Is it Time for the ILCU to throw in the Towel on Savings Protection ?

Is it Time for the ILCU to throw in the Towel on Savings Protection ?

Is the sector facing a potential S&L style crisis as a result of its investment and loans strategy in recent years. There appears to be two factors at play: (1) Investment Losses and (2) Bad Loans. Both these brought the S&L’s to their knees in the US. The primary issues were poor investments where S&L’s had large holding of junk bonds and risky lending practices.

Recent media reports here have highlighted regulatory intervention forcing some credit unions to increase bad debt provisions.

There is a bigger story hidden from view within the Enfield ruling. It appears c€221m in perpetual bonds were sold to about 160 credit unions who may now be facing losses of apparenty €45m. These bonds were sold in association with the ILCU with its implicit endorsement at the time of sale of fitness for use by its member credit unions.

It seems the ILCU effectively certified perpetual bonds as safe investments for credit unions to make. It subsequently publically claimed in the media that the investments were viable, defending them in it’s internal memos and admitted it had invested SPS funds in such bonds.

It is quite amazing this has not been picked up on….particularly as the ILCU is also a stabilisation fund provider and supervisor. Then again its governance and management of it’s stabilisation support system is not subject to supervision by the Regulator.

Credit unions have also lost money on ISTC investments and those who have holdings in Irish equities or equity based funds are incurring losses at this time. The scale of underlying equity and bond exposures is unknown. For example many credit unions invested in unit linked, with profit and tracker funds/bonds the vast majority of which are invested or are exposed to equities and bonds. They have locked into illiquid investments that carry high encashment costs and in some cases may have been closed for withdrawals. There are investment risks, interest rate risk and liquidity risks inherent in the faulty strategy adopted by the vast majority of credit unions. Most do not have an ALM strategy or supporting systems in place and have effectively “bet the bank” in a high income play. In short they may have invested far too long. The average duration of credit union deposits is reckoned to be close to the average duration of loans of about 2-2.8yrs yet credit unions have investments tied up for much longer terms. This has led to concerns being expressed over liquidity.

The Regulator expects credit unions to provide for investment losses at this time irrespective of investment maturity guarantees which has a direct effect on reserves which if impaired enough could trigger a request for the assistance of the ILCU SPS Fund. Media reports indicated what appeared to be ILCU ambiguity in the accounting treatment of investment gains and losses in its communications with its members.

The two media reported investment loss estimates of c€45m (Perps), €18m (ISTC) amounts to €63m. The ILCU stabilisation fund c€100 m is arguably highly exposed should credit unions look for support to shore up the effect of investment losses on their already thin reserve base.

Few credit union savers realise just how exposed their share account savings are. As savers they are in effect in a private shareholders position where dividends are at the discretion of the board. Their consumer expectaton of earning "interest" on the savings cannot be guaranteed by their credit union.

Irish credit unions (alone in the western world) do not provide for risk based capital. There is no link between risk including investment risks and their statutory reserves. Many observers consider the reserve base too thin in the current credit union risk environment. Rather than building cash reserves, many credit unions have opted for a high dividend pay out strategy and investments in new buildings. Allied to this the ILCU has not maintained its target SPS ratio of 1% to total savings and has used the money for other purposes.

The odd thing is the ILCU is no more than a club for credit unions (its an unincorporated body) and governed/controlled via by-laws passed by its club members. In effect the members collectively own the fund which is a type of benevolent fund used to support members in trouble at the discretion of a sub-committee of the clubs committee…with no written rules or procedures etc. Could it be possible that its members will demand the club committee gets their SPS money and investments back ?

Expert testimony to the High Court regarding the operation of the ILCU SPS is telling in this regard:

"Concerns about the adequacy of SPS resources are exacerbated by certain high risks and/or illiquid investments by the SPS. It is a core principle that an insurance fund’s assets should be liquid and therefore available at all times to meet unexpected losses. Yet, as noted above, the SPS fund has been used to fund (a) the purchase and development of League premises, (b) an ill-fated computer project (ISIS) and (c) the League’s Central Financial Service. The SPS fund’s combined exposure to these illiquid and/or high risk investments appears to be significant. " (Professor Richard Dale/IHC 2004)[my italcs]

The ILCU rules for the management and provision of supports to credit unions are vary scant indeed. There are no publically available policy, procedures or rules set out. The entire operation is administered by sub-committee of the board of the ILCU at its non-transparent discretion.

But and here is the BIG BUT its internal stated policy is unnerving:

“In the event of a credit union not complying with procedures, the Administration Committee is given the power to recommend to the League Board its disaffiliation. The Committee also has the power to propose the amalgamation of any member credit union, which is considered to be in default with procedures, with another credit union. This, however, will be a discretion since in many cases it might be necessary to provide temporary support to a particular credit union for the good of the Movement even though compliance was not being secured or had not been secured in the past.” ILCU [emphasis added]

It seems that no matter what the problems it will support a credit union even where it cannot achieve compliance. Where does this leave the credit unions that have done the right thing and invested resources in improving governance, risk and compliance ?

If this is the embedded thinking then what chance does any reformed “independent” scheme have ? For sure it will have to be “independent” of a culture that provides a safe haven for black sheep.

Here’s a frightening thought. The minute the ILCU board decides not to provide stabilisation support to a credit union is the minute all confidence will be lost in credit unions. Maybe its leaders know this. If so are they captive of an aberrant thinking that effectively undermines the good efforts of many credit unions and provides non-compliant mavericks with a safe harbour ?

Are Regulatory and Departmental officials awake to the very real risk of an S&L type crisis emerging ? If they are then surely it puts talk of an arrangement with the ILCU on its "reform" of the SPS into a wholly different public interest perspective.

Of course we are hardly likely to hear from the Regulator on this as it has been hobbled by Departmental and Ministerial concerns that “a solution should be found within the context of current legislation” when everyone knows the current legislation is deeply flawed documenting the political capture of trade body lobbying. Of course departmental concerns would extend to the catastrophic scenario of the state having to provide a full state guarantee to all credit union savers in a crisis. Which is of course what state backed statutory savings compensation schemes are designed to protect against.

Could it be that ILCU reform plans are coming unstuck ?