ANALYSIS: The Financial Regulator is planning to force credit unions to act ahead of potential losses, writes SIMON CARSWELLFinance Correspondent

ONLY WEEKS after the Government disclosed that it faced a recapitalisation bill of up to €32 billion for the banks, concerns now emerge about the financial health of credit unions.

The state of small savings institutions has come into focus across Europe this week after four Spanish “cajas”, which are similar to credit unions, were merged following the seizure by the Bank of Spain of CajaSur, which lost almost €600 million in 2009.

The Irish credit union movement is somewhat different, having avoided property lending during the boom. The cajas helped fuelled Spain’s housing boom, providing about half the property loans, and are now reeling from the property crash and the country’s worst recession in 60 years.

Despite bypassing the problems of the banks, Irish credit unions are facing difficult times as the regulator is planning to force them to set aside more in reserve to protect against losses on loans that borrowers are struggling to repay.

The recently appointed registrar of credit unions, James O’Brien, told an Oireachtas committee yesterday that the sector had fared better than the banks, but that the economic environment, with rising unemployment, meant credit unions must better protect themselves against losses.

While the wider credit union sector had “withstood the financial crisis better than most”, the movement still had mounting problems and there were worrying trends of rising arrears and low levels of provisions to cover losses.

The registrar wants credit unions to set aside more money to cover loans which have been rescheduled to give a distressed borrower more time to repay.

The proposals have created tension with the credit union movement, with its representative bodies, including the Irish League of Credit Unions (ILCU) and the Credit Union Development Association, voicing strong opposition.

At issue is a new measure introduced in the Central Bank Bill published at the end of March.

Section 35 of the Bill will force credit unions to set aside 20 per cent of the value of a rescheduled loan, and if a member misses another repayment after this, more must put aside in case the credit union incurs more losses.

The credit union sector has lobbied Minister for Finance Brian Lenihan to ease the proposed changes, fearing that a one-size-fits-all approach will damage the small credit unions which have relatively low levels of lending. The ILCU met the Minister on Wednesday demanding changes.

The credit union movement fears that without dividends to distribute to members at the end of their financial year due to higher levels of reserves demanded by the regulator, they may lose some business to the large retail banks which are offering better deposit rates.

Credit unions warn that this could lead to a run on deposits, a point acknowledged by the registrar yesterday, but he defended the proposals, saying they would maintain strength in the credit union sector.

The registrar also pointed out that if rescheduled loans did not go bad, then these funds could be distributed to members later on.

O’Brien defended the planned measure before the Oireachtas Joint Committee on Economic Regulatory Affairs, saying it was “not overly draconian”.

Section 35 was a “preventative measure” and a “proportionate” response, aimed at heading off problems crystallising at credit unions over the coming 12 to 18 months, he said.

“We believe that this is a critical period for credit unions. It is not a time to ignore the realities of what’s happening in the sector.”

The representative bodies have criticised the registrar for not consulting them in advance on the proposals to increase provisions for rescheduled loans. The ILCU initially welcomed the Central Bank Bill, but later said that it had not seen amendments outlining the changes and that it objects to the one-size-fits-all approach.

The regulator said that it was “surprised” at the tension with the credit union movement, and “slightly disappointed” with its reaction to the proposed changes.

TDs queried why the registrar was not waiting for the first part of a strategic review of the sector being carried out by the registrar to be completed at the end of this year, or a second phase by March 2011, in order to devise a more measured approach and to respond to credit unions’ concerns.

O’Brien said there wasn’t time – it might be too late in 18 months’ time, he said; prudent measures to protect against losses were needed immediately, as he felt many problems and significant arrears would emerge by the end of the credit unions’ fiscal year in September.

While acknowledging that credit unions avoided the speculative lending that cost the banks dearly, the regulator feels that it cannot be complacent with credit unions and that it must take action to prevent greater problems.

“We are seeing trends that are causing us concern,” said O’Brien.

There are 414 credit unions in the country with assets of €14.5 billion at the end of last year. They had €6.8 billion in loans and €7.3 billion held in investments.

Loan arrears have doubled in the past two years, rising to 13.5 per cent of loans which have not been repaid for 10 weeks or more from 6 per cent, the registrar said, and he was seeing “a significant increase” in the number of loans being rescheduled as more members come under financial stress.

The legislative changes would give credit unions flexibility to reschedule loans without categorising them under arrears, he said, but they would have to make a provision against those loans.

“Some of these loans will not go bad; some of these loans will go bad – this is a pot of money that you are holding to one side just in case,” said O’Brien.

Credit unions must hold 10 per cent of assets in reserve to cover possible losses on loans and investments, though credit unions who struggle to meet this can hold 7.5 per cent as a transitionary measure until September 2011.

A “reasonable amount” of the top 100 credit unions in the country were meeting the 10 per cent reserving requirement, said O’Brien. Some 84 per cent hold more than 10 per cent, meeting the registrar’s threshold, while 2 per cent of credit unions have not reached the 7.5 per cent level.

A handful pose problems. Jonathan McMahon, assistant director-general of financial institutions supervision at the Central Bank, said 20 credit unions had “serious solvency issues”.

O’Brien said these were credit unions “across the board”, of varying sizes. A spokeswoman later clarified that there were 20 credit unions on the registrar’s “watch list” for potential solvency issues.

He warned that a failure to set aside more money to cover potential losses on rescheduled loans could wipe out a credit union’s reserves “quite quickly”.

A review of 100 loan books by the registrar found that between 85 and 90 per cent of credit unions had not provided sufficiently for potential losses. “That is a significant number,” said O’Brien.

The ILCU argues that credit unions as a sector had sufficient reserves to meet possible losses, saying that they had on average 13.4 per cent of assets in reserve.

The 404 ILCU-affiliated credit unions hold €1.72 billion in reserve, covering assets of €12.8 billion.

O’Brien told the Oireachtas committee that a wider look at the sector did not reflect the problems facing credit unions. “The sum of the parts does not reflect the level of risk in each of the individual credit unions,” he said.

Worryingly, the regulator is only “at the early stage” of assessing the growing debt levels across the credit union sector, said McMahon, and it planned to carry out stress tests on credit unions.

The level of resources within the regulator was also a problem.

“We have got 28 people currently looking at 414 credit unions. We don’t have the resources to get down into the detail of some potential problem areas,” he said.

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