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Wholesale Credit Union Failures: Painful Implications All Around

The ink is barely dry on the latest round of multi-billion dollar government-assisted failures.

The ink is barely dry on the latest round of multi-billion dollar government-assisted failures.

Last Friday's takeover of three wholesale credit unions (Members Corporate FCU, Southwest Corporate FCU, Constitution Corporate FCU) with assets totaling $20 billion is the latest thud in a series of lurching failures across the wholesale financial industry infrastructure. This journey started with the Fannie Mae and Freddie Mac conservatorships in September 2008. In addition to the two big government-sponsored entities, the wholesale credit union system is crumbling and the Federal Home Loan Bank System and some "banker's banks" have taken hits too.

Since these wholesale institutions do not serve retail customers directly, some readers may shrug off the fate of these institutions as part of the Federal government's resolution process that will not really have much direct impact on the private and mutually owned institutions that serve customers. This column is not about the wisdom of the actions taken by governmental agencies. It is about my point of view on the relevance of these wholesale institutional failures.

For starters, in one way or another, these failed institutions provided liquidity, investment alternatives, and/or correspondent/outsourcing services to their constituents. A high percentage of these failures are connected one way or the other to the mortgage market. When these institutions fail, the repercussions ripple through to hundreds or thousands of institutions. The financial ecosystem has had mild to massive cases of indigestion. In some failures, like Fannie Mae, Freddie Mac, and the wholesale credit unions, their capital is wiped out and institutions owning stock or preferred stock in these institutions see those investments wiped out, depleting each institution's capital. Lower capital levels force institutions to cut costs, shrink in size, or a combination of both. Some institutions have been pushed over the edge to their own demise.

The credit unions directly affected by the three failures last Friday start working this week on their contingency plans to deal with the failure of their wholesale credit unions. In addition to the financial (e.g., higher assessments) and capital consequences, many of these credit unions will have to evaluate their options for the outsourcing services the wholesale CU provided. Why, some readers might wonder? These three wholesale CUs and two other failed ones from 2009 (US Central CFCU, Western CFCU) are going out of business. The sales teams at the bank and credit union technology vendors have a golden chance to hit or exceed their sales targets for 2010. The management teams at these vendors will be pushing hard to close deals and register organic revenue growth.

Darwin's survival of the fittest is at work. Market churn, like these failures create, does not translate into higher industry technology spending by itself. What does lead to higher spending by institutions is the implementation of more effective technology solutions that can support growth without adding to staff, and in some cases support growth with fewer staff. I expect the next six months will produce a lot of outsourcing deals involving the affected credit unions.

The big mortgage market picture is still a political guessing game that will not change much until the new Congress settles in next year. It is clear that the expanding portfolio of government-run institutions adds more complexity to the picture, especially with a less-than-robust recovery. Until some direction takes shape, mortgage market participants are left to focus on tactical, short-term actions while keeping an eye on the political weathervane. Bill Bradway, founder and managing director of Bradway Research LLC, analyzes the business strategies and IT investments of US banks and credit unions.

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