Should the state continue to subsidise credit unions?
Benefits such as state aid and exemption from corporation tax need to be reformed in this climate, writes Bill Hobbs
28th September 2009
In poor shape to deliver on their core purpose to generate credit in the economy and requiring fundamental reform, Irish credit unions may need to justify why the state should continue to subsidise their operations. Similarly the ILCU (Irish League of Credit Unions) may need to justify why its state subsidy should continue.
Ten years ago, Finance Minister Charlie McCreevy’s move to tax dividends on credit union savings accounts sparked an intense national lobbying campaign spearheaded by the ILCU during which activists threatened to run as general election candidates. Under pressure from Independent TD’s, then Taoiseach Bertie Ahern forced McCreevy into a climb down. Citing non-resident account abuses McCreevy warned that credit unions could become a haven for tax evasion.
Close to €9bn, has since accumulated in credit union non-DIRT “ordinary share” accounts, notwithstanding the availability of a DIRT account. As untaxed dividends are taxable at a person’s marginal rate many people may not have declared their credit union dividend in their tax returns. It is probably also the case that a sizeable amount of savings balances is undeclared income hidden away from the taxman. Should Revenue have a mind to investigate the use of these accounts it may well uncover a treasure trove in tax revenue. As a form of state aid, many consider the non-DIRT exemption distorts the market for savings with credit unions benefiting from higher savings balances.
But there is another, far more valuable state aid. Credit unions are exempt from paying corporation tax. It’s a discretionary exemption, wholly dependent on prevailing government policy, which has been withdrawn in other countries and never applied in others. The tax exemption is based on the notion that untaxed profits paid as dividends are taxable in the hands of savers. Such is the scale of this state subsidy that credit union reserves of €1.4bn arguably represents tax foregone by the state.
Credit union’s primary economic purpose is to advance credit using savings gathered from ordinary people. With less than 52% of assets in loans and the balance on deposit with Irish banks or held in investment portfolios, credit unions are not fulfilling this core purpose. Loans as a percentage of total assets peaked in the late 90’s and have been declining ever since. Pursuing a policy of maximising savers dividends and unable to generate enough profits from lending, credit unions adopted an ill-conceived investment strategy that ultimately led to large losses over the past two years. At the same time to bolster lending they also made more risky loans such as speculative property development finance which have led to rising bad debts. Far too many pursued a strategy of maximising profits for distribution as dividends to savers at the expense of building reserves and investing in improving products and services. It’s fair to say this dividend maximisation policy contradicts the intent of the state subsidy which was provided to underpin and support credit union’s economic and social function to provide affordable credit, bolster financial stability and fund development and growth.
Credit union leadership maintains that servicing the “financially excluded” justifies a state subsidy. In 2006, a Combat Poverty Agency research report estimated the number of financially excluded adults at about 180,000 and found that they did not use credit union services. With over 2m customers the vast majority of credit union customers are not financially excluded. Indeed a recent report commissioned by ILCU found that credit unions are predominantly servicing middle class customers. Whatever about community based credit unions, it can hardly be said customers of employer based credit unions, such as teachers, police, prison officers, utilities etc are financially excluded. And with a vibrant official licensed and regulated money lender sector, combating financial exclusion does not appear to be a dominant enough feature of credit union activity to justify continuing state aid.
Much is also made of “social finance” which is repayable financing of local community initiatives. The ILCU maintains about 10% of credit union lending or about €700m is for social finance purposes. This figure includes start up business loans to individuals. A narrower definition favoured by others would reduce this figure considerably below €100m or less than 2% of loans. While legally permitted to allocate profits to build social funds, credit unions have been criticised for not using these funds. A small number have funded successful local community initiates but the majority have not. An ad hoc approach to social finance does not support the case for a global tax exemption. Nonetheless a well designed national credit union social finance strategy would probably justify a degree of state aid.
Overall the case for a state subsidy is not at all compelling and requires a cogent rational justification if it is to continue. But there appears to be no compelling reason for the state continuing to subsidise the ILCU which is also exempt from paying corporation tax. When queried during a High Court case, the explanation provided for its tax exemption was it was “best to let sleeping dogs lie”. The ILCU has consistently declined to incorporate as its activities subjected to regulatory supervision or its commercial businesses exposed to tax. Yet it comports itself as a corporate entity, commercially engaging in regulated financial intermediary markets in which its competitors are not in receipt of state aid. Observers have commented in particular on how it capitalises its wholly owned insurance subsidiary ECCU using tax exempt profits earned through a management service agreement.
