Ominous signs of a credit union perfect storm
“Credit unions are like an armada of small wooden inshore sailing ships that have sailed far out into an uncharted sea and an ice pack field of growlers. The fleet will be hard put to navigate safely through these dangerous waters. The flag ship, ILCU and many of the ships have already collided with one growler – one ship the “Imprudence” has collided with two and is still leaking above and below the waterline. The armada is heading in the wrong direction, ignoring the tell tale signs of worsening seas ahead. Navigating by the stars and rudimentary compasses, these little ships are unaware that they are dangerously off course and have been for some considerable time.”
Collision with one of these growlers resulted in the Davy offer to make good credit union losses in investments in what it terms were “constant maturity swaps” in effect “floating rate coupon perpetual bonds”. It is a noteworthy, admirable and honourable settlement – made without admission of liability. It is a patch to a leak that amounts to over €70m of credit unions precious ballast of reserves.
One wonders how many credit union investment committees understand what a constant maturity swap is. Thing is, if credit unions didn’t understand the risks involved in perpetuals will they understand their complicated workout solution? They would be well advised to seek independent advice on whether or not to sign up for the deal. But many will accept the settlement as it is. They will do so to save the embarrassment of having to admit to their members/customers that they have once again lost millions. ISIS resulted in losses of c€40m – added to perpetual losses of €70m and ISTC losses of €18m – that’s a cool €128m of losses in just 7 years.
“Credit unions are like an armada of small wooden inshore sailing ships that have sailed far out into an uncharted sea and an ice pack field of growlers. The fleet will be hard put to navigate safely through these dangerous waters. The flag ship, ILCU and many of the ships have already collided with one growler – one ship the “Imprudence” has collided with two and is still leaking above and below the waterline. The armada is heading in the wrong direction, ignoring the tell tale signs of worsening seas ahead. Navigating by the stars and rudimentary compasses, these little ships are unaware that they are dangerously off course and have been for some considerable time.”
Collision with one of these growlers resulted in the Davy offer to make good credit union losses in investments in what it terms were “constant maturity swaps” in effect “floating rate coupon perpetual bonds”. It is a noteworthy, admirable and honourable settlement – made without admission of liability. It is a patch to a leak that amounts to over €70m of credit unions precious ballast of reserves.
One wonders how many credit union investment committees understand what a constant maturity swap is. Thing is, if credit unions didn’t understand the risks involved in perpetuals will they understand their complicated workout solution? They would be well advised to seek independent advice on whether or not to sign up for the deal. But many will accept the settlement as it is. They will do so to save the embarrassment of having to admit to their members/customers that they have once again lost millions. ISIS resulted in losses of c€40m – added to perpetual losses of €70m and ISTC losses of €18m – that’s a cool €128m of losses in just 7 years.
One cannot but feel for Davy as it was sucked into the vortex of the leaderless vacuum between ILCU and credit union boards - between boards and their investment committees- even between people on the investment committees.
Anyone dealing with most credit unions realises quite quickly they are not dealing with a commercial enterprise that acts as a business but with a collective of many voices – the voluntary board and sub-committees. They will know of how difficult it is to get a credit union to commit to any decision. They will know that many credit union people have elevated prevarication, procrastination and obfuscation to a high art form thus ensuring that accountability and responsibility is so diluted it disappears into the fog. After all most credit union boards view their role as being accountable only to members and do not perceive they have a fiduciary duty of care to the credit union itself. If they did then they would have ensured they employed the competence required to professionally engage with Davy and others.
Origins of the Investments Issue
This particular growler has been floating around for over ten years – in 1998 the Minister for Finance Order amending the 1958 Trustee Investment Act had the unwitting consequence of permitting credit unions to invest in instruments they should never be permitted to invest in. At the time the governing Department was Enterprise Trade & Employment and the error appears to have been an interdepartmental slip of the legislature’s pen. However despite regulatory concerns no moves were made to reverse this error and the effects it would have on credit unions and their risk taking. A magnet had been placed next to the credit union compass, steering them well off a prudent course.
