Regulator and Media Highlight Credit Union Investment Losses

Both the Irish Times and Examiner have highlighted credit union stories in the past week that have highlighted the scale of challenges facing credit unions.

The Regulator, Registrar of Credit Unions, Brendan Logue has written of a need for liquidity supports and in a hard hitting speach once again highlighted credit union investments and lending as key issues.The content and tone of the Regulators message is once again robust and forthright.

Referring to loans he said "Lending for personal needs was the traditional purpose of credit union loans but in recent years loans have increasingly been advanced for business capital, project finance or even, in a small number of cases, for speculative purposes. Consequently, the lending model has changed substantially in some credit unions without a corresponding improvement in risk assessment capabilities and this has given rise to substantially enhanced credit risk."

Commenting on investments he said "the biggest change of all has happened due to the enormous accumulation of surplus funds which has developed over the past ten years.This change has had a negative effect on the financial model, profitability and ethos of the movement. Had these surplus funds been invested in a conservative and prudent fashion and held on behalf of members separately from the affairs of the credit union, the investment losses of the past year could have been avoided."

He went on to say "The idea that community funds should be invested in bonds or equities issued by institutions whose connection to local communities is at best unclear, or even in some cases in derivative products whose operations were not understood by board members, and in contravention of our guidance, is hard to understand. Such ill-conceived strategies have resulted in reduced profitability and dividends in credit unions and in a loss of credibility for the movement."

Getting to the heart of the matter he said "Many of you will be aware that my office sought for many years, to change what we considered to be an inherently risky and inappropriate investment strategy operated by credit unions. This process of reform proved quite difficult and did not receive adequate support from some groups within the movement. A lengthy and convoluted consultation process delayed the introduction of investment guidelines which were ultimately issued in October 2006. When I used the words “investment strategy” I did so advisedly because what occurred in the area of credit union investments was not a series of random events but arose from movement policy. "

The Examiner carried a story of credit union losses of €700m in a article written by Bill Hobbs ex CEO CUDA who was responsible for the publication of its Call to Action report in 2006. Hobbs' estimates of investment and loan loss impairment were refuted by the ILCU not because they were inaccurate but because the ILCU maintains no one knows as credit union audited accounts have yet to be published this year. In an interesting radio tussle, in one programme an angered ILCU said credit unions were not exposed to the sub-prime crisis as claimed by Hobbs. In a later radio interview Hobbs said he had never said they were adding the ILCU should read his article in which he wrote credit unions were "more exposed to the global crisis, domestic property collapse and recession" where the global crisis had led to the collapse in financial assets credit unions had invested in.

The ILCU was at pains to point out that the average loan was small at €8000 for "household events and cars etc" and lending to business was only 5% of the loan book !

Yet larger credit unions average loan is over 100% higher than the ILCU stated average and they are quite proud of business lending which for many is much higher than the 5% suggested by the ILCU. For example one leading credit union was involved in court action to recover a business loan of over €1m and another mid-sized credit union admitted to breaching loan limits in advancing a €1.5m business loan facility. It appears that ILCU estimates of business lending may be a wee bit too low not least because in one category, social finance, it has claimed lending in excess of 10%.

Not that it really matters as bad debt provisions have been far too low for the past 5 years as many credit unions sought to maintain high dividends streams. In a highly unsual case one leading credit union increased its bad debt provisions by €1m not from operating income but by transfer from its reserves to meet resolution 49 provisions. In yet another no provisions were made at all for over 4 years despite a growing loan book.

It is yet another case of regulatory and media commentary highlighting serious issues where the ILCU has refused to face up a reality that the crdit union movement is facing a very real crisis.

ILCU creates political friction in Northern Ireland

O dear, ILCU President Adair's posturing in Northern Ireland seems to have politically backfired as the ILCU has cheesed off both Sinn Fein and the SDLP.

Sinn Fein - Martina Anderson
Responding to ILCU claims that credit unions have been snubbed by the NI Assembly leading Sinn Fein assembly member said she was "disappointed at the sweeping accusation by Uel Adair that the 'Assembly has snubbed' the Credit Union Movement" she added that if he "was paying attention instead of using a scatter gun approach in his criticism he should have been aware of the consistent and persistent efforts of Sinn Fein in the Assembly to have barriers to Credit Unions ability to offer wider Financial Services removed..it would be nice of he could at least acknowledge the efforts that we are making and will continue to make in support of the Credit Union Movement"

SDLP - Mark Durkan (Party Leader and chair of the NI Assembly enterprise committee)
Durkan said he was equally "disappointed" adding that "people should not be given the impression that parties are not doing anything in the Assembly when the record and current business shows they are". His initiative he said resulted in "a formal enquiry into the very subject"

At a time when credit unions need all the friends they can get, going offside with influential politicians is hardly the right course to take. More so as Irish Times and Examiner articles highlight growing concerns over credit unions

Credit Unions are not safer than banks

Make no bones about it, our recession is credit driven off the back of a property boom to bust cycle. With an overhang of unsold new homes of 50,000, house prices are predicted to fall by at least 30% by the end of 2009 from peak prices in 2006. This is a conservative estimate where analysts have no previous experience in which to ground their expectations. Unemployment is expected to double with upwards of 70,000 additional people signing on the dole and private sector incomes will contract as taxes are increased and discretionary income is slashed by struggling employers. Credit and savings growth will drop from 20+% pa to low of about 6%.

