Primary Risks

The types of risk a CUSO can pose to a credit union vary greatly from CUSO to CUSO, and are influenced by a CUSO’s operating structure and the services it offers.

A well-managed CUSO relationship can have a positive impact on a credit union’s earnings, net worth, and operational condition. In fact, many CUSO relationships are established to achieve this goal through the products or services they provide to the credit union. On the other hand, a poorly managed relationship, or a relationship with a CUSO that engages in certain complex or high-risk activities, has the potential to harm the credit union.

Although some are owned in whole or in part by credit unions, CUSOs operate as third-party vendors. Credit unions that invest in or loan to a CUSO or receive services from a CUSO should conduct third-party due diligence reviews. For more information, see NCUA Letter to Credit Unions 07-CU-13, Evaluating Third Party Relationships.

CUSOs, as independent entities, may face many of the same risks credit unions face. More importantly, CUSOs may be the source of various risks for affiliated credit unions; these risk exposures can be mitigated with adequate controls and proper management oversight.

Compliance Risk

A CUSO’s failure to properly identify and manage its own compliance risk can potentially pass that risk to affiliated credit unions. The potential compliance risk exposure will vary depending on whether a credit union has an investor, lender, or client relationship with a CUSO. The table below identifies the specific exposures.

Compliance Risk Exposure for Credit Unions as a CUSO...
Investor Lender Client
  • Pass-through liability
  • Loss of investor capital
  • Harm to reputation
  • Regulatory violations
  • Pass-through liability
  • Potential for CUSO loan default
  • Regulatory violations
  • Pass-through liability
  • Loss of a product or service
  • Diminished business
  • Harm to reputation
  • Exposure from regulatory violation

In addition, credit unions must comply with regulatory limits on the amount of investments in and loans to affiliated CUSOs. For more information, see NCUA regulation § 712.2, How much can an FCU invest in or loan to CUSOs, and what parties may participate?

Credit Risk

A CUSO’s credit risk exposure is largely dependent upon its business lines and balance sheet composition. In certain CUSOs, this can be the risk of default associated with various products such as commercial loans, mortgage loans, or investments the CUSO holds or processes.

A CUSO’s failure to properly identify and manage credit risk can pass risk directly to, or create risk for, credit unions. Risk is driven by:

  • The credit union’s relationship with the CUSO (investor, lender, or client)
  • The types of services the CUSO provides to the credit union
  • The volume of activity

Failure to properly identify and manage credit risk in this relationship can lead to exposure of excess risk in the products a credit union obtains from a CUSO, or a loss of funds invested in or loaned to the CUSO.

Credit Risk Exposure for Credit Unions as a CUSO...
Investor Lender Client
  • Pass-through liability

  • Financial statement consolidation risk (for wholly-owned CUSOs)

  • Loss of investor capital
  • Potential for CUSO loan default
  • Cash-flow disruption
  • Collateral associated risk (holding or disposition)
  • Pass-through liability
  • Potential loan losses
  • Loss of a product or service
  • Legal/contractual risk
  • Diminished business
  • Harm to reputation

Interest Rate Risk

A CUSO’s IRR exposure is different from a credit union’s due to the differences in balance sheet composition. CUSOs that offer limited services may have minimal IRR. CUSOs that offer market-priced products, such as loans, may have significant IRR. A CUSO’s failure to properly identify and manage IRR can pass risk to, or create risk for, credit unions.

As with credit risk, IRR is driven by:

  • The credit union’s relationship with the CUSO (investor, lender, or client)
  • The types of services the CUSO offers to the credit union
  • The volume of activity

Changes in market rates can impact the pricing of products or services offered by a CUSO, potentially having a negative impact on a credit union’s balance sheet and income statement beyond the loan or investment made in a CUSO. A change in interest rates may affect the value or price of a CUSO’s assets and associated income, potentially having a negative impact on its liquidity and equity. The assessment of IRR should consider risk from both an accounting perspective and the economic perspective (the effect on the market value of loans and investments).

IRR Exposure for Credit Unions as a CUSO...
Investor Lender Client
  • Loss of, or changes in, investor capital
  • Financial statement consolidation risk (for wholly-owned CUSOs)
  • Potential for CUSO loan default
  • Pass-through IRR (primarily loan products)
  • Performance failure, exposing client to changes in market rates or durations

Liquidity Risk

A CUSO’s liquidity risk exposure is largely dependent upon its business lines and balance sheet composition. A CUSO may be unable to sustain operations due to insufficient cash flow, or an inability to access or obtain:

  • Lines of credit
  • Additional paid-in-capital (investments)
  • Secondary sources of operating funds

Typically, the liquidity risk a CUSO passes to or creates for its affiliated credit unions is dependent upon the type of product or service it provides; however, liquidity risk may be more pronounced for a credit union already experiencing higher liquidity risk in its own operations.

Liquidity Risk Exposure for Credit Unions as a CUSO...
Investor Lender Client
  • Loss of, changes in, or inability to liquidate investor capital
  • Financial statement consolidation risk (for wholly-owned CUSOs)
  • Potential for CUSO loan default
  • Cash-flow disruption
  • Cash-flow disruption
  • Legal/contractual risk
  • Harm to reputation

Reputation Risk

A CUSO’s failure to properly manage its reputation can potentially pass risk to, or create risk for, credit unions. Reputational damage at the CUSO level may transfer directly to, or reflect poorly on, affiliated credit unions and their members and, potentially, affect third-party perception.

Reputation Risk Exposure for Credit Unions as a CUSO...
Investor Lender Client
  • Pass-through reputation risk
  • Loss of, changes in, or inability to liquidate investor capital
  • Pass-through reputation risk
  • Potential for CUSO loan default
  • Pass-through reputation risk
  • Loss of a product or service
  • Diminished business

Strategic Risk

Strategic risk is the current and prospective risk arising from adverse business decisions, improper implementation of decisions, or lack of responsiveness to industry changes. Strategic risk can also include risk associated with the products and services developed or provided by a CUSO.

A CUSO’s failure to properly identify and manage strategic risk can potentially pass risk to, or create risk for, credit unions. For example, if a credit union relies on a CUSO to perform a business function or to provide a significant source of income and the CUSO fails or is otherwise unable to continue to provide the same level of service or support, this could have a material negative impact on the credit union.

CUSOs, as independent entities, may face many of the same risks credit unions face. More importantly, CUSOs may be the source of various risks for affiliated credit unions; these risk exposures can be mitigated with adequate controls and proper management oversight.

Strategic Risk Exposure for Credit Unions as a CUSO...
Investor Lender Client
  • Integrated or pass-through strategic risk
  • Loss of, changes in, or inability to liquidate investor capital
  • Potential for CUSO loan default
  • Cash-flow disruption
  • Integrated or pass-through strategic risk
  • Loss of a product or service
  • Terminated or diminished business
  • Harm to reputation

Transaction Risk

A CUSO’s failure to properly identify and manage its own transaction risk can potentially pass risk to, or create risk for, credit unions. This risk may include inaccurate consolidated financial statements, loss of funds in the form of write-offs, and inaccurate accounting and reporting that directly impacts the credit union’s relationship with a member.

Transaction Risk Exposure for Credit Unions as a CUSO...
Investor Lender Client
  • Loss of, changes in, or inability to liquidate investor capital
  • Financial statement consolidation risk
  • Harm to reputation
  • Potential for CUSO loan default
  • Cash-flow disruption
  • Pass-through transaction risk
  • Potential accounting losses
  • Cash-flow disruption
  • Legal/contractual risk
  • Loss of a product or service
  • Harm to reputation

Last updated August 9, 2018