There is little evidence to suggest the ILCU spotted this slip and advocated against this change. There is little evidence it instigated action to improve its members competence in investments – given its SPS role it could have insisted on the adoption of an appropriate investment strategy and policies including the development of professional competence by its members – it wasn’t until late 2005 that it issued an investment policy document for credit unions – a move which was it seems largely in response to regulatory concerns.
In 1997 in recognition of a need for greater investment expertise the ILCU entered into its partnership with Davy through its CIM service. In 1998 credit union total assets were €4.2bn of which loans comprised €2.64bn and investments €1.42bn. The key loan to asset ratio was 64% which even then lagged behind accepted safe levels of 70%+. Previous years had seen the decoupling of savings and loan growth with savings growing faster than lending and regulatory concerns were being expressed over this key loan/asset ratio.
Today credit union total assets are €14bn , loans €6.3bn and investments €7.1bn of which the ILCU CIM/Davy relationship manages €2.4bn or 34%. This means that nearly €5bn is invested by credit unions outside of the CIM relationship by credit unions having little or no professional competence or sophistication in investments. The top 100 credit unions control c€9.1bn in total assets of which c€4.6bn is in investments. None are reported to employ investment mananagement or treasury expertise and are wholly reliant on board investment committees and external advisors. The whole nature of the relationship between advisor and credit union remains indirectly regulated and little guidance exists to adequately define roles, responsibilities and accountabilities. More recently the regulator issued a clear warning to credit unions:
“It is not acceptable for a board to blindly follow the advice of an investment advisor or broker. It should be remembered that in such situations the broker is generally not exposed to the risks associated with the investment. The authority for investment decisions and the responsibility for the consequences of such decisions rests with the board of the credit union. This responsibility cannot be delegated or outsourced.”[RCU, National Supervisors Conference 2007]
The Regulator has also reiterated the view that whereas a product may comply with the Trustee Investment Order it does not mean that it is an appropriate investment for a credit union. More recently the Regulator has spoken of issues relating to accounting for investments:
“the Irish League of Credit Unions issued a circular concerning the accounting treatment of investments dated 27 September 2007. This circular implies that Fair Value accounting is an acceptable policy for credit unions. I would like to point out that this circular has no standing with the Financial Regulator nor indeed within the accounting profession.” [RCU, National Supervisors Conference 2007]
In response the ILCU wrote :
“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]
The ILCU has been engaged in a continuous negative criticism of the Financial Regulator:
“….the matter of the role of the Board of the Financial Regulator in the affairs of credit unions was raised. Serious concern was expressed that the Registrar of Credit Unions was in attendance at this Board on a monthly basis and the Board was now having a decisive role in credit union regulation. The negative effect of this has been seen in the attitude taken to the reliability of the SPS guarantee to one credit union. This role for the Board of the Financial Regulator was not what was agreed with the credit union movement by Minister McCreevy and it is not acceptable to the League. “ (League memo following its address to the Joint Finance Committee)
More recently commentary includes :
"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." (SPEECH BY UEL ADAIR, PRESIDENT, ILCU TO ANNUAL GENERAL MEETING 2008) [my italics]
Taken together the ILCU position appears to be most unhelpful in addressing genuine fears for credit union financial stability.
Its leadership legacy is one where credit union governance and management of assets & liabilities remain underdeveloped and exposed to significant ongoing risks – interest rate, liquidity, investment and counterparty.
Under its hegemony credit unions have failed to modernise and professionalise operations, governance and management and are wholly reliant on share and loan products developed for the benign needs of the 1960’s and not the complexity of the 21st century. IT systems do not provide the MIS and decision support systems required of modern financial co-operative operations within an increasingly competitive and regulatory compliance environment. Rudimentary ALM practices and systems are rare.
However in recent years some of the better credit unions have invested time and resources in developing ALM competence in association with truly independent advisory specialists. But they are few and far between. Most credit unions have rejected this approach due to a stubborn self-belief in their own expertise and continuing misguided trust in their trade body.
From about €500m (1998), CIM funds have grown to €2.4bn (2007). What is highly unusual about this arrangement is the fact that an unregulated trade body is involved in what is the co-management of an unregulated money fund in which 34% of the sectors excess savings are held. Its much smaller CTT is a regulated open ended retail investment scheme – not a regulated credit union scheme. The ILCU is an unregulated unincorporated body and it seems hundreds of millions of credit union CIM orders are transacted through its bank accounts. But the CIM is not a separate independently regulated corporate service.
