The Jigsaw Puzzle: Redefining Tomorrow’s Corporates
Many experts believe they see the future, and it involves wholesale revamping of the corporate credit union business model.
“Corporates need to reinvent themselves,” flatly said Michael Scheuerman, senior consultant with CCG Catalyst, a financial services consulting firm. “To survive, corporates need to provide value to natural person credit unions.” And of course that means figuring out what they need. “Corporates need to think about how credit unions operate. That will help them decide what services are needed.”
Not every expert believes the remake needs to be radical. There are voices who insist all is well with right-sized, old-fashioned corporates.
But know that the mainstream view is that for most corporates to survive, they will need to rebuild themselves from the ground up.
Another reality is that the credit union system needs corporate credit unions. At least, that is the view of most industry leaders. There are alternatives, and some credit unions have elected to opt out of the corporate system entirely, but for most natural person credit unions some kind of corporate credit union relationship will be part of their future.
In all likelihood, many corporates are not going to survive the next couple years. Scheuerman, for instance, predicts “we will wind up with no more than 10 corporates.”
Other experts are more optimistic; numbers in the high teens are most commonly heard. But nobody disagrees that the corporate credit union universe of 2012 will look dramatically different and probably smaller from what existed just five years earlier. Big changes are coming, possibly faster than many are ready for.
There are many, many ideas. And this is the year they will be tried out.
What Credit Unions Want
“We listen to our credit union clients, we hear their worries,” said Victor Howe, a credit union expert with consulting firm McGladrey. “And their biggest concern is, can their corporate handle the risks they face? The natural person credit union wants to know, is our capital safe? They want to see evidence that the corporate can manage risk.”
The key word there: evidence. Natural person credit unions no longer are likely to simply accept that a corporate knows what it is doing. They want proof, which leads to a second point from Howe. “Natural person credit unions also want transparency and openness from their corporate. Going forward, corporates are going to need to be much more open and to have many more discussions with their members.”
Many credit unions lost money in the meltdown of some corporates and there is an insistence among credit union executives that they mustn’t let that happen again. This spawns skepticism about all corporates in some quarters, but that is not the majority view. “We will have corporate credit unions,” said Howe. “For smaller credit unions particularly, this is a very good option.” Big credit unions, those with $1 billion in assets or more, can take their correspondent business wherever they please. Not so for tiny credit unions. They need corporates and that is a prime reason no expert is predicting they will go away.
“The credit union industry has been through all the phases of grief–denial, anger, loss–arising from the collapse of the big corporates. Finally, we now are in the acceptance phase and, as an industry, we are beginning to look at what can be done now,” said Jeff Russell, executive vice president of CUSO card processor The Members Group.
Russell added that rebuilding the corporate system has to start with a close look at what services corporates actually provide.
And he believes a corporate system will be rebuilt. “Credit unions want to control their own destiny, and they will need corporates,” he said.
“Corporates need to rethink who they are and what services they provide,” agreed Michael Scheuerman, senior consultant with CCG Catalyst.
Russell acknowledged those foundational questions are all good. The former system cannot be resurrected, not that anybody is calling for that. But what shape will a newly imagined system take?
“We can get hung up on what the structure should be. But the real question,” said Russell, “is what are the core needs? What do credit unions need from corporates?”
Russell insisted that the underlying reality is that natural person credit union needs from corporates will remain constant: liquidity, settlements and short-term lending.
“Those,” said Russell, “are the three critical components served by corporates.”
Little is likely to change in terms of those needs and the big picture. But much may change in close-up snapshots of individual natural person credit unions and corporates.
Stressed Russell, “Going forward corporates may not serve all three of these needs.” That is, other kinds of entities (correspondent banks and CUSOs, to name two) may come along and pick up large slices of traditional corporate credit union business.
This may arise out of the need for restructured corporates to provide more transparent and accurate pricing of services, said Russell. He elaborated that traditionally corporates provided members with many “free” services, such as lines of credit, that were not in fact free at all. The costs were absorbed by higher fees on other services.
Will natural person credit unions take their business elsewhere as they are confronted with true costs and fees at corporates? In some cases maybe, acknowledged Russell, but he also stressed that right now this is a period of immense innovation that is critically needed. And if the innovation is permitted to flow, “we as an industry will come out O.K..”
Some traditional activity of corporates such as providing investment services is unlikely to thrive in the present context. The memories of huge losses just are too recent and raw. Some corporates are establishing investment advisory services that will be fee-based. Few, however, will want to have investments monies on their balance sheets, in part because new NCUA rules are often seen as encouraging smaller balance sheets, thus necessitating less capital.
But, if Russell is right, there will continue to be an important role for corporates to play in providing traditional services, and whatever form corporates take in the years to come, he sees those activities as important to maintaining relevance to the system.
Is that all? That is the short version of Louis Hernandez Jr.’s reaction to sketches of a corporate future that hinges on item processing. The CEO of Open Solutions and author of Too Small to Fail: How the Financial Industry Crisis Changed the World’s Perceptions brings a broader, more paradigm-shattering view of the future of corporates to the discussion.
