Address by Registrar of Credit Unions, Anne Marie McKiernan, at the Credit Union Restructuring Board annual conference

Good morning ladies and gentlemen.

Thank you, Mr Chairman, for inviting me to speak at your conference today. Your theme of “Credit Union restructuring and the long term benefits for the sector” deals with a critically important issue at this time, in view of the challenges to the business model and long term viability of credit unions. In my remarks today, I will outline my views on the restructuring challenge, in the context of the current position of the sector. Then I will set out our experience as Regulator with regard to restructuring, sharing with you some insights into where it works well, where problems can arise, and what we expect to see in merger proposals. I will also highlight the importance of the post-restructuring period for delivering on promises made and providing the opportunity to prudently grow and develop your business to revitalise your sector. I will then highlight the role of the Central Bank in resolving credit unions in difficulty when voluntary restructurings prove not to be possible and some of the challenges which remain to be addressed.

The Need for Restructuring - Current Financial Position

The restructuring of the credit union sector was a core recommendation of the Commission on Credit Unions. That report recommended, in 2012, that restructuring should be achieved in a voluntary, incentivised and time-bound manner, in order to allow the credit union sector perform to a greater level of efficiency. Section 9.1 of the final Commission Report states that restructuring can be viewed in two ways: firstly, as a way of addressing the current weaknesses in the sector, and second, as a business strategy for credit unions that want to achieve the scale necessary to move to a more efficient and sophisticated business model.

In line with the recommendations in the Commission’s Report, a number of supports for voluntary, incentivised and time-bound restructuring have been put in place. The Credit Union Restructuring Board (ReBo) was established to facilitate and oversee the voluntary restructuring of credit unions, to support their financial stability and long term sustainability. ReBo has been working extensively to facilitate and oversee voluntary consolidation and there has been a marked pick-up in merger activity, especially over the past year, for which ReBo and the credit union sector deserve credit.

Since 2006, the number of registered credit unions has fallen from 428 to the current figure of 376 active credit unions, and about half of that activity has taken place since the Report of the Commission on Credit Unions. More importantly, at an overall sectoral level, this restructuring has occurred in a smooth and managed way. Voluntary restructuring is always the preferred solution, where this can be achieved, and we fully support and engage with ReBo as it fulfils its statutory agenda. Also, given ReBo’s time-bound mandate to the end of this year, we would strongly encourage all credit unions, who feel that restructuring may be an option, to engage proactively and early with ReBo.

At this stage it is a case of plenty done and underway, but how much more is there to do? It is worth reiterating the financial and other challenges which continue to face your sector, as a backdrop to the need for continuing consolidation. The latest sectoral financial statistics provide a sobering picture : loans to members continue to decrease in aggregate, down almost 10% in the last 15 months. The average loan-to-asset ratio is now 30%, down 7 percentage points in 24 months. At the time the Commission on Credit Unions report was published, the comparable figure was 41%, and drew the description of a sector that was “significantly underlent”. Total loan interest income has fallen by a little under half in the last five years, and while this was compensated in part by higher investment income in that period, we are now entering a period of much lower investment returns. Accordingly this will have a serious impact on the ability of many credit unions’ to generate surpluses and to provide a dividend return to their members. Total interest income, as a percentage of total income, is now at 54% and contrasts with the 71% at the time the Commission reported. Arrears continue to be historically high, at 17%, but almost 1/3 of credit unions have arrears greater than 20% of their gross loans.

As well as these financial concerns, many credit unions continue to face difficulties in meeting aspects of our regulatory requirements. These requirements are the minimum standards required to ensure that your members’ funds are adequately protected and your business is well-governed and risk managed. Among the issues we have identified are: stagnant business models and lack of clarity over how to grow income from loans, limited strategic thinking on new business offerings and on attracting and retaining new and active members, and poor governance and risk management practices. The lack of economies of scale is an issue too, particularly where it inhibits credit unions' ability to develop the systems that would facilitate new business offerings to members. Our focus, in highlighting these issues, is to ensure that they are given sufficient priority by the sector and through the resulting actions the sector is put on a safer long term footing.

We have used restrictions on lending, investments and other business activities as temporary measures to reduce risks until credit unions have demonstrated that they have addressed our regulatory concerns. However, it is clear that major rather than minor changes continue to be needed, and needed quickly, to safeguard the important role of credit unions in the financial sector.

Restructuring – Experience

The change that is required to ensure the future viability of the credit union sector in Ireland can take different forms. In some cases, this may involve restructurings of services, - towards shared service delivery models, for example - and / or voluntary mergers aimed at strengthening financial positions, achieving economies of scale and improving the ability to provide new services to members. Another option, which some credit unions have been or are considering is dissolution; the credit unions concerned consider that the growth and development opportunities, or practical transfer options, do not exist and are unlikely to arise and the best result for members is to receive a distribution from surplus funds.

The steps in the voluntary merger process are set out in ReBo’s Credit Union Merger Process Handbook. Our role, at the Registry, is to put the protection of member savings and the financial stability and well-being of the credit union sector as a whole to the forefront. Because the failure of any credit union can damage public confidence in the sector, we assess each proposed transfer of engagement to ensure it represents a positive outcome for the protection of members’ funds in the long term.

