Credit Unions Face National Turmoil

The game is up for Irish credit unions as the scale of losses is unveiled in the public domain. Long used to hiding behind rhetoric, the ILCU has been rendered mute - silenced in two revealing sets of figures.

Credit union problems have exploded on the front page. 115 are operating at a loss for their first quarter and unlikely to turn a profit this year, with another 123 sailing close to the red ink. Oops! all four wheels are coming off.

Some are going to fail and others have been told to stop lending. Last year loan arrears jumped 22% hitting a whopping €513m , provisions weighed in at a hefty €284m or 4%. Believe it or not! Write offs were only €50m! Oops! the long awaited bad lending workout has started.

But this isn’t the half of it as credit unions had refinanced a whopping €272m raising the bar on impaired loans to €785m in 2008.

Oops! it’s not over yet …..The other bit called investments is reckoned according to one astute observer to be another €345m bringing the grand total to €1.13bn or 7.7% of total assets.

Just how bad these figures will finally finish up at is anyone’s guess. My guess is the good old unions will realise at least 10% loan write offs if not higher.

It seems that some are taking the pain early. I have seen one or two even write down the value of their buildings as their new auditors make their standards known. High street commercial property is down about 50%. Some of the bigger credit unions sank their entire reseves into new iconic buildings that are empty most of the week.

Meanwhile back in Mount Street things are not looking so rosy. Rumour has it that requests for help from cash starved credit unions are being declined. Oops!...seems as if the good old savings protection scheme fund is not as liquid as it should be.

The ILCU annual Beano, its accounts, are showing the weakness of its financial affairs that blows the notion it has the financial muscle to prevent credit unions from failing. Rather it looks ominously like it will do well to survive the results of its own aggressive investment strategy. Declaring €5.7m in investment losses on a portfolio heavily weighted to marketable securities is quite something else when the world and its mother knows what happened in 2008. Maybe it thinks credit union directors will only look at the colour pictures. I suspect that accounting flexibility is being used in the "held to maturity category" and values reflect maturity rather than current values. Then again maybe it has managed to do what no one else has. Then again pigs might fly.

More challenging will be the capitalisation call from ECCU and where the ILCU gets this money from. Up North it is believed to be busy talking up the value of credit unions paying premiums years in advance. Then again it does hold premiums on account feeding them to ECCU on the drip and earning a nice return to boot.

This brings up another strange issue. ECCU is a regulated and taxed entity. ILCU is unregulated and enjoys income tax free status. Nice one if you can get it. Now ILCU acts as an agent for ECCU. But ECCU has only one staff member so how is it managing its operations? Well its operations are managed under agreement with ILCU to whom it pays commission which is of course a cost. So ECCU pays income to ILCU which is tax free in its hands. ILCU in turn capitalises ECCU with guess what – yup the very same money ECCU has paid it, less a bit to pay for administration costs.

It’s all nice and dandy until ECCU needs more capital which seems to have happened with the unexplained losses on investments of €4m odd.

So what’s the real story? Well if you strip out ECCU and SPS income and costs and focus on the core business it evaporates before you eyes. That’s right. The core business ain’t paying its way by a country mile and then some. Apart from its never ending supply of rhetoric, the only asset the ILCU has is its headquarters building – a jaded near worthless pile, worth about its written down book value. The return for its 510 odd members massive investment is a big fat ZERO, a few glossy magazines and two websites.

As it faces the turmoil of credit union failure the ILCU should recall an epoch when it threatened to bring down a government. The same party remains in power today and recalls how a deal made was broken and how a government nearly fell. Double Oops!

Minister Brian Lenihan has told the Regulator to issue a code on loan arrears to credit union as the latest attempt to garner support for longer lending limits appear to have foundered.

Bottom line is the problems been stored up for years are now all popping up at the same time which not such a bad thing as it may finally act as the calalyst for change.

ILCU SPS Rhetoric To Come Unstuck in 2009

The Irish League of Credit Unions needs to face reality. In proclaiming credit unions safer than banks and implying it can always prevent a credit union failing, it risks being hoist on its own pétard. A sovereign state may well prevent failures but surely not an unincorporated trade association, operating an unregulated informal bail out fund. Yet ILCU claims its savings protection scheme most recent bail out was similar to the British Government’s bail out of Northern Rock. As many of its members are struggling in the wake of global and domestic crisis, its resolve may be sorely tested.