But, he stressed, as out-there as his ideas may be, they are also rooted in the history of corporates. He elaborated: “Corporates will have their second coming by embracing their original intent. As they collaborate they will prosper.”
Hernandez comes at this with a core belief: technology is revolutionizing financial services–it is utterly redrawing the map.
A related belief is that the institutions that fall behind in technology are setting themselves up to perish.
“This industry is laden with old technology, but that is no way to compete,” said Hernandez.
How does a smaller credit union keep pace with a rapidly evolving world of technology? For Hernandez, a key piece in this puzzle becomes revamped corporates, which, he believes, are ideally placed to “become the facilitators that allow common purchasing of technology. This should produce big discounts–perhaps 50%.”
“Corporates,” he added, “should be reconstituted as a cost-saving operational tool.”
Right now growing numbers of credit unions are struggling with deploying mobile banking solutions. Costs are not insignificant and the technological hurdles can be high. So, brainstormed Hernandez, what if a corporate put together a mobile banking solution that it made available to its members? Each would get custom front-end, user-facing screens that are individualized for the particular credit union, but they would share a pooled back end where all the transactional heavy lifting occurred.
That has long happened with credit cards, but Hernandez is pushing this bar much higher, envisioning a time when corporates position themselves as the place for natural person credit unions to get the latest tech they need along with all the support required, at prices that no lone buyer could match. “Corporates should be there to help credit unions win,” said Hernandez. “This leverages collective strength.”
“Corporates could be bringing innovation to thousands of natural person credit unions, sharing ideas, driving down costs,” said Hernandez. “This would be the second coming of corporates. To gain the benefits you have to join the community. And many credit unions would see why they should.”
But Hernandez ominously added this: “Somebody will do this. If not corporates, it will come from someplace else. It is too good and too needed not to happen.”
Old Way Still Works
There is one sure way to irritate the usually mild-mannered Lee Butke, CEO of Corporate One, and that is to tell him that his business model is broken, that he needs to do a complete rethink of how to run a corporate credit union.
Butke is adamant in his disagreement: “Our new business model looks like our old model. We create exceptional efficiencies and we manage our risks. That is what a corporate needs to do.”
Over at Corporate Central, CEO Bob Fouch said exactly the same. “There are pundits who keep saying we need to reinvent our business model. But we have been doing this for 30 years, and we will be doing it for many more years.”
Fouch elaborated on the essence of that model: “We put our members first. We are stewards of their resources. Our job is to guard their assets.”
Fouch also had a loud message he wants every credit union to hear: It just is not true that every corporate lost all their members’ capital. “There are corporates that did not extinguish their members’ capital,” said Fouch, who acknowledged Corporate Central lost $73 million in the U.S. Central debacle. But while that wiped out much of the corporate’s retained earnings, Fouch did not have to make an emergency call for contributions from members. Corporate Central simply carried on.
Ditto for Butke at Corporate One. “We did not cost our members a dime.”
The big question: Is there a role for smaller, regional corporates such as Corporate One and Corporate Central, especially in an era where at least some experts talk about the need for corporates to scale up, to increase volume in order to compete against giant correspondent banks and the Federal Reserve?
Finance attorney Lawrence Remmel with Pryor Cashman is adamant that in fact it is the regionals that have a bright future. “New technologies will let smaller, regional corporates survive and they also have unique regional advantages.”
He elaborated on that second point: “It is better, particularly for a smaller credit union, to do business with a regional corporate that is attuned to their interests.” A Wisconsin corporate–a Corporate Central, for instance–just will understand upper Midwest credit unions better, said Remmel, and this will lead to harmonious business dealings that go beyond simple business fundamentals. “Smaller corporates are closer to their communities and that matters.”
Remmel, incidentally, is more pessimistic about the future of larger corporates. “They will not be able to compete. They don’t have regional advantages. They are in direct competition with large, national banks and the banks will win.
LendingTools CEO Eric Goering also shares much of Remmel’s optimism about the future of regional corporates. “There are good, healthy regional corporates that will succeed,” said Goering, whose company provides correspondent services tools to financial institutions. (Kansas Corporate has signed a letter of intent to adopt LendingTool’s Private Correspondent Suite.) “Smaller corporates that adopt the right technologies will be able to compete,” added Goering, who foresees a future where corporates will look more like banker’s banks with a focus on helping their credit union members better manage their operations. With the right technology, suggested Goering, there is plenty of reason to be optimistic about how corporates will rise to that challenge.
Goering, incidentally, also agreed that rationality will be an advantage: “You have to have feet on the street to serve credit unions. They need customer service.”
As for the Federal Reserve as a competitor to regional corporates, Butke does not see it: “Our prices to members in fact are lower.”
Fouch added that whenever there is a glitch in processing an item, “it’s night and day comparing us to the Fed. There is a lot of work that needs to be done to make sure the exceptions are properly processed. We do the work, the Fed doesn’t. A natural person credit union has to consider that when making decisions.”