There are no known international credit union comparisons. Every where else central credit union treasury operations are tightly regulated, professionally governed and managed through state approved or quasi-statutory entities. They have high grade professional capabilities and competence in providing credit union access to wholesale markets in providing liquidity and capital supports.
Here in Ireland ILCU central treasury objectives have been stalled for over a decade. More recently it is once again talking up the notion of a central treasury function. Through its 2007 Credit Union Movement Strategy it is promoting an ILCU owned central treasury management CUSO – in the face of mounting concern over credit union safety and soundness and their investment losses, it is unlikely the ILCU may be permitted to establish a central treasury function.
Favourable Taxation treatment of Share Accounts
In 2000 the same Minister for Finance, Charlie McCreevy in an embarrassing U turn was forced to ditch plans to tax credit union dividends in the face of back bencher and independent TD revolt. This revolt was orchestrated by an intensive ILCU lobbying campaign during which its activists threatened to run candidates in the general election.
At the time McCreevy said the U turn was “an open invitation to people to put their money in savings which will not come to the attention of the Revenue Commissioners….the credit unions will get a competitive advantage, because people will automatically put their money there to get this tax exemption. We will be inviting people to evade tax. That is what will happen. It is a fact.”
The ILCU angrily rejected this and said “"The credit union movement will not be used for tax evasion,"
McCreevy’s prescient comments were correct. Billions have since been funnelled into non-taxable accounts, exacerbating the already worrying imbalance between savings and loans.
Taken together the ILCU position appears to be most unhelpful in addressing genuine fears for credit union financial stability.
Its leadership legacy is one where credit union governance and management of assets & liabilities remain underdeveloped and exposed to significant ongoing risks – interest rate, liquidity, investment and counterparty.
Under its hegemony credit unions have failed to modernise and professionalise operations, governance and management and are wholly reliant on share and loan products developed for the benign needs of the 1960’s and not the complexity of the 21st century. IT systems do not provide the MIS and decision support systems required of modern financial co-operative operations within an increasingly competitive and regulatory compliance environment. Rudimentary ALM practices and systems are rare.
However in recent years some of the better credit unions have invested time and resources in developing ALM competence in association with truly independent advisory specialists. But they are few and far between. Most credit unions have rejected this approach due to a stubborn self-belief in their own expertise and continuing misguided trust in their trade body.
From about €500m (1998), CIM funds have grown to €2.4bn (2007). What is highly unusual about this arrangement is the fact that an unregulated trade body is involved in what is the co-management of an unregulated money fund in which 34% of the sectors excess savings are held. Its much smaller CTT is a regulated open ended retail investment scheme – not a regulated credit union scheme. The ILCU is an unregulated unincorporated body and it seems hundreds of millions of credit union CIM orders are transacted through its bank accounts. But the CIM is not a separate independently regulated corporate service.
There are no known international credit union comparisons. Every where else central credit union treasury operations are tightly regulated, professionally governed and managed through state approved or quasi-statutory entities. They have high grade professional capabilities and competence in providing credit union access to wholesale markets in providing liquidity and capital supports.
Here in Ireland ILCU central treasury objectives have been stalled for over a decade. More recently it is once again talking up the notion of a central treasury function. Through its 2007 Credit Union Movement Strategy it is promoting an ILCU owned central treasury management CUSO – in the face of mounting concern over credit union safety and soundness and their investment losses, it is unlikely the ILCU may be permitted to establish a central treasury function.
Favourable Taxation treatment of Share Accounts
In 2000 the same Minister for Finance, Charlie McCreevy in an embarrassing U turn was forced to ditch plans to tax credit union dividends in the face of back bencher and independent TD revolt. This revolt was orchestrated by an intensive ILCU lobbying campaign during which its activists threatened to run candidates in the general election.
At the time McCreevy said the U turn was “an open invitation to people to put their money in savings which will not come to the attention of the Revenue Commissioners….the credit unions will get a competitive advantage, because people will automatically put their money there to get this tax exemption. We will be inviting people to evade tax. That is what will happen. It is a fact.”
