Deciding on the Davy Proposal

Deciding on the Davy proposal

Context: Credit Union investments in highly illiquid floating rate CMS perpetual bonds having accumulated losses at today’s prices of c40%.

The deal on the table means the credit union will

(a) Crystallise losses incurred to date through granting a call option to Davy at an agreed strike price which Davy at its discretion may call and sell the perpetual bonds at some time in the future – presumably when the bonds realise sufficient excess gain to fund Davy obligations under the 10 year “loss recovery” bond.

(b) Recoup these losses over ten years via a ten year zero coupon bond (the loss recovery bond). This will be funded by Davy who will initially fund at c18% of the face value of the perpetuals. It is anticipated this recovery bond will appreciate to mature at 40% of perpetual bond face value.

(c) Agree to a reduction in the perpetual bond coupon to the ECB rate or the coupon rate whichever is lower. Any excess income over the ECB rate will be for Davy who it seems will use the excess to fund its obligations under the 10 year recovery bond structure.

(d) For at least two years the credit union remains exposed to any further losses below the strike price until Davy exercise its call option and or if the bonds fall in value by more that 15% for more than 60 days permitting the credit union to set aside the call option and sell the bonds itself.

(e) Once Davy exercises the option and sells the perpetual bonds the credit union is exposed to income impairment on 40% of its holding for the remaining term, if any, of the ten year bond. Eg Davy sells in year three – credit union will not earn any income on 40% of the face value of the perpetual bond for 7 years.

On the face of it the bargain is a reasonable proposition that a credit union may consider accepting providing it obtains independent advice. It is most important it demonstrates that it took account of the full context of the proposal including legal, investment, taxation, accounting and compliance issues and risks in making its decision.

It is clear there are compliance and resultant legal issues associated with the initial sale and purchase of the perpetuals and within the structuring of the Davy proposal. However it is highly probable that a regulatory blind eye may apply as the deal is in the interest of credit unions whose boards are obligated to ensure the safety of savers funds. Recovering capital losses on investments, whilst foregoing income, is a reasonable proposition when the alternative scenario is considered.

The alternative is to sue to recover in full in the hope that the courts and or the Financial Ombudsman will rule fully in favour of the credit union. Notwithstanding the Enfield case, success is by no means certain and it would take a very confident board indeed to sue. In doing so the credit union may suffer substantial reputational damage as the full extent of its knowledge and competence in investments will be exposed in a court. It is highly likely that a court may find a credit union partially responsible – in which case the actual result could carry a far higher cost than accepting the Davy proposal. The problem is this is an uncertain outcome with inestimable costs.

The decision is either

(a) accept the proposal in the full knowledge of its risks and costs

(b) reject and sue with its uncertainty and potential for reputational damage

(c) reject, book losses now, sell the perpetual bonds when possible and move on

In the final analysis a credit union board will need to ensure it effects a robust informed decision making process through which its decision can subsequently be shown as being made in the best interests of the credit union.

Many consider that perpetual bonds should never have been sold to or bought by credit unions. They remain innappropriate investments and are no longer permitted under regulatory guidance notes. If it was wrong to sell them, it was also wrong to buy them. Who may have been more wrong than the other is not the issue. What matters now is the commercial reality is dealt with in which case option (a) is the only reasonable way forward.

Perpetual Crisis - The aftermath tackling the fundamentals

In Perpetual Crisis – A fundamental reality that confronts the Movement

The perpetual bond saga is a symptom of far greater problems with the credit union movement, its financial safety net, financial stability and survival.

In pursuing its own agenda, the ILCU has facilitated the decline of credit unions to a point where their financial stability is so threatened there is a very real and growing danger of systemic destabilisation.

The credit union business model is failing fast. The ILCU institutional form has already failed to deliver value. It has become a classic value destroyer whose activities have directly and indirectly resulted in the expropiation of millions in community capital – ISIS and Perpetual Bond losses alone are over €110m.

But its misguided ambition remains: It wants to evolve as a central credit union for all Irish credit unions. Despite nearly 20 years of trying, it is further away now than it has ever been. It remains blind to the reality that confronts it; it is the prime body that has prevented, hampered and frustrated credit union reform and modernisation.

