corporate credit union," Hampel said.
With less or no income from those investments, he said, economies of scale will gain in importance.
"The task force believes the bulk of credit unions didn't fully appreciate that historically a lot of corporates gave really good deals with really good personal service because they were subsidized by high investment returns," Hampel said. "And, now we know in hindsight it was a fairly risky investment portfolio."
As the loss of investment income trickles down, costs to natural person credit unions will increase.
DeGroot said volume driven business like check and ACH processing do benefit from economy of scale. However, long before the corporate crisis hit, efficiency ratios were "hit and miss" among corporates, and didn't correspond to asset size.
Eisenhauer said in many cases, economies of scale don't result in lower fees and operating expenses at credit unions as promised.
"We feel like even though Kansas is a small state, there is enough economy of scale here if everybody participates," he said. "I think credit unions in some parts of the country will become far more cooperative with each other than they were five or six years ago, because they have to be. I think we'll see more participation in the corporates that do survive."
Hampel said collaboration provides the same efficiencies as collaboration, and the task force doesn't have a position regarding how corporates achieve those efficiencies. Rather, going forward, efficiency will be a huge premium.
Eisenhauer and Merry said corporate consolidation, even if it included regional service centers, would still result in less personalized service, and their members have made it clear they don't want that.
The blood between credit unions and bankers is so bad in the sunflower state, KCCU members have told their corporate they don't want to depend upon the for-profit providers for anything. That includes a currency and coin service launched for Y2K that continues to be one of the corporate's most popular, delivering more than $700 million last year. Such a service might be deemed inefficient by a large, consolidated corporate.
KCCU's ALM service also includes quarterly in-person meetings with member boards.
"That's not going to happen in a large, consolidated entity," Eisenhauer said. "They're not going to drive out to Kansas to sit down with a credit union board and go over ALM analysis. But, that helps [credit union boards] make better decisions for their members."
Personal contact, in which you can look someone in the eye while doing business, is still valued in some parts of the country, he added.
Hampel said he realizes face-to-face contact is important in business, but as an economist he has to ask, how much is it worth?
"Compared to the alternatives, if that will cost you twice as much, are they willing to pay that as opposed to getting to know a friendly person over the phone? There are tradeoffs, and these are decisions credit unions will have to make," he said.