A gaping hole in the credit union financial safety net was closed last September when Government fearing a general run on deposits increased the deposit guarantee limit to €100,000 and included credit union savers under its Deposit Protection Scheme. However there’s a catch as Government says the guarantee is a “backstop” to an approved credit union SPS, ambiguously juxtaposing “Deposit Protection” with “savings protection” continuing it seems to accommodate trade body self-interest to the detriment of the public good.

Backstop, means the financial safety net remains incomplete and missing two critical “stabilisation” elements without which governments savers guarantee is a damp squib. The missing elements are a system to provide emergency liquidity and a system to inject temporary or long term capital. Both can be a function of an integrated deposit insurance system such as that designed in the O’Toole Bill or can sit in an independent regulated stabilisation entity complimenting a deposit guarantee scheme. The US uses an integrated system and Canada the complimentary model.

Standing in the gap is ILCU with its tiny unregulated bail out fund of €110m, it claims is sufficient to support 525 credit unions, having €15.5bn in assets and operating in two differing legal and regulatory jurisdictions. Worryingly its fund may still be heavily invested in high risk assets, including equities, debt instruments, and unit funds. As these asset classes tanked last year, ILCU would be very lucky indeed not to have lost money. If it has lost money, then its ability to deliver is highly questionable. ILCU “Group” accounts which are audited by PWC will be eagerly awaited this year.

To make matters more intriguing both ILCU affiliation fees and contributions to its fund are charged by many credit unions to their customers savings accounts without their written permission. It’s a practice no doubt consumer bodies will have something to say about. In all ILCU has been paid over €19m in SPS contributions and over €17m in affiliation fees since 2003.

ILCU remains rooted in credit unionist rhetoric, resonant of another form of unionism that at one time cried “no surrender”. Time will tell if it alone can prevent credit unions from failing or if it has been hoist on its own petard.

Regulator Warns Credit Unions

The text of the regulators recent speech is produced here without comment for none is required:

Speech by Registrar of Credit Unions at Credit Union Development Association AGM (Feb 2009)

The financial and economic world which we now inhabit is a radically different place than that which existed when we met a year ago. Many of the old certainties are gone and we all have to adjust to the new realities which now exist and which will continue to emerge. The financial landscape is now somewhat analogous to the physical landscape which emerged a few years ago after the destructive Asian tsunami receded. Structures which once seemed impregnable lie in ruins and reputations have come crashing down. It is fair to say that the financial world has been changed irrevocably both nationally and internationally.

In speaking to you here today I have to acknowledge that my own organisation has suffered criticism as a result of the banking crisis. However, I think you would agree, in hindsight, that at all times we have acted in best interest credit unions and their savers.

One part of the Irish financial industry which has stood up better than most to the battering which the financial system has taken has been the credit union movement. While credit unions have not escaped unscathed from the global storm that has swept over the financial system they have, so far, stood up very well to the stresses. Despite the damage done by investment losses in many credit unions, the movement itself, taken in consolidated form, remains robust. However, I would caution that the movement is facing a year of unprecedented difficulty in the economy which will require credit unions to make significant changes in how they do business. But more of that later.

It might firstly be useful to examine the strengths underpinning the movement that have buttressed its survival in the teeth of the financial storm and perhaps also to look at where it may have taken a wrong course in some situations.

Strengths

The credit union model, based on member interdependence and mutual support is, to my mind, central to the strength of the movement. The ethos of self-reliance, prudence and thrift are, of course, an integral part of this model. The financial model arising from these underlying principles that is enshrined in the Credit Union Act (despite all its defects), is inherently robust. This is despite the fact that the apparent imbalance between funding from members, which is mostly on demand, and loans and investments which are not, seems to defy the laws of financial gravity. However, because of the checks and balances which are inherent in the model, especially those which moderate any tendency to a serious asset liability mismatch, (e.g. Section 35 of the Act) the model is inherently quite stable.

I believe that one of the key reasons for the strength and flexibility of the movement is a characteristic that cannot be described on a balance sheet. That is the fierce loyalty of credit union members to their credit union. I was very gratified to see that in the cases where credit unions were able to pay only a reduced dividend or no dividend at all for the year just ended, that members resolutely stuck with their credit union. In cases where serious losses or other problems arose this has also proven to be the case. This reservoir of goodwill or "Brand Loyalty" as a marketing guru might describe it, cannot be valued on a balance sheet but most definitely is the invisible pillar on which credit unions rest.

The dedication and skill of credit union directors and supervisors and in particular the sound common sense and knowledge of local affairs of such people, is undoubtedly a critical component of the strength of the movement. Professional managers have also played an important part in steering the movement to where it is today.