Credit unions despite what the ILCU has said are not immune from the effects of recession and global credit crisis. In many ways they are more acutely exposed than the troubled Irish banks and are far less safe than banks.

The global crisis has seen the collapse in financial asset values underpinning credit union investments in retail financial products. Already multi-million euro losses are being recorded across a range of products including the ILCU sponsored unit trust vehicle, the CTT, which has experienced a 10% loss of about €60m in FRN’s.

The loan to total asset ratio is key to understanding the leveraging effect of the global crisis as the lower the ratio, the higher the investment risk exposure to investment losses. Those credit unions having a low ratio and exposure to equity based products are likely to be experiencing large accumulating losses that will have to be accounted for this year. In all likelihood a significant number of low ratio credit unions will be unable to pay any dividend to their savers.

As far as lending is concerned, over the past 5 years or so, credit unions have been storing up a hard core of bad debt they have yet to write off. Loan delinquency levels, even under lax ILCU provisioning standards, have been the highest when benchmarked to mature credit union sectors elsewhere. Since the collapse of the property bubble, loan delinquency has worsened as borrowers begin to default on unsecured loans taken out to finance and furnish their new homes. As credit union lending is almost 100% unsecured, these loans are almost always the first people decide not to make repayments on. Furthermore many credit unions engaged in high risk commercial lending and speculative property development finance, two sectors experiencing melt down. Many of these loans are severely impaired where security, if any, has lost 40% of value. Some of the largest credit unions are faced with writing off multi-million euro business lending exposures.

Credit union lending is highly exposed to the impact of a worsening recession which is not predicted to wane until 2011.

It seems then that most if not all credit unions will be declaring investment losses in their accounts which for many will impact quite negatively on dividends and even reserves. As far as bad loans are concerned, credit unions should increase general provisions and start making the specific provisions needed to begin the process of write downs which must inevitably occur. The days of hiding bad debts are over.

ILCU Treasury Ambitions in Shreds?

In what appears to be a rancorous divorce, ex-partners Davy and the ILCU are locked in a struggle for credit unions hearts, minds and wallets as they vie for control of credit union investment portfolios. Their eleven year partnership through which they co-manage a fund of €2.3bn ended abruptly as Davy withdrew, opting instead to focus on its relationships with individual credit unions. The partnership called Central Investment Management (CIM) comprises an ongoing fund of c€1.7bn in individual credit union accounts and a €600m collective investment scheme or unit trust called the Central Treasury Trust (CTT).

Whilst Davy has offered to continue to provide support until a new partner is found, its decision to end the relationship raises more questions than it answers. One is thing is clear the ILCU needs a new partner as it is neither an approved deposit taker or regulated investment manager.

On the 2nd October last Davy wrote to the ILCU formally confirming its decision to end its CIM relationship. The following day it announced its decision to credit unions including an assurance it would continue to business with them on an individual basis.

Beaten to the punch, the ILCU countered, claiming that it had requested Davy to resign. This claim was strenuously denied by sources close to Davy who expressed surprise and annoyance on hearing the ILCU had also urged credit unions not commit to doing business with Davy until a new partner is found. The old adage “when in a hole, first stop digging” may well apply as ILCU action could be construed as anti-competitive behavior exposing it once again to scrutiny by the competition authority.

The ILCU/Davy relationship goes back eleven years during which time funds under management grew from about €500m to €2.3bn. As credit unions lending lagged way behind savings growth, the CIM arrangement grabbed a sizeable share of the €7bn in excess credit union funds generating a lucrative income stream for its partners. In 2006 this valuable partnership seemed to have been cooper fastened when it launched a unit trust vehicle, the CTT, promising credit unions instant access to their funds without putting capital at risk. Last month credit unions were shocked to be told instant access would result in capital losses as the credit crunch had taken a sizeable €40m bite out of the €600m CTT fund.

Despite the sundered partnership, Davy remains open to dealing with individual credit unions allowing it to cherry pick rather than having to deal with all 430 credit unions under the CIM arrangement. As a significant number of larger credit unions have solid relationships with Davy they will ignore the ILCU memo which is something Davy is obviously counting on and the ILCU has every reason to fear.

A remarkable feature of the Irish credit union movement has been its failure to evolve central treasury operations similar to those found in the US and Canada where central credit unions (a credit union for credit unions) exist. Called “Centrals”, they are state approved regulated credit union entities providing the pooled liquidity and solvency funding services fundamental to a well designed credit union financial safety net. Davy decision to go its own way could scupper an ILCU long standing strategy to develop similar services for its members. Unless the ILCU retains its member credit unions support and find a new partner quickly its ambitious strategy will fail.

In the struggle for control of credit unions investments Davy appears to have upper hand as the ILCU hunts for a new partner so necessary for it to retain control over billions in credit union funds. It is a struggle that exposes a gap in the credit union safety net that may take Government and regulatory intervention to address as concerns grow over investment losses in the c€7bn held by credit unions in their investment portfolios. The concern is accumulating losses could impact on credit unions balance sheets, profits and dividends which in turn may cause liquidity and solvency problems.