Credit unions should have the capacity to deliver valuable financial services to ordinary people and small businesses. But after a decade of pursuing an ill-conceived business strategy many are unable to deliver on what society requires of a vibrant, competitive and financially stable credit co-operative sector. As Minister Brian Lenihan deliberates on the future of the Irish banking system no doubt he will be concerned about reforming the credit union sector. The trade off for continuing state aid may well require credit unions to implement long overdue changes in structure, governance, management and operational competence.
A version of this article appeared in the Irish Examiner, Business Section, Monday 28th Sept 2009
Monday, September 28, 2009
Monday, September 21, 2009
Government playing fast and loose with banking
Brian Lenihan is using estimates of estimates to justify the NAMA plan writes Bill Hobbs
21st September 2009
NAMA is designed to do one thing and that is to stop banking destroying the economy. Playing fast and lose with language, Government is busy spinning misleading and inaccurate sound bites designed to sell the new dogma – the NAMA soft landing and social dividend.
NAMA is designed to bail out the banks at the expense of taxpayers who are overexposed by at least €16bn. This figure is made up of two quite startling numbers. €9bn in loan arrears (rolled up unpaid interest) and a €7bn overpayment principally engineered to keep AIB and Bank of Ireland in private ownership.
The two big banks are so large they are impossible to bail out using traditional options. Given the dire state of public finances, nationalisation is unaffordable and it is taking a unique arrangement with the ECB to orchestrate what has at best will buy some time. And as the entirety of commercial land and property loan book of five banks is being nationalised, NAMA will become the only game in town for financing the recovery of what is left of the Irish property sector.
Government is saying the €77bn in loans it is buying are currently estimated to be worth €47bn but will pay €54bn and has declined to say how both these figures break down between the banks. It needs to pay more as if it were to stick with the lower amount the two big banks would have to be nationalised. This is something government cannot afford.
So it has to manipulate the value upwards by an amount it reckons will prevent it having to take the banks into full public ownership. It also needs their share price to improve as if it has to provide additional capital it will end up with a lower shareholding. The hope is private investors may find the banks an attractive proposition. But while NAMA may have to provide for liquidity, the banks capital base remains dangerously thin and exposed to further loan losses.
As soon as Minister Lenihan finished unveiling NAMA in the Dail, AIB started claiming its share of the pain was lower than the Minister’s overall estimates. It is not the first time AIB has said something only to have to retract it months later. After an initial speculative jump, its share price has slid back to semi-zombie price status. As has Bank of Ireland’s, which was a tad more circumspect in telling its story as it warned of challenges it still faces.
The logic of Minister Lenihan’s story is based on estimates of what approximates the full extent of Irish banks catastrophic loan losses. But the estimates are subject to verification as every loan and each bank is different.
With estimates based on estimates of estimates, trying to figure it all out is like trying to pin jelly to a wall which is of course what was intended. In short the story spun by the Minister allowed the banks to spin their own version or as he said the market would be able to make out what he was saying.
To add spice to the NAMA soft landing story, Minister Lenihan confidently predicted that property has reached the floor and could only go up from here, as prime commercial property yields in Dublin are high when compared to other capital cities.
With only €8bn of the €77bn loans apparently lent on good quality commercial property, the Minister extrapolated his confident prediction for all Irish property. But yields are high only as rents haven’t come down yet and anecdotal evidence is rents are rapidly adjusting downwards. Meanwhile Government is sitting on legislation doing away with upward only rent reviews which underpin property values.
A critical factor in the Ministers estimates is the belief property on average has fallen by 47%. Yet not a scintilla of supporting evidence has been produced to support this figure. In talking up the property market he seemed to thread a thin line between optimism and delusion as have other Ministers since. Some are leading property economists saying property could yet collapse by 60-80%, which means the bottom has not yet been reached.
Based on the Minister’s lead, his colleagues maintain property has only to increase by 10% over ten years for NAMA to be a success and it will cover its costs from the start.