I mentioned the word prudence a moment ago in relation to the ethos of the movement. I firmly believe that the historical culture of prudence in the lending function to which many, but not all, credit unions clung, also provided a stabilising sheet anchor which kept the ship steady.

You could be forgiven for thinking that I am saying that the credit union movement is indestructible. This is clearly not the case for any industry, and the speed with which once household names can collapse has been amply illustrated over the past few months.

Threats

It is important to note where the movement has suffered damage in recent years but it is also now vital to look forward in an attempt to anticipate the threats of the future. It is not an exaggeration to say that the Irish economy has suffered a dramatic slowdown. Business collapses, job losses, cutbacks etc. are at a high level.

Credit unions should prepare themselves for an extremely difficult year in managing their affairs. Unprecedented pressures can be expected in the lending and investment functions and credit unions will need to manoeuvre carefully to maintain their stability and to protect their members' savings. Consequently, this economic slowdown must also be matched by an appropriate application of the brakes in credit unions, where necessary, in the areas of lending and investing, so that a runaway situation can be avoided. A prudent application of the brakes as the road descends is preferable to waiting until it is too late to avoid going off the road when a sharp bend is encountered.

Investments

Credit unions can expect further losses on investments in 2009, particularly those made before October 2006 - the date of the issue of our guidance note on investments. It is likely that further losses could arise from perpetual bonds, the Central Treasury Management Fund and equity based products. Credit unions should prepare for these losses and should try to anticipate the likely effect on solvency and liquidity. It is particularly important that very close attention is paid to the availability of liquid funds. Unless there is absolutely no risk to future liquidity, credit unions should limit their lending to a conservative percentage of their cash inflow on a monthly basis. It is no longer safe to assume that a liquid market exists for all investment instruments (other than bank deposits). Some investments, while retaining their inherent long term value, may now be difficult to realise at short notice.

Our circular of 13 January requires credit unions to give priority to the holding of surplus funds in liquid form. I know that some credit unions will consider that such a requirement is unreasonable due to the present prevailing low interest rates. However, we take the view that when an investment is being made that the decision pyramid must always prioritise capital security and liquidity over return. The chasing of return by credit unions in the past has been akin to a desert traveller chasing a mirage and this has led some credit unions into the quick sands. Please, therefore, beware.

With regard to the boards of those credit unions which have suffered investment losses, I would say the following - Promises about investment returns that appear to be too good to be true are, generally, just that. You should always read all of the investment contract material carefully and seek professional advice about its content and conditions prior to making any decision on such a matter. You should rely only on the written contract and not on verbal assurances provided by the broker or product producer.

Lending

In common with other lenders many credit unions drifted away from the strict lending criteria which traditionally set conservative limits to loan approval amounts on the basis of a member's income, savings record and local standing. In addition, some credit unions ventured into business lending or even project finance, not always with a successful outcome.

Consequently, arrears in credit unions have been rising and this trend needs to be carefully controlled and reversed. Loan repayments including interest, constitute the most important cash flow source for most credit unions. Loan advances represent the largest channel for the outflow of liquidity and these must be carefully controlled.

Credit unions, especially their credit committees can expect a sharp increase in the demand for loans from existing and new members. It is of particular importance that the credit committee should be given clear monetary limits on the total funds available for the granting of loans, bearing in mind the availability of liquid resources. Close monitoring of liquidity inflows and outflows in the lending function must take place on a weekly basis. The extent to which loans may be made must be strictly related to the intake of cash from borrowers, and investments, adjusted for savings movements. Each credit union should examine its own cash flow to determine a safe rule of thumb in setting limits for the approval of loans for the credit committee.

We have now introduced monthly reports for selected credit unions where we believe liquidity is lower than normal so that we can monitor such situations. Such reporting will be extended to other credit unions, as necessary.

To those boards which have been engaged in the provision of loans for purposes and for amounts which would never have been regarded as normal for the business of a credit union, I have this to say. Please stop trying to be banks. Borrowers have a choice of banks from which they can borrow. Lending for commercial property, project finance or main line business activity is not the business of credit unions and is not in the interests of members.

Taking Stock

There is no reason why credit unions cannot survive and thrive in the present financial storm. There are however, a few provisos:- Liquidity is now king and the focus of day-to-day management must be to ensure that adequate liquid resources are always available for operational purposes. All surplus funds must be held in liquid form. - Lending criteria must become more restrictive and should be based on carefully researched criteria and on conservative estimates of the ability and commitment of the potential borrower to repay a loan.- Strict cost control must be implemented. Capital expenditure (e.g. on premises) must be carefully evaluated and curtailed unless strictly necessary.The rights of savers must be prioritised over those of borrowers.