As for where this all shakes out, Butke said: “In looking at corporates, it is not about economies of scale. It is about efficiencies of the operation. And a natural person credit union should go where they find those efficiencies.”
Both Fouch and Butke are optimistic about their near-term prospects.
“We have about 300 members right now. We will have 100 more by year-end,” said Fouch.
“We have 775 members now. We will have 850 by year-end,” said Butke, who acknowledged that number could go higher. “Around 200 credit unions are looking at us.”
But, added Butke, as much as Corporate One may grow, it will not become a mega-corporate, Butke’s term for what the NCUA calls a Tier 1. “The functional risk to the network is too high.”
Bridge to Tomorrow
Right now, efforts are far advanced to recreate many of the bridge corporates, but as smaller versions of what had been. The stories that are the most fleshed out are at Southwest Bridge and Members United, with both seemingly very optimistic they will have second acts.
Ask Greg Moore, CEO of Georgia Corporate, about the future of corporates and his answer distills to one word: scale. “You need a model based on scale and efficiency. You need fee income. You need scale to make this happen.” He added: “That is why we pursued consolidation with a Tier 1.”
In Moore’s case, staying relevant in the 21st century has meant attempting to cobble together a merger with Southwest Bridge, creating a new corporate (assuming adequate capital contributions by members) to be named Catalyst and to be headquartered in Plano, Texas, (the current home of Southwest Bridge).
Catalyst will not be a revival of Southwest Bridge, it will be an utterly different corporate. “Corporates need to be much more efficient, with significantly smaller balance sheets,” said Moore.
Over at Members United Bridge, John Fiore, CEO of the Motorola Employees Credit Union and currently chair of the Charter Advisory Group at Members United, has taken a different direction. After tentative efforts to piece together a merger with WesCorp were resoundingly rejected by the NCUA, Members United adopted a go-it-alone strategy that is strikingly different in some respects from how corporates had operated. Said Fiore: “Forget about the past and move forward. We are creating the corporate of the future. It will be different from what we had before.”
But Fiore, too, said scale will be crucial to a successful revival of Members United Bridge. “There has to be scale to sustain the new corporate.”
For both these new corporates, crucial will be the willingness of large credit unions to participate. Said Fiore: “If the big credit unions do not join there will not enough volume to sustain corporates. Those large credit unions would be turning their back on the movement. This would change the credit union industry.”
The big credit unions are needed precisely because of the volume of their business. With them on board, these new corporates would have ample transactional volume to stay in business primarily by providing correspondent services. Without the big credit unions, the lack of scale just might doom the efforts to recreate the bridges into new corporates.
Moore agreed: “Key will be getting enough of the big members. The model is based on scale. We have to depend on fee income. We are seeking to provide a value proposition that appeals to both small and large credit unions.”
Fiore optimistically added: “No large credit union has yet told me they will not join in recapitalizing this corporate.”
Both Moore and Fiore stressed that, going forward, they will be asking for smaller capital contributions from members.
Said Moore: “We are requiring a lot less capital than we had in the past. Dramatically less.”
At the reconstituting Members United Bridge, Fiore said the new corporate revolves around a capital contribution formula that is innovative. It hinges on a member’s use of the corporates services rather than on the member’s size. And this, too, will result in much lower contributions, said Fiore. “I have not seen any corporate with capital requirements as low as ours will be.”
Fiore upped the ante by insisting that the new corporate will run so lean and efficiently that “within the first four years, many members will have saved so much money on services that they cover the capital contribution.”
Fiore is a realist however. He acknowledged: “Our early estimates are that we will lose around one-third of our members. Not every credit union will decide to join.”
Moore added: “Our town hall meetings for Georgia Corporate’s members–we had 11 town halls–went extremely well. We are optimistic. The feedback I’ve gotten from Southwest is that their town halls were also well received. I am optimistic we will get a good number of members.”
Moore concluded, “We will know late summer.”
Bob Fouch pinpoints what may be the issue for natural person credit unions: “Do they have a Plan B?,” he asked.
Plan A is recapitalizing a bridge, for example, or maybe just staying put with a smaller corporate. But what if, come late fall, those options are taken off the table? What if the preferred bridge fails to gain enough commitments to reconstitute itself? Or perhaps the smaller corporate fails to measure up to NCUA’s new financial ratios?
Fouch’s worry is that many, many credit unions, certainly numbering in the hundreds, maybe more, will find themselves facing that problem, as soon as this autumn.
Bigger credit unions, those over $500 million, will probably face few difficulties. Many third parties want to do business with them and, furthermore, they have sufficient staffing so they probably have generated alternative scenarios in case their preferred Plan A blows up.
It is the smaller credit unions where problems may be most acute, said Fouch.
And for them, Fouch has one important message: Come up with a Plan B now before you need it. Because amidst the immense uncertainties that are transforming the corporate credit union universe, the only real certainty is that there just may be a need for a Plan B no matter how good Plan A may look.