Optimize your network of credit union branches
As the leader of a credit union, you read it, see it and hear it all the time. If you want to survive you have to grow, which means meeting two crucial challenges: keeping pace with capital and profits. The urgency of this equation has been heightened by market disruptions from COVID, especially in the way members interact with their credit union – behavioral changes that are likely here to stay. Here we will focus on streamlining the branch system and suggest a useful implementation tool for credit unions with the right setup of facilities.
Streamlining the branch system
In a recent article for CU time, industry thought leader Tom Long of The Long Group spoke about how the branch system has gone silent due to COVID-related member behavior changes, which have caused in-branch transaction volume to drop by 30 % – a pattern that should be more or less permanent. Long said, “Credit unions that successfully realign network delivery to meet this challenge will emerge with the ability to seize a growing share of present and future market opportunities.”
Reducing member utilization and changing market demographics are driving the need to streamline your branch network. The elements of the process are simple: marry an appropriately sized branch network footprint with improved technology and a small but “skilled” workforce to better engage and attract members. Relocate and redesign branches to better align with changing populations and key demographics such as life stage, housing and transportation preferences, financial needs and ‘point of contact’ habits . Transform cost savings from a small footprint and redeploy them as technology and marketing investments. All sound advice, as far as it goes, but the guideline for reshaping your branch footprint should incorporate another key element – maximizing the associated capital investment.
Legacy real estate considerations
Once you’ve decided what your streamlined branch network looks like, you need to figure out how to get there. Undesirable possesses properties must be sold or, if necessary and permitted by regulation, rented on an interim basis. Undesirable rented properties must either be transferred through negotiated lease terminations or, if the lease and regulations permit, provisionally sublet.
Next comes the challenge of properly sizing the investment in your conserved core network. Branches that are leased are likely to remain under lease, ideally with opportunistic changes in rent, footprint, permitted use, duration, and sublease rights. The owned locations you want to keep are those where significant opportunities exist to optimize your investment in a key asset that is often overlooked.
Data suggests that more than 65% of branches of credit unions nationwide are owned rather than leased. But ownership in many cases is simply an inherited decision rather than an informed decision. The squeeze on margins and pressures on CAPEX have been intensified by the looming costs of loan suspensions and other write-downs, as well as the potential ripple effects of eviction bans. Operating facilities held in the main branch network represent an opportunity to address these financial pressures and to reallocate capital to stimulate and support growth.
An opportunity for owned, maintained and “main” offices
A key element of your forward-looking strategy could be the financial benefits of exploiting the unrealized, tax-free appreciation of operating real estate held through sale-leaseback transactions. A “sale-leaseback” is a proven strategy to improve the financial condition of your credit union in an operationally transparent manner. While the logic of sale-leasebacks has always been compelling, the new reality of unexpected and substantial loan loss allowance expenses superimposed on the overhaul of the branch network makes this strategy more effective than ever.
The basic value proposition is simple and proven in a variety of industries, including community banks. Many credit unions have operating facilities on their books that regularly depreciate in book value, while these facilities actually enjoy increasing market value. With recent changes in accounting rules, by selling one or more operating facilities, your credit union could see an immediate tax-free gain, offset the COVID loan loss allowance charge, and generate new cash without deposit to invest in projects intended for members. technology as well as in loans to replenish interest income while increasing capital. By leasing the facility, the credit union maintains uninterrupted operations and control over a negotiated lease term based on its long-term occupancy preferences, which are typically 20 years or more.
From a tactical point of view, a sale-leaseback of an agency network can be structured as a single transaction or it can be carried out through a series of multi-site transactions spread over several years in order to have a predictable annuity-like impact on financial performance. .
The accompanying illustration shows a simplified strategy for streamlining the branch system. A $ 2 billion credit union with 10% equity has a branch system of 28 offices. Management determines that only 16 existing offices are critical to the needs of its members, while market research indicates that six new locations should be sought. Rationalization involves the sale of the 12 non-core offices, the rental of 6 new offices and the sale and leaseback of the 16 “legacy core” offices. The transactions result in a leased branch network of 22 offices and generate $ 55 million in cash from net sales proceeds and $ 23 million in combined tax-free gains on sales. They also provide a 102 basis point increase in capital that supports future asset growth up to $ 230 million.
The impact of a sale-leaseback transaction is synergistic. Your credit union unlocks profits, money, and capital that are otherwise trapped or invisible on its books. You can deploy these resources to support strategic investments and loans to benefit members and communities in need like never before. The ownership of the underlying real estate is placed in the hands of an investor who can take advantage of the recently improved tax benefits of real estate ownership (including extended depreciation and lower effective tax rates), none of which credit cannot be used due to their non-profit status.
The accompanying illustration has been simplified for ease of understanding. There are accounting, legal, and regulatory issues that require the attention of the credit union, but they are easily manageable. So when you geographically and technologically optimize your branch network, be sure to optimize it financially as well.
Steven Eimert, co-founder and general counsel (left) and Edward Lopes, CEO of CU Real Estate Solutions Boston