Its misguided ambition was articulated in its submission on investments in 2006:

"The long-term aim of the credit union movement is to build, own and operate a centralised treasury operation around a newly developed, and Financial Regulator approved, unit trust that would manage the credit union movement’s investments. This centralised treasury model is well established in the credit union movements in America, Canada and Australia. The legislators and regulators in these countries insist on the credit unions using the central treasury operation. Such an approach from the equivalent authorities in Ireland would have a very positive effect on the management of investments by credit unions in Ireland.(ILCU Submission on Investments to the Department for Finance 2006)

The central treasury model is not a “unit trust” in any of these countries. Once again, as with Deposit Insurance, the ILCU was playing fast and loose with financial stability concepts to benefit its own agenda.

Both the CIM and CMTF (Unit Trust) are unregulated and unsupervised as “central credit union entities”. Of course the CMTF is regulated as is every other authorised collective investment scheme in the state – but it is not a regulated credit union central treasury entity.

Neither the ILCU nor its advisers have any statutory role, responsibility or accountability for the central management of credit union funds. Many consider it is highly imprudent of the Irish government to continue to allow for such an unregulated unsupervised system.

Central treasury operations are provided by “Central Credit Unions” in the US, Canada and Australia. They are sophisticated regulated banking type operations providing liquidity, wholesale funding and other central services such as access to clearing, etc. The are empowered and incorporated under credit union legislation and are regulated and supervised by credit union regulators.

They operate as a credit union “central banker” many probiding quasi lender of last resort(LOLR) facilities - some are backed by the full faith and credit of the state. In some cases such support is indirect through deposit insurance schemes (Canada).

In Canada and Australia these central credit unions are operating on a similar basis to the federal RaboBank or German/ Austrian Raiffeisen co-operative models. For example RaboBank is a bank owned by 400 odd small co-operative banks.

Centrals have robust governance systems including risk governance, management and internal controls. They even have ratings -the Australians issued a bond in 2006 which carried in part a “AAA” rating. Their existence is the reason why credit unions provide mortgages as they can access to wholesale funding required to support mortgage books.

Canadian and Australian Centrals own subsidiaries that are brokerages, insurance companies, credit card issuers etc. They provide access to clearing and a host of IT based products that credit unions on their own could never hope to provide.

The US differs due to scale and history – but all states have a central etc. Other central services are provided by different entities called CUSO’s. These are companies owned by credit unions such as IT companies, wealth management etc and provide services to their owners and other credit unions.

Centrals actively promote, facilitate and finance rationalisation (mergers) which has seen the reduction in numbers of credit unions – but not outlets or customers: the latter two have grown not shrunk as has the breadth and scope of products and services offered.

Central credit unions are a necessary component of a well designed financial safety net. Credit unions are obligated to place all of or a significant portion of excess funds with them. Centrals stand alone and are specifically legislated for and regulated by credit union regulators. They are viewed as critical components of governmental policy in the control of credit union risk taking and protection of savers funds. Their existence has allowed credit unions to offer better products and services – mortgages etc. Such entities are fundamental to the design of the financial safety net, ensuring credit union financial stability and growth.

Such a system is a huge missing piece in Ireland along with a state owned deposit insurance (guarantee) scheme.

If a central credit union system is ever to be developed it cannot sit within the ILCU system. However there is no reason why existing services provided by the ILCU cannot sit within a Central, as is the case in Canada or separate as in US. In Canada, Centrals also act as trade bodies – but whilst owned by credit unions they are not controlled or dominated by them in the way the ILCU is dominated by its members. Governance is what would be expected of incorporated bodies of such national importance to financial stability.

Developing a similar system here will require a fundamental shift in Irish credit unionist thinking about “independence” and a mind shift towards a federalist subsidiarity. Everywhere else laws are written to establish and empower central credit unions and similar entities. The same will have to happen here if credit unions are to survive.

But the ILCU won’t hear of it. It has a strategy to evolve into the RaboBank of all Irish credit unions, North and South. The problem is it’s starting 30 years behind the game line and hasn’t the resources or professional competence to build the system. Neither has it the trust and commitment of its member credit unions. Critically it hasn’t the reputational capital to persuade government either here or the UK to legislate to allow it to become a central credit union entity. It insists on trying to manufacture a silk purse from a sows ear.

