The family silver is now needed .....

The family silver is now needed….

From 2000 to 2007 credit unions adopted a poorly conceived response to a low interest rate environment. The majority pursued a dividend maximisation policy which saw rates as high as 3-4% being paid on what are essentially demand deposits. It is widely known that demand deposits are relatively inelastic with average durations of about 2.8 years. Competing bank rates were about .50% and even lower for equivalent deposits. During this time, bank demand deposits increased at about the same rate as credit union deposits.

Credit unions paid a rate many times higher then they needed to and in doing so failed to build reserves, creating the cushion required for when times got tougher. As they now have.

For example had the dividend payout been lower by say by 1% then the movement would have generated an additional e€300m in reserves. Furthermore had the ratio of loans to total assets been maintained at 64% this would have generated an additional e€200m in reserves. Much of this could have been used to invest in improving operating efficiences, modernistion of IT capability, proper marketing and revitalised products.

In short credit unions could have competed for loans and have assembled the resources necessary for modernisation but did not. They now face a far less benign market in 2008 with a very thin reserve base and still have to invest in modernisation.

As it stands, operating expenses are now greater than core operating income, fee income is less than 1% of total income and many credit unions have illiquid investment portfolios with real returns under some pressure. There are signs that the loan to asset ratio has stopped declining but whether this represents an increase in loan demand or a decline in savings growth or a combination of both is uncertain.

There is clear evidence from reported delinquency experience that many credit unions have incurred significant loan losses that have yet to be written off. The lead delinquency indicator has not been translated into bad debt provisions or write offs. The Regulator once again recently highlighted the issue :

“Based on our recent inspections of credit unions we have found that in all cases where we have commissioned an in-depth analysis of a credit union’s loan portfolio, that substantial additional provisions for bad and doubtful debts have been identified……..It may be the case that with margins in credit unions declining, that pressure may be felt by boards to maintain the dividend level of the credit union over and above that which would be fully justified by the underlying financial results of the year in question. Such pressure may result in a temptation to artificially increase the credit union’s surplus, by a variety of means. The understatement of the provision for bad and doubtful debts is a feature of this tendency which we have commonly detected in our inspections. Various unacceptable devices to achieve this have been uncovered by our inspection teams. These include inappropriate rescheduling of overdue loans, the issuance of top-up loans in arrears situations or the exclusion from the provision calculation of overdue loans where security is held.” (National Supervisors Forum, Annual General Meeting 3 & 4 November 2007, Speech by Brendan Logue Registrar of Credit Unions)

The worry is that a lot of credit union lending was business and speculative property development finance which is now highly exposed to the sharp decline in construction and house sales activity. It is also widely known that millions were lent to first time house buyers to finance the balance of their 100% mortgage requirements and household furnishings etc. These borrowers are now facing the very real probability of negative equity as house prices have declined rapidly and interest rates risen. Under increasing pressure to finance loan repayments they will beging to default on unsecured personal loans rather than put their homes at risk.

Some estimates of the scale of potential write offs are between €150-200m of irrecoverable unsecured loans. Even were loans have been secured questions have arisen as to the reliability of the security taken by many credit unions. The rise in Judgements being obtained by credit unions is indicative of increasing loan default rates.

Reported investment losses are adding to the heady mix of issues to be dealt with.

A recent media article may be right; in a credit crunch perhaps people will once again turn to credit unions for their loans. Thing is credit unions may not in a position to safely meet a surge in demand and would be foolish indeed to respond without careful analysis of borrower repayment capacity. Is this is feature of current loan assessment processes? Well only 16 credit unions’ are members of the Irish Credit Bureau.