This has all the hallmarks of a calculated deception, as it all too conveniently ignores the costs of funding NAMA which will probably rise by at least 200% within the next few years.
Some Ministers are even saying the ECB is providing a special deal on “cheap money”. Yet the interest NAMA will pay is 50% higher than its best rate, reflecting NAMA’s risk profile. The ECB may have a temporary arrangement but does not cut sweat heart deals nor has it said it has for NAMA. And as it begins to unravel its emergency support system for European banking, NAMA and the banks face an uncertainty fraught with interest rate and liquidity funding risks.
NAMA may well initially cover its costs only because some good loans will generate interest. But loan quality will come under pressure as the ECB rates rise ands default risks rise.
Government says that NAMA provides an economic stimulus. However this is likely to be too weak and subject to leakage. As the banks swop or sell on NAMA bonds for cash they will use the bulk of it to mend their balance sheets and the balance to make good low risk loans.
Both Anglo Irish and INBS will transfer 35bn in loans, including the lion’s share of rolled up interest. Anglo will not be able to generate a red cent in lending, if any at all, for years. INBS already a dead man walking will shrink to a husk to be taken over.
This week the Minister produced some more pieces of the NAMA jigsaw puzzle but did not produce the box with the picture on top. He has done nothing more than invite people to imagine what the picture might look like. Which is worrying as no one not even the Minister knows what’s on the lid of the box.
21st September 2009
NAMA is designed to do one thing and that is to stop banking destroying the economy. Playing fast and lose with language, Government is busy spinning misleading and inaccurate sound bites designed to sell the new dogma – the NAMA soft landing and social dividend.
NAMA is designed to bail out the banks at the expense of taxpayers who are overexposed by at least €16bn. This figure is made up of two quite startling numbers. €9bn in loan arrears (rolled up unpaid interest) and a €7bn overpayment principally engineered to keep AIB and Bank of Ireland in private ownership.
The two big banks are so large they are impossible to bail out using traditional options. Given the dire state of public finances, nationalisation is unaffordable and it is taking a unique arrangement with the ECB to orchestrate what has at best will buy some time. And as the entirety of commercial land and property loan book of five banks is being nationalised, NAMA will become the only game in town for financing the recovery of what is left of the Irish property sector.
Government is saying the €77bn in loans it is buying are currently estimated to be worth €47bn but will pay €54bn and has declined to say how both these figures break down between the banks. It needs to pay more as if it were to stick with the lower amount the two big banks would have to be nationalised. This is something government cannot afford.
So it has to manipulate the value upwards by an amount it reckons will prevent it having to take the banks into full public ownership. It also needs their share price to improve as if it has to provide additional capital it will end up with a lower shareholding. The hope is private investors may find the banks an attractive proposition. But while NAMA may have to provide for liquidity, the banks capital base remains dangerously thin and exposed to further loan losses.
As soon as Minister Lenihan finished unveiling NAMA in the Dail, AIB started claiming its share of the pain was lower than the Minister’s overall estimates. It is not the first time AIB has said something only to have to retract it months later. After an initial speculative jump, its share price has slid back to semi-zombie price status. As has Bank of Ireland’s, which was a tad more circumspect in telling its story as it warned of challenges it still faces.
The logic of Minister Lenihan’s story is based on estimates of what approximates the full extent of Irish banks catastrophic loan losses. But the estimates are subject to verification as every loan and each bank is different.
With estimates based on estimates of estimates, trying to figure it all out is like trying to pin jelly to a wall which is of course what was intended. In short the story spun by the Minister allowed the banks to spin their own version or as he said the market would be able to make out what he was saying.
To add spice to the NAMA soft landing story, Minister Lenihan confidently predicted that property has reached the floor and could only go up from here, as prime commercial property yields in Dublin are high when compared to other capital cities.
With only €8bn of the €77bn loans apparently lent on good quality commercial property, the Minister extrapolated his confident prediction for all Irish property. But yields are high only as rents haven’t come down yet and anecdotal evidence is rents are rapidly adjusting downwards. Meanwhile Government is sitting on legislation doing away with upward only rent reviews which underpin property values.