The ILCU angrily rejected this and said “"The credit union movement will not be used for tax evasion,"
McCreevy’s prescient comments were correct. Billions have since been funnelled into non-taxable accounts, exacerbating the already worrying imbalance between savings and loans.
Warnings were clearly sounded - but they went unheeded and ignored. The twin effects of the legislative slip in the Trustee Investment Order and Tax U turn had unintended consequences which have destabilised the credit union business model.
Destabilisation of the Credit Union Business Model
The destabilisation of the credit union financial business model has occurred mainly due to the collapse in the critical loans to assets ratio. This ratio is now so low that the financial stability of the sector is seriously threatened. Credit Unions are expected to maintain loan to asset ratios of over 70% but in Ireland this ratio is a disturbing 45% with some of the largest credit unions reporting figures as low as 40%. In one case of a large well known national employer credit union it is only 20%.
The effect of extremely low lending volumes fundamentally destabilises the financial model. Over the past three years credit unions operating income (loan interest) has been significantly less that operating costs. (Fee income is a negligible 1% of total income.) The gap is widening due to declining margins, rising costs, increasing bad debt provisions and investment losses. This means the core business of savings and loans is running at a loss and it is getting worse not better. Credit Unions have become wholly dependent on generating income from investments – so much that they have c€7.1bn of total assets of about €14bn invested in a wide range of investment instruments- many of these investments are inappropriate and imprudent even where they may comply with the Trustee Investment Order.
As early as 1998, the regulator was sounding warnings over credit union investments. Clear forthright warnings were re-iterated in 2001:
“Credit unions should bear in mind that even where a particular investment is legally permissible, prudential considerations also have to be taken into account. They should be extremely cautious when considering the increasingly sophisticated investment products which are currently on the market” (Registrar of Friendly Societies Report 2001)
Yet it wasn’t until 2006 that regulatory authorities finally took action to limit credit union risk taking. It appears that frustrated in its attempts to agree a voluntary code with the ILCU, the Regulator petitioned the Minister for Finance for legislative change to the laws governing credit union investments – this move resulted in publication of an Investment Guidance Note in October 2006. But critically the Note allows credit unions to continue to hold non-qualifying instruments having a maturity date until they mature. Their publication was too late -in the month published the perpetual bond story emerged.
Taken for a Ride – the exploitation of naivety.
The past decade saw the concurrent expansion in the range and complexity of retail investment instruments sold by commission driven sales people. From the one man local band to large companies – the investment advisory and sales industry exploited the credit union niche frequently using high pressure sales tactics.
In many cases the relationship between “advisor” and credit union was far too close for comfort – some even sitting on credit union boards. Still in others, auditors peddled their “investment services” – often from the floor of credit union AGM’s.
Credit union boards are but groups of ordinary people with no more sophistication in investments than the average consumer. This un-sophistication was wholeheartedly exploited. Credit unions were sold imprudent and inappropriate products designed to maximise commission and fee income rather than consideration for what credit unions should have invested in within the context of a safe and sound credit union investment strategy.
Yet the Investments Intermediary Act 1995 could have been used to protect credit unions – but it wasn’t until January 2005 regulatory authorities formally brought the matter to the attention of credit unions and their advisors.
“Credit Unions Have Rights as “Private Clients” under the Investment Intermediaries Act 1995 (IIA) in their relationship with their Investment Advisors. Unless they choose otherwise, credit unions are regarded as “private clients” for the purposes of Section 37 of the Investment Intermediaries Act 1995. (IIA). This entitles credit unions to important rights in their relationships with Investment Intermediaries.[IFRSA – RCU Guidance Note on Investments – Jan 2005]
How many credit unions realised they had protection? Had regulatory action been taken earlier pressure could have been brought to bear to ensure credit union investments were appropriate and prudent.
The ILCU as a voluntary governed and committe managed entity is probably no more competent in investments than the board of a credit union – given its board is made up of credit union directors. In many ways its response was naïve. But if one accepts that it has a duty of care to the movement – then this duty should have extended to ensuring its members were not exposing savers funds to undue risks. Rather it appears its actions were not based on prudential concerns but it seems on a narrow trade body self-interest to dominate credit union treasury management and to protect and enhance its income stream derived from its CIM operations.
