Optimizing Your Credit Union Branch Network

As a credit union executive, you read, see and hear it all the time. If you're going to survive you need to grow, which means navigating two critical challenges: Keeping up with capital and with earnings. The urgency of this equation has been intensified by COVID-based market disruptions, notably in the way members interact with their credit union – behavioral changes that likely are here to stay. Here, we'll focus on branch system rationalization and suggest a useful implementation tool for credit unions with the right facilities configuration.

Branch System Rationalization

In a recent article for CU Times, industry thought leader Tom Long of The Long Group explained how the branch system has gone quiet because of COVID-related shifts in member behavior, which has driven down branch-based transaction volume by 30% – a pattern that is expected to be more or less permanent. Long said: "Credit unions that successfully realign network delivery to traverse this challenge will emerge with the ability to capture an increasing share of present and future market opportunity."

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Reduced member usage and shifting market demographics are driving the need to rationalize your branch network. The process elements are straightforward: Marry a right-sized branch network footprint with enhanced technology and reduced but "upskilled" staff to better engage and attract members. Relocate and redesign branches to better align with shifting populations and key demographics such as life stage, housing and transportation preferences, financial needs and "touch point" habits. Transform cost savings from a reduced footprint and redeploy them as technology and marketing investments. All sound advice, as far as it goes, but the directive to reshape your branch footprint should integrate another key element – optimizing the associated capital investment.

Legacy Real Estate Considerations

Once you've decided what your rationalized branch network looks like, you need to determine how to get there. Unwanted owned properties must be sold or, if necessary and permitted by regulations, leased out on an interim basis. Unwanted leased properties must either be surrendered through negotiated lease terminations or, if permitted by the lease and regulations, subleased on an interim basis.

Then comes the challenge of right-sizing the investment in your retained core network. Branches that are leased presumably remain under lease, ideally with opportunistic modifications to rent, footprint, permitted use, term and subleasing rights. Owned locations you wish to keep are where significant opportunities exist to optimize your investment in an often overlooked key asset.

Data suggests that more than 65% of credit union branches nationwide are owned rather than leased. But ownership in many cases is simply an inherited rather than an informed decision. Margin compression and CAPEX pressures have been intensified by the looming costs of loan forbearances and other impairments, and the potential spillover effects of eviction prohibitions. Owned operating facilities in the core branch network represent an opportunity to address these financial pressures and effect capital reallocation to drive and support growth.

An Opportunity for Owned, Retained, 'Core' Offices

A key element of your look-forward strategy could be the financial benefits of tapping the unrealized, tax-free appreciation of owned operating real estate through sale and leaseback transactions. A "sale leaseback" is a proven strategy to enhance your credit union's financial condition in an operationally seamless manner. While the logic of sale-leasebacks was always compelling, the new reality of unexpected and substantial loan loss provision expenses overlaid on branch network redesign makes this strategy more effective than ever.

The basic value proposition is simple and time-tested across a variety of industries, including community banks. Many credit unions have operating facilities on their books at steadily depreciating carrying values while those facilities in reality enjoy increasing market values. Thanks to recent changes in accounting rules, by selling one or more operating facilities, your credit union could recognize an immediate tax-free gain, offset COVID-related loan loss provision expense, and generate fresh non-deposit liquidity to invest in member-facing technology as well as in loans to rebuild interest income, all while boosting capital. By leasing back the facility, the credit union maintains uninterrupted operations and control for a lease term negotiated to suit its long-term occupancy preferences, which are typically 20 or more years.

From a tactical standpoint, a sale leaseback of a branch network can be structured as a single transaction or it can be done through a series of multi-location transactions phased over several years in order to make a predictable, annuity-like impact on financial performance.

The accompanying illustration depicts a simplified branch system rationalization strategy. A $2 billion credit union with 10% capital has a 28-office branch system. Management determines that only 16 existing offices are core to its members' needs, while market research indicates six new locations should be pursued. Rationalization involves the sale of the 12 non-core offices, the lease of six new offices and the sale-leaseback of the 16 "legacy core" offices. The transactions result in a 22-office leased branch network, and generates $55 million in liquidity from net sales proceeds and $23 million in combined tax-free gains on sales. They also provide a 102 basis point boost to capital that supports future asset growth of up to $230 million.

The impact of a sale leaseback transaction is synergistic. Your credit union unlocks profit, cash and capital that are otherwise trapped or invisible on its books. You can deploy those resources to support strategic investments and loans to benefit members and communities that are in need like never before. Ownership of the underlying real estate is placed in the hands of an investor who can utilize recently enhanced tax benefits from real estate ownership (including expanded depreciation write-offs and lower effective tax rates), none of which credit unions can use because of their not-for-profit status.

The accompanying illustration has been simplified for ease of understanding. There are accounting, legal and regulatory issues that require the credit union's attention, but they are readily manageable. So, when you optimize your branch network geographically and technologically, be sure you also optimize it financially.