A critical factor in the Ministers estimates is the belief property on average has fallen by 47%. Yet not a scintilla of supporting evidence has been produced to support this figure. In talking up the property market he seemed to thread a thin line between optimism and delusion as have other Ministers since. Some are leading property economists saying property could yet collapse by 60-80%, which means the bottom has not yet been reached.
Based on the Minister’s lead, his colleagues maintain property has only to increase by 10% over ten years for NAMA to be a success and it will cover its costs from the start.
This has all the hallmarks of a calculated deception, as it all too conveniently ignores the costs of funding NAMA which will probably rise by at least 200% within the next few years.
Some Ministers are even saying the ECB is providing a special deal on “cheap money”. Yet the interest NAMA will pay is 50% higher than its best rate, reflecting NAMA’s risk profile. The ECB may have a temporary arrangement but does not cut sweat heart deals nor has it said it has for NAMA. And as it begins to unravel its emergency support system for European banking, NAMA and the banks face an uncertainty fraught with interest rate and liquidity funding risks.
NAMA may well initially cover its costs only because some good loans will generate interest. But loan quality will come under pressure as the ECB rates rise ands default risks rise.
Government says that NAMA provides an economic stimulus. However this is likely to be too weak and subject to leakage. As the banks swop or sell on NAMA bonds for cash they will use the bulk of it to mend their balance sheets and the balance to make good low risk loans.
Both Anglo Irish and INBS will transfer 35bn in loans, including the lion’s share of rolled up interest. Anglo will not be able to generate a red cent in lending, if any at all, for years. INBS already a dead man walking will shrink to a husk to be taken over.
This week the Minister produced some more pieces of the NAMA jigsaw puzzle but did not produce the box with the picture on top. He has done nothing more than invite people to imagine what the picture might look like. Which is worrying as no one not even the Minister knows what’s on the lid of the box.
Friday, September 4, 2009
Bet the house, then hope for the best
Nama is projecting into an imagined future in order to value property today. But what price will we pay if it gets this future wrong, asks Bill Hobbs
The British Academy recently assembled an expert group of eminent people to respond to the Queen’s simple but powerful question “why had nobody noticed the credit crunch was on its way?”
In response its letter, in summary said it was “principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole”.
Commenting on people who thought novel financial instruments virtually removed risks altogether the letter said “It is difficult to recall a greater example of wishful thinking combined with hubris”. A novel financial instrument that tries to replicate the future is a controversial feature of the NAMA strategy to rescue banking.
The novel concept being used to fix the banks is called “long term economic value”. Asset management companies similar to NAMA have been used worldwide to rescue banks but none appear ever to have deployed it to value bad loans. Government is claiming ECB endorsement for its use in its recent letter.
Yet others reading the ECB letter say it clearly warns against overpaying for loans. The ECB is also concerned that any process should ensure bank’s should start lending again and not engage in risk adverse behavior. Whilst not a fan of nationalisation it does accept greater public ownership may be necessary and says risk should be shared between tax payers, banks and their shareholders.
So far the Minister has provided scant insight into how it will work. NAMA intends buying billions in loans, some good but most bad, at a price yet to be determined. The price will be based not on the value of these assets today but their value some time in the future calculated using a “statutory formula”.
Some claim the intention is to financially engineer the value of the loans and their property collateral to remove the risk of insolvency from Irish banks and having to take them into public ownership. If the Minister pays too little for the loans the fix won’t work, so he has to pay a price for it to work.
The fix works as the banks do not have to write off all of their losses, they improve their capital ratios and can swap the bonds used by NAMA to pay for their loans for cash. The Minister says they will then start lending again. Will they? The evidence from other credit crisis is loan starvation lasts long after banks are rescued.
It’s said that once banks are freed of their bad loans, investors will be happy to invest equity in them again. But will they? No one knows for sure in the case of Ireland’s experience of what the IMF has called the deepest recession of all advanced countries.
Good science fiction writers tell plausible stories by projecting today into an imagined future. NAMA will use a formula designed to project loans and property into an imagined future economy to value them today. The Minister is betting his formula may get it right. Yet its very use amplifies the risk of getting it wrong. Should he overpay for loans, the economy grows too slowly and property stagnate in value for years, then NAMA will incur massive losses. Should he pay the going rate he faces taking the banks into public ownership. For now all have to wait for the 16th September when the Minister will unveil his statutory formula.