Destabilisation of the Credit Union Business Model
The destabilisation of the credit union financial business model has occurred mainly due to the collapse in the critical loans to assets ratio. This ratio is now so low that the financial stability of the sector is seriously threatened. Credit Unions are expected to maintain loan to asset ratios of over 70% but in Ireland this ratio is a disturbing 45% with some of the largest credit unions reporting figures as low as 40%. In one case of a large well known national employer credit union it is only 20%.
The effect of extremely low lending volumes fundamentally destabilises the financial model. Over the past three years credit unions operating income (loan interest) has been significantly less that operating costs. (Fee income is a negligible 1% of total income.) The gap is widening due to declining margins, rising costs, increasing bad debt provisions and investment losses. This means the core business of savings and loans is running at a loss and it is getting worse not better. Credit Unions have become wholly dependent on generating income from investments – so much that they have c€7.1bn of total assets of about €14bn invested in a wide range of investment instruments- many of these investments are inappropriate and imprudent even where they may comply with the Trustee Investment Order.
As early as 1998, the regulator was sounding warnings over credit union investments. Clear forthright warnings were re-iterated in 2001:
“Credit unions should bear in mind that even where a particular investment is legally permissible, prudential considerations also have to be taken into account. They should be extremely cautious when considering the increasingly sophisticated investment products which are currently on the market” (Registrar of Friendly Societies Report 2001)
Yet it wasn’t until 2006 that regulatory authorities finally took action to limit credit union risk taking. It appears that frustrated in its attempts to agree a voluntary code with the ILCU, the Regulator petitioned the Minister for Finance for legislative change to the laws governing credit union investments – this move resulted in publication of an Investment Guidance Note in October 2006. But critically the Note allows credit unions to continue to hold non-qualifying instruments having a maturity date until they mature. Their publication was too late -in the month published the perpetual bond story emerged.
Taken for a Ride – the exploitation of naivety.
The past decade saw the concurrent expansion in the range and complexity of retail investment instruments sold by commission driven sales people. From the one man local band to large companies – the investment advisory and sales industry exploited the credit union niche frequently using high pressure sales tactics.
In many cases the relationship between “advisor” and credit union was far too close for comfort – some even sitting on credit union boards. Still in others, auditors peddled their “investment services” – often from the floor of credit union AGM’s.
Credit union boards are but groups of ordinary people with no more sophistication in investments than the average consumer. This un-sophistication was wholeheartedly exploited. Credit unions were sold imprudent and inappropriate products designed to maximise commission and fee income rather than consideration for what credit unions should have invested in within the context of a safe and sound credit union investment strategy.
Yet the Investments Intermediary Act 1995 could have been used to protect credit unions – but it wasn’t until January 2005 regulatory authorities formally brought the matter to the attention of credit unions and their advisors.
“Credit Unions Have Rights as “Private Clients” under the Investment Intermediaries Act 1995 (IIA) in their relationship with their Investment Advisors. Unless they choose otherwise, credit unions are regarded as “private clients” for the purposes of Section 37 of the Investment Intermediaries Act 1995. (IIA). This entitles credit unions to important rights in their relationships with Investment Intermediaries.[IFRSA – RCU Guidance Note on Investments – Jan 2005]
How many credit unions realised they had protection? Had regulatory action been taken earlier pressure could have been brought to bear to ensure credit union investments were appropriate and prudent.
The ILCU as a voluntary governed and committe managed entity is probably no more competent in investments than the board of a credit union – given its board is made up of credit union directors. In many ways its response was naïve. But if one accepts that it has a duty of care to the movement – then this duty should have extended to ensuring its members were not exposing savers funds to undue risks. Rather it appears its actions were not based on prudential concerns but it seems on a narrow trade body self-interest to dominate credit union treasury management and to protect and enhance its income stream derived from its CIM operations.
In April 2007 despite reported accumulated looses of €23m in certain investments it wrote to its members roundly defending its investment strategy – which eventually led to the losses Davy is now proposing to settle. Yet this body from 1998 to 2007 did not have any employees who were treasury professionals but relied on exactly the same structure as a credit union – a voluntary layman investment committee advised by external expertise. It even reported that 10% of SPS funds were invested in perpetual bonds – which are investments a regulated and approved deposit insurer would not be permitted to make.