The fundamental issue is this. The credit union institutional collaborative system, the ILCU, is the real problem. Far less than the sum of its parts, it is a failed entity – a classic value destroyer. Unless this problem is tackled, it will remain what it has been for over 20 years the single greatest road block to a sustainable future for Irish credit unions.

Irish credit unionists need to develop new federated structures through which they truly co-operate to survive. Government will have to heed the perpetual wake up call by designing and implementing a proper financial safety net. If not the perpetual saga of one crisis after another will continue and credit unions will eventually disappear.

Hong Kong in July !

Hong Kong Photo Gallery - some familiar faces

http://www.woccu.org/events/wcuc/wcuc_photogallery

Fresh from the Annual Conference credit unionists are looking forward to their annual jolly abroad.

Last year a well known Irish credit union activist volunteer boarded the flight to Calgary in Canada wearing a tee shirt festooned with credit union pins from across the world. This year no doubt they are looking forward to adding to their growing collection of pins. It seems about the only thing of value garnered from these international jollies is the ubiquitous credit union pin.

Once again the largest group of international delegates will probably be the Irish credit unionist brigade who this year will travel to Hong Kong for their annual get together.

What isn’t widely known is credit unions foot the bill for these travelling delegates and sometimes their partners. A quick calculation of the cost of a trip, including the conference, comes to somewhere in the region of €4000 per delegate and €2000 for their companion. It is common for 150 or so Irish delegates to attend which amounts to a cost of €600,000 all paid for by their credit unions.

The Irish delegation to these annual events is always one of the largest. The WOCCU World Conference is touted as a developmental opportunity – yet after years of tripping abroad Irish credit unions haven’t introduced one new product or innovation.

So what value has really accrued save the odd credit union pin, photographs, fond memories of nights out and the odd souvenir ?

In a year when credit unions have lost over €95m in investments with many faced with announcing the lowest dividends ever – can credit unions really justify sending so many so far for so little.

see here for previous trips:
http://www.independent.ie/business/habemus-junketus-maximus-469317.html

http://archives.tcm.ie/irishexaminer/2002/06/24/story30669.asp

The strange story of the Regulator and the ILCU Annual Conference.

It is rumored the Regulator chose not to accept the ILCU invitation as he was precluded from addressing its AGM. The ILCU were incensed it seems by his published speech to the National Supervisors Conference which for the first time highlighted in robust frank language the scale of issues faced by the movement.

“The League considers your public comments to be inappropriate and could contribute to undermining public confidence in the credit union movement, especially in light of the recent issues in the financial markets. It is hard to imagine that any other department head would make similar public comments in relation to the financial service providers that he/she regulates, Such treatment of credit unions is unacceptable”[League letter to RCU following his address to the National Supervisors Conference]

Why has the relationship soured? The answer perhaps lies within the at times belligerent and ambiguous advocacy of the ILCU which is rooted in its continuing ambitions to retain a self-regulatory role and evolve a Canadian type in-system central credit union control and dominance of the movement.

“It is important that Regulators concentrate on their goals of regulation and supervision. In the Republic we have seen the intervention of the Registrar into areas which I consider to be outside his remit, such as accounting standards. This is unacceptable but we of course recognise the Registrar as the only credit union regulator and a key stakeholder. The development of regulation must be done as a process of consultation involving all key stakeholders. The implementation of new regulatory standards without proper consultation and engagement is not acceptable and will be resisted. In this regard, it is regrettable that the Registrar has chosen not to attend this meeting.” ( Presidents Address to ILCU Conference 2008)

Such are the words of the ILCU president at this year’s AGM, indicative of the continuing ambiguity of its response to state regulation and supervision. The ILCU behaves as if credit unions have some form of veto on regulatory reform where its actions have consistently frustrated reforms. For example it now accepts the investment guidelines. It initially frustrated their development delaying their introduction for well over a year.