The British Academy recently assembled an expert group of eminent people to respond to the Queen’s simple but powerful question “why had nobody noticed the credit crunch was on its way?”
In response its letter, in summary said it was “principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole”.
Commenting on people who thought novel financial instruments virtually removed risks altogether the letter said “It is difficult to recall a greater example of wishful thinking combined with hubris”. A novel financial instrument that tries to replicate the future is a controversial feature of the NAMA strategy to rescue banking.
The novel concept being used to fix the banks is called “long term economic value”. Asset management companies similar to NAMA have been used worldwide to rescue banks but none appear ever to have deployed it to value bad loans. Government is claiming ECB endorsement for its use in its recent letter.
Yet others reading the ECB letter say it clearly warns against overpaying for loans. The ECB is also concerned that any process should ensure bank’s should start lending again and not engage in risk adverse behavior. Whilst not a fan of nationalisation it does accept greater public ownership may be necessary and says risk should be shared between tax payers, banks and their shareholders.
So far the Minister has provided scant insight into how it will work. NAMA intends buying billions in loans, some good but most bad, at a price yet to be determined. The price will be based not on the value of these assets today but their value some time in the future calculated using a “statutory formula”.
Some claim the intention is to financially engineer the value of the loans and their property collateral to remove the risk of insolvency from Irish banks and having to take them into public ownership. If the Minister pays too little for the loans the fix won’t work, so he has to pay a price for it to work.
The fix works as the banks do not have to write off all of their losses, they improve their capital ratios and can swap the bonds used by NAMA to pay for their loans for cash. The Minister says they will then start lending again. Will they? The evidence from other credit crisis is loan starvation lasts long after banks are rescued.
It’s said that once banks are freed of their bad loans, investors will be happy to invest equity in them again. But will they? No one knows for sure in the case of Ireland’s experience of what the IMF has called the deepest recession of all advanced countries.
Good science fiction writers tell plausible stories by projecting today into an imagined future. NAMA will use a formula designed to project loans and property into an imagined future economy to value them today. The Minister is betting his formula may get it right. Yet its very use amplifies the risk of getting it wrong. Should he overpay for loans, the economy grows too slowly and property stagnate in value for years, then NAMA will incur massive losses. Should he pay the going rate he faces taking the banks into public ownership. For now all have to wait for the 16th September when the Minister will unveil his statutory formula.
Asset agency must be accountable and transparent
After months of dithering, Government finally acted to begin reconstructing the Irish banking system with its planned take over of some of Irish banks most toxic loans. Without doing so the economy stood no chance of recovery.
Ever since last September getting banks back to reasonable health was an absolute requirement of any state facing deflationary meltdown. The creation of the National Asset Management Agency or NAMA, is an EU first, proclaiming as it does the states “Banama Republic” status – a combination of sovereign rating and bad bank.
The numbers keep getting bigger. €90bn with its toxic mess of €29bn are headline figures that hide a complexity that will cost the state and tax payer billions no matter how sugar coated the bitter pill is. This bitter pill amounts to buying toxic assets, probably for more than they are worth, as paying fair value will destabilise the banks.
To hedge against overpayment, Finance Minister Brian Lenihan says he will “levy” the banks with a recovery fee if NAMA falls short on breaking even. The true cost will not be known for years and any “levy” will be carefully constructed to fit a different state v banker relationship.
It also seems the door is being left open to nationalisation should a bank not survive NAMA’s haircut pricing mechanism as it mandatorily hoovers up property loans. This is probably safety cover, as the full due diligence on loans to be bought will not be done for some time yet.
For now Government has no intention of taking the next logical step which should be nationalisation. Instead it hopes the banks will feel liberated to get credit flowing once again rather than acting to save their shareholder and bond holders skins.
Extreme risk aversion is a documented feature of private banking behaviour in banking crisis as they are susceptible to a paralyzing fear that new loans will put their capital at risk.
Furthermore because future bank profits will be only be generated as banks have been freed from their toxic assets, their shareholders gain at the expense of the taxpayer who foots the bill for swallowing the bitter pill. Government’s structuring of the deal does not allow for a tax payer dividend unless that is banks are temporarily nationalised which is what happened in Sweden.
