Credit unions are paying a hefty price

With one credit union declaring losses of close to €5m on subordinated bank bonds, many more will be admitting to similar losses at their annual general meetings (AGM’s).

Understandably, the Irish League of Credit Unions (ILCU) has been reluctant to admit to scale of losses in bonds it once heavily promoted to its member credit unions. Estimates earlier this year put the scale of losses at €200m.

Including consumer loan write-downs, the sector is facing total losses of upwards of €1.5bn. While some of this will be covered by operating income, state bail-out funding will be needed to rebuild capital buffers.

The Government’s recent budget earmarked €500m in bail-out assistance -credit unions are to be advanced €250m in 2011 and €250m in 2012.

Just how taxpayer’s funds are to be made available is unclear. Presumably the state will not take an ownership stake as this would sunder the credit union co-operative structure.

It is probably the case that loan funding will be provided to support viable credit union balance sheets as non-viable operations are closed down and others are merged into better governed operations.

One question that looms large is why were Irish credit unions investing at all in long dated and perpetual subordinated bank bonds?

The root of the answer lies in 1998 when finance minister Charlie McCreevy relaxed the type of investments trustees were permitted to make. As credit union investments were also governed by these rules, McCreevy’s move had the effect of permitting them to invest in riskier assets. This was entirely out of kilter with other countries that insist credit unions invest in the safest of assets, principally government stock and top-rated senior bank bonds.

As consumer credit boomed from 2000 onwards, credit unions were left behind, causing a fundamental distortion in their balance sheets as loans shrank and investments grew.

Anxious to maintain high dividend pay-out rates to savers, boards placed excess funds in riskier investments, chasing higher yields.

Many credit unions unwittingly behaved as commercial for-profit enterprises, sweating their balance sheets to maximise dividends to savers. The irony was that they were funding both the cash and capital used by banks to finance the property bubble.

Realising the growing balance sheet distortion and inherent investment risk, the credit union regulator looked to have the law amended to reign in risk taking.

This was rebuffed by government officials as ILCU and its then investment partner Davy, aggressively lobbied against the change.

Eventually after two years of consultations, the regulator was able to publish non-binding guidelines in late 2006. While these limited risk taking, it was too late and many credit unions lost money from 2007 onwards. Indeed, many failed to unwind their holdings of subordinated bank bonds and suffered the consequences this year.

To date, there has been no official investigation or report on credit union investment activity during the boom years.

Hundreds of millions were invested in imprudent products and tens of millions lost in what has all the hallmarks of a mis-selling scandal. 

Easy targets, far too many credit union boards of directors and managers, were persuaded to invest in products their financial advisors barely understood themselves.

A small number of credit unions have sued their advisors with varying degrees of success. In some cases advisors have had to make good losses, in others they have not. Some credit unions are deemed to be “consumers”.

Whether a credit union is a consumer or not is defined by its turnover, which is hard to define for a credit institution. The problem is this: If a credit union is marginally under the threshold it is covered under consumer protection regulations. If it’s over the threshold, it is not.

But it’s not a matter of defining a credit union as a consumer or not a consumer.

A credit union board is charged with responsibility and accountability for prudent governance which means making safe and sound investment decisions.

As it is a responsibility that cannot be outsourced to a third party, it should be within the competence of a credit union’s board and management to understand balance sheet risks, including investment risk.

Competence, responsibility, accountability and fiduciary care are at the heart of good governance of all credit institutions. Fitness and probity means having the competence and experience to understand and control for all risks the enterprise faces. Bond losses are symptomatic of poor standards of care and indicator of why the credit union sector needs to be reformed.

As credit union members attend AGMs this year, they should be aware of one fact. Credit union bond losses arise from an ill-advised boom-time strategy to chase higher yields.

They might be mindful to ask searching questions and demand that their credit union insists that its regulatory authority investigates and reports on just how so much money was needlessly lost.

A version of this article appeared in the Irish Examiner, Business Section, Monday 19^th December 2011.