“The investment framework which was negotiated with the Registrar of Credit Unions is one that allows credit unions invest their excess liquidity in a manner which protects the members’ money yet allows for significant income generation. While the ILCU remains concerned as to the language used to describe how the guidelines will be regulated, it is comforted by the Registrar’s commitment to continue to regulate via the Credit Union Act 1997.” (Presidents Speach ILCU Annual Conference 2008)

Firstly the investment framework was not negotiated with the regulator – this is patent nonsense. The Regulator frustrated in its attempt to persuade the adoption of voluntary guidelines with the ILCU, published draft investment guidelines and through a process of consultation with key stakeholders revised them to their final published form. To suggest the ILCU has some form of “negotiation mandate” or for that matter is afforded this position is wrong.

The ILCU has no legislative, regulatory or supervisory mandate nor is afforded any recognition by the state save that of a body expert in credit union affairs that may be consulted – this hardly amounts to “negotiating” for regulatory change. Regulation is the sole remit of the state regulator and one which the ILCU has consistently sought at every turn to undermine.

In its submission to the Joint Committee is quite telling:
“When initially published, the Central Bank and Financial Services Authority of Ireland Bill 2002 contained a provision which stipulated that the Registrar of Credit Unions would not be subject to the control or direction of the regulatory authority, namely, the board of the Financial Regulator, in carrying out or exercising his responsibilities or powers in respect of the registration of credit unions or the supervision of their affairs or activities. This section was removed prior to the enactment of the Bill. Instead, it is now provided that the registrar, through the chief executive, is subject to the control of the regulatory authority and is required to comply with directions given by the authority with respect to the carrying out of his responsibilities and the exercise of his powers…. The ILCU expressed concern about this in late 2002 and early 2003 when the Bill was going through the Houses. However, it was assured that the only concern of the interim authority was with regard to the accountability of the registrar to the CEO of the authority and that if the ILCU had a problem with what the registrar might be doing, the authority would not act. This is clearly not the case in practice. While the ILCU has developed a reasonably efficient working relationship with the registrar, it has serious concerns about the reporting relationship between the registrar, the chief executive of the regulatory authority and the board of the regulatory authority, which now clearly goes beyond the promise of “accountability” only.”(ILCU Joint Committee on Finance and the Public Sector June 2006)

Did it believe that Government was offering a veto to the ILCU of it “didn’t like what the regulator was doing”? Hardly, but to suggest it had is but more of the nonsensical advocacy it has so often managed to shoot itself in the foot with.

It is past time for the ILCU to mature as a representative body: to cease and desist its negative adversarial advocacy reminiscent of 70’s trade unionism or worse still resonant of another from of unionism – that which cried “no surrender”.

Completing the job of “driving the moneylenders from our communities” may be laudable mission – but surely the primary mission must be to ensure the sustainability of credit unions.

It is important that the reputational capital of the credit union movement is improved – it most certainly has been severely dented by recent media stories – many of which are highlighted on this blog. Continuing to whinge, complain about and attack the Financial Regulator undermines reputational capital further.

Most people realise that credit unions have failed to make the business case for greater flexibility and also understand the risks to credit union instability – some highlight these risks in a genuine effort to get people to wake up and take action.

Looking good and sounding good is rather easy – doing good is where the challenge lies. Professional advocacy is all about persuading and influencing others to take action favourable to your position. The ILCU it appears has a long way to go to repair the consistent damage it has facilitated to credit union reputational capital.

Surely it is in the best interests of the credit union movement that robust effective and effective supervision and regulation underpins financial stability – yet we read of change being resisted unless it is agreed change – this is not a relationship that depends on agreement and voting – credit unionism is not trade unionism.

The state rightfully legislates, regulates and supervises credit institutions – to suggest that credit unions should resist change unless agreed is patent nonsense. To suggest that change be resisted unless there is prior consultation is also nonsense. One has to create the conditions in which consultation is valued and appreciated rather than sustain the conditions in which consultation becomes procrastination and obdurate refusal to recognise and work with a reality they threatens the future of credit unions.

Neither the Regulator nor Government were responsible for the ISIS crisis, increasing credit union instability or investment losses. In contrast the ILCU mandate includes stabilisation supervision, business model development and central investment management. Rather than deflecting attention away from its failings it should address where the real problems lie and start doing something about them.