A recent IMF report on “NAMA” type approaches said “Fiscal costs, net of recoveries, associated with crisis management can be substantial, averaging about 13.3 percent of GDP on average, and can be as high as 55.1 percent of GDP. Recoveries of fiscal outlays vary widely as well, with the average recovery rate reaching 18 percent of gross fiscal costs”
But this may only the first NAMA scheme, as the scale of wider distressed debt problems becomes apparent in consumer mortgages and wider business sectors.
The NAMA deal will swap government bonds for bad loans, allowing banks to deleverage and bolster capital levels depending on what price NAMA extracts. Some say the price will be carefully calculated to maintain capital at legal regulatory requirements. Whatever the outcome after banks have realised their property loan write downs, they face the reality of increasing consumer and business loan defaults.
All eyes are on the price to be paid for toxic loan assets, details it seems will not be divulged for “commercial reasons”. In short the tax payer is being asked to “trust us we know what we are doing” despite a recent history of doing exactly the opposite.
NAMA will become a powerful manipulative force in the property market for years to come as it takes ownership of vast portfolios of land and property. Clear accountable and transparent governance will be required along with proper public oversight. The public should not accept bland assurances of governmental and regulator system whose opacity and failure to regulate led to the property bubble.
Ever since last September getting banks back to reasonable health was an absolute requirement of any state facing deflationary meltdown. The creation of the National Asset Management Agency or NAMA, is an EU first, proclaiming as it does the states “Banama Republic” status – a combination of sovereign rating and bad bank.
The numbers keep getting bigger. €90bn with its toxic mess of €29bn are headline figures that hide a complexity that will cost the state and tax payer billions no matter how sugar coated the bitter pill is. This bitter pill amounts to buying toxic assets, probably for more than they are worth, as paying fair value will destabilise the banks.
To hedge against overpayment, Finance Minister Brian Lenihan says he will “levy” the banks with a recovery fee if NAMA falls short on breaking even. The true cost will not be known for years and any “levy” will be carefully constructed to fit a different state v banker relationship.
It also seems the door is being left open to nationalisation should a bank not survive NAMA’s haircut pricing mechanism as it mandatorily hoovers up property loans. This is probably safety cover, as the full due diligence on loans to be bought will not be done for some time yet.
For now Government has no intention of taking the next logical step which should be nationalisation. Instead it hopes the banks will feel liberated to get credit flowing once again rather than acting to save their shareholder and bond holders skins.
Extreme risk aversion is a documented feature of private banking behaviour in banking crisis as they are susceptible to a paralyzing fear that new loans will put their capital at risk.
Furthermore because future bank profits will be only be generated as banks have been freed from their toxic assets, their shareholders gain at the expense of the taxpayer who foots the bill for swallowing the bitter pill. Government’s structuring of the deal does not allow for a tax payer dividend unless that is banks are temporarily nationalised which is what happened in Sweden.
A recent IMF report on “NAMA” type approaches said “Fiscal costs, net of recoveries, associated with crisis management can be substantial, averaging about 13.3 percent of GDP on average, and can be as high as 55.1 percent of GDP. Recoveries of fiscal outlays vary widely as well, with the average recovery rate reaching 18 percent of gross fiscal costs”
But this may only the first NAMA scheme, as the scale of wider distressed debt problems becomes apparent in consumer mortgages and wider business sectors.
The NAMA deal will swap government bonds for bad loans, allowing banks to deleverage and bolster capital levels depending on what price NAMA extracts. Some say the price will be carefully calculated to maintain capital at legal regulatory requirements. Whatever the outcome after banks have realised their property loan write downs, they face the reality of increasing consumer and business loan defaults.
All eyes are on the price to be paid for toxic loan assets, details it seems will not be divulged for “commercial reasons”. In short the tax payer is being asked to “trust us we know what we are doing” despite a recent history of doing exactly the opposite.
NAMA will become a powerful manipulative force in the property market for years to come as it takes ownership of vast portfolios of land and property. Clear accountable and transparent governance will be required along with proper public oversight. The public should not accept bland assurances of governmental and regulator system whose opacity and failure to regulate led to the property bubble.
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