An Ill Conceived Strategy that undermined stability
Of course credit unions exacerbated the loan/savings disconnect when they did not respond to lower interests rates. Instead they insisted on maintaining far too high a dividend ignoring savers price inelasticity which was a feature of the low interest rate environment. It was this ill-conceived strategy that created the pressures to maintain high dividends which triggered in turn a requirement for riskier high growth and income return from their investments. Blind to the effects of this ill-advised strategy, it was far too easy for sales people to exploit the credit unions thirst for higher investment returns.
At the same time credit unions kept their lending rates far too high – driving away creditworthy members. Then in order to shore up lending in many instances, they lent to high risk borrowers. The result was worsening bad loans experience with over 70% of credit unions reporting loan delinquency well in excess of minimum safe thresholds. The true picture here has yet to emerge as standardisation in reporting loan delinquency has not been implemented. It was due in 2008 but is now delayed until 2009 in response it seems to investment losses. The regulator has said in all cases where it has investigated loan books, it has required increased provisions. It has also highlighted certain dangerous bad debt manipulation practices yet to be unwound.
In chasing higher investment income credit unions invested long and the liquidity of their portfolios dramatically reduced – many have investments of millions in illiquid retail tracker bonds and other long term capital guaranteed products. Some were highly exposed to direct equities where in one case fully 100% of investments were invested in the stock exchange.
The duration of credit union savings is about 2.8 years closely matching loan duration yet credit union investment portfolios are dangerously skewed towards a 5-10 year investment horizon.
Many are operating as dysfunctional unregulated money fund managers exposing their balance sheets to undue risk- risks not passed onto their savers who have benefitted from high dividends.
Shortly before the Investment Guidelines issued, one producer was actively selling an 8.5 year life wrapper investment bond in an underlying property asset index – hardly a marketable security. These type of retail investment products earned huge commissions and fees for providers and sellers. Credit Unions were quite simply fleeced with millions of easy fees being earned by others.
Throughout this time credit unions were the meat in risk sandwich. Providers and advisors didn’t carry the risk nor did credit union savers who were paid a handsome risk free,in many cases, a non-taxed dividend. Credit unions carried the risks and still do – without providing any risk capital to back up positions they continue to be exposed to. Indeed credit unions are only required to provide for reserves at 10% of net income before dividends – a provision which is linked to liabilities (shares) and not risk assets. Such a regime is unknown anywhere else. Credit union reserves are entirely unrelated to lending, investment and operational risks. More recently where Regulatory permission is required for investment and lending flexibility, credit unions are required to maintain minimum statutory reserves of a mere 6%. Many consider this to be far too low and that it should be closer to 10%.
The Amplifying Effect of Investment Losses
Consider two credit unions – one with 70m in assets 70% lent and the other with 100m in assets 45% lent each targeting a 2% dividend– which one will generate the higher income?
The answer is of course the first. Why? Because the gross margin on lending is c7% whereas the margin on investments is about 2.0%. This simple fact has been ignored by credit unions and in many cases is unknown to them- this is what is most worrying – many credit unions simply do not realise how exposed they are to financial instability.
The effects of any investment losses are greatly amplified the lower the loan to asset ratio. For example with a €50m asset credit union; a 40% write down on 10% of its investment portfolio would wipe out net income – leaving nothing to pay a dividend. The credit union would have to rely on reserves created for dividend purposes. Or more ominoulsy petition the ILCU for stabilisation assistance of its discretionary SPS fund.
A Davy type settlement offer for the €70m credit union is on the face of it ok – they have only about c20% in investments and will have a minor income exposure to investment losses – the second and third examples are quite different as it they are entirely dependent on investment income to generate a dividend – thus the effect of investment losses on a credit union with a low loan to asset ratio is greatly amplified. There are few if any credit unions 70% lent and far too many well below 45%.
Accounting treatment of investment losses versus future “settlement bond” gains will need clever positioning including regulatory approval. Time will tell if the Davy settlement is successful – but it is only one of many growlers credit unions are on course to collide with in 2008.
Shortly before the Investment Guidelines issued, one producer was actively selling an 8.5 year life wrapper investment bond in an underlying property asset index – hardly a marketable security. These type of retail investment products earned huge commissions and fees for providers and sellers. Credit Unions were quite simply fleeced with millions of easy fees being earned by others.
Throughout this time credit unions were the meat in risk sandwich. Providers and advisors didn’t carry the risk nor did credit union savers who were paid a handsome risk free,in many cases, a non-taxed dividend. Credit unions carried the risks and still do – without providing any risk capital to back up positions they continue to be exposed to. Indeed credit unions are only required to provide for reserves at 10% of net income before dividends – a provision which is linked to liabilities (shares) and not risk assets. Such a regime is unknown anywhere else. Credit union reserves are entirely unrelated to lending, investment and operational risks. More recently where Regulatory permission is required for investment and lending flexibility, credit unions are required to maintain minimum statutory reserves of a mere 6%. Many consider this to be far too low and that it should be closer to 10%.
The Amplifying Effect of Investment Losses
Consider two credit unions – one with 70m in assets 70% lent and the other with 100m in assets 45% lent each targeting a 2% dividend– which one will generate the higher income?
The answer is of course the first. Why? Because the gross margin on lending is c7% whereas the margin on investments is about 2.0%. This simple fact has been ignored by credit unions and in many cases is unknown to them- this is what is most worrying – many credit unions simply do not realise how exposed they are to financial instability.
The effects of any investment losses are greatly amplified the lower the loan to asset ratio. For example with a €50m asset credit union; a 40% write down on 10% of its investment portfolio would wipe out net income – leaving nothing to pay a dividend. The credit union would have to rely on reserves created for dividend purposes. Or more ominoulsy petition the ILCU for stabilisation assistance of its discretionary SPS fund.
A Davy type settlement offer for the €70m credit union is on the face of it ok – they have only about c20% in investments and will have a minor income exposure to investment losses – the second and third examples are quite different as it they are entirely dependent on investment income to generate a dividend – thus the effect of investment losses on a credit union with a low loan to asset ratio is greatly amplified. There are few if any credit unions 70% lent and far too many well below 45%.
Accounting treatment of investment losses versus future “settlement bond” gains will need clever positioning including regulatory approval. Time will tell if the Davy settlement is successful – but it is only one of many growlers credit unions are on course to collide with in 2008.
Ominous signs
In a recent press article the ILCU said “credit unions are not directly exposed to the credit crunch”. Perhaps it might now explain its agreement to settle millions of credit crunch related losses. Or for that matter it might explain why losses being incurred on its CMTF fund are not credit crunch related. It seems the flag ship is still blindly sailing in the wrong direction. Perhaps it will alter course if mayday calls come in for stabilisation assistance - a call on the ballast of the ILCU.
One thing is certain, the public is only beginning to see the effect of the credit crunch on credit unions – it is highly probable these negative effects will not unwind in time for this years round of annual accounts and credit union AGM’s. In which case, 2008 could well be an annus horribulus for credit unions.
"The credit union armada is sailing into a horizon of gathering storm clouds which could be the harbinger of a perfect storm. Ancient mariners placed their fate in the hands of the gods – many hope the gods will smile benignly on the fleet of little credit union ships and shepherd them to safer waters. "
In a recent press article the ILCU said “credit unions are not directly exposed to the credit crunch”. Perhaps it might now explain its agreement to settle millions of credit crunch related losses. Or for that matter it might explain why losses being incurred on its CMTF fund are not credit crunch related. It seems the flag ship is still blindly sailing in the wrong direction. Perhaps it will alter course if mayday calls come in for stabilisation assistance - a call on the ballast of the ILCU.
One thing is certain, the public is only beginning to see the effect of the credit crunch on credit unions – it is highly probable these negative effects will not unwind in time for this years round of annual accounts and credit union AGM’s. In which case, 2008 could well be an annus horribulus for credit unions.
"The credit union armada is sailing into a horizon of gathering storm clouds which could be the harbinger of a perfect storm. Ancient mariners placed their fate in the hands of the gods – many hope the gods will smile benignly on the fleet of little credit union ships and shepherd them to safer waters. "