At the Registry, we are taking a proactive approach to facilitating restructuring. We have developed a new modelling tool which helps us to identify, at a high level, credit unions that may be facing viability issues and may therefore need to more urgently consider possible restructuring options. This and other tools help inform our priorities for on-site engagements and risk assessments. As has been communicated previously, we have also made a change this year in our engagement approach, so that we are now engaging onsite with Low Impact credit unions that were not previously subject to PRISM onsite engagement. We recognise that long term viability challenges being experienced by many credit unions are likely to be even more acute for smaller credit unions. Our focus is to understand how these credit unions are addressing their key risks and how they can satisfy themselves and their membership as to their long-term sustainability. It is still the very early stages in the rollout of our amended engagement approach. What we can say, however, is that we have seen some Low Impact credit unions which are able to demonstrate their ability to meet regulatory standards and have viability into the future. On the other hand, we have also seen in some smaller credit unions poor practices with regard to lending, risk management and operational controls, alongside concerns regarding future viability. In short, these very preliminary findings mirror many of those highlighted in our broader PRISM review in 2014.

Credit unions that are not in a position to satisfy regulatory requirements will need to demonstrate that they are actively pursuing alternative arrangements to protect members’ interests and ensure continuity of services to their members. Clearly, where viability cannot be demonstrated on a stand-alone basis, restructuring – in its different forms - must be considered.

Overall, it is clear that the pick-up in the pace of voluntary restructuring needs to continue, particularly when the time period available for incentivised restructuring is nearing an end. I urge all credit unions, who feel that restructuring may be required, to use the opportunity afforded by ReBo in the time available.

For each credit union, the questions to consider include: are we providing the services that best suits our members now and in the near term; how is the credit union positioned to provide the best levels of service to current members, and to attract new business in the future; and is there a strategic opportunity to place our credit union on a path of growth and development?

As you know, restructuring proposals have to be approved by the Registry. Let me set out clearly our position: we support restructuring proposals which are financially sound, supported by proper risk and control frameworks and have clear leadership and vision in terms of the future direction of the merged entity. In practice, this means that we accommodate proposals put forward by financially strong and well-run credit unions. We do not favour the merger of weak credit unions where the focus is on cost alleviation alone and there is no coherent vision for the future development and strength of their combined businesses. As you know, our approval process requires that appropriate due diligence be conducted on the credit unions involved. This is to ensure that the respective boards have an understanding of all factors involved before making any decisions. The due diligence process should be complemented with detailed integration and post integration planning, about which I will say more later.

I will outline the milestones in our restructuring process and share with you our experiences of what makes mergers work well and where challenges can arise. The process begins when one or a number of credit unions approach ReBo, or the Registry, expressing an interest in a potential transfer or proposing an actual transfer solution. At an early stage in the process, the credit unions need to consider the particular challenges which they are each facing and how they may be addressed by a transfer, and the organisational and governance structure of the combined entity.

Once the credit unions have agreed to pursue a transfer of engagements, a high level business case should be prepared and submitted to the Registry. The purpose of the business case is to set out the rationale for the transfer, the essence of the proposed business strategy and the high level forecast financial position of the combined credit union. At the Central Bank, we review this high level business case to see whether it demonstrates that the proposed transfer is likely to enhance the viability of the credit unions and also whether there are any outstanding supervisory issues that will have to be addressed before the transfer process can proceed.

The next step – which is in line with good practice for mergers in general – is for an asset review and a due diligence review to be undertaken by an independent third party for each of the credit unions. These reviews are designed to provide each credit union with a thorough understanding of the operations and governance culture of the partner credit union and assurance that the financial position of the partner is correctly stated. Any matters arising from these reviews must be addressed by the credit unions in a timely way. The decision to affect a transfer is one of the most difficult decisions that a credit union board will have to make. Without the benefit of a through due diligence process, a board can simply not be in a position to make an informed decision that a transfer is in the best interests of their members.

On the basis of these reviews, a detailed business plan for the merged credit union must then be submitted to the Registry. This is intended to be a clear expression of how the transfer will address the current and likely challenges facing the credit unions and result in a viable new entity with enhanced benefits for members. It should also make clear the organisational and governance structure and strategy for the consolidated credit union, and include financial projections for at least 3 years.

Each of these steps provides opportunities for constructive challenge, clarifications and further development of the proposal. It is important to consider the strategic rationale for a merger in detail. I urge you to use the opportunity of consolidation as an enabler of growth and development in your sector. We have seen, for example, many cases where the rationale for merging appears focused on cost alleviation or more benefits to current members, with little or no thought to the strategy for ensuring viability in the future and for addressing known or possible risks. Detailed business cases must also clarify how to deal with issues such as low lending activity, marrying the scale of savings and loans, attracting new members and developing new services in a realistic way. We also need to see the ability and expertise to achieve the goals set out in the business plan.

I would emphasise that restructuring focused on scale alone does not translate into viability, but it may provide the opportunity for growth and development.

We have seen cases where credit unions may propose to come together but have not clarified the leadership and decision making structures. It is important to ensure that, in any merger, there is clarity of vision and leadership for the new entity, to enable the often difficult decisions that will be required to be made in a timely and well-understood way. A related issue is how to agree the combined credit union’s board or management composition after the transfer is completed, and meet legal requirements in relation to governance, including the required mix of skills, expertise and experience that is appropriate for the combined credit union.

Increasing lending, in a prudent and viable way, is at the heart of growth and development for any credit union, whether merging or not. In this context, we expect credit unions to apply prudent lending standards for all new loans and top-ups of existing loans, and to have appropriate systems in place to be able to fully assess and confirm the member’s ability to repay the loan.

Lending restrictions arise from on-going matters of supervisory concern arising in individual credit unions. As you know, we are reviewing such restrictions at present. We have invited all credit unions with a lending restriction to demonstrate that they have, and can document, the appropriate systems and controls so that we can consider easing or removing the lending restriction as appropriate. Clearly, credit unions which are considering restructuring as a means to enhance their business should be active in ensuring that they meet our requirements, to enable lending and other restrictions to be lifted. It is also an opportunity to demonstrate to members – in their own and the transferring credit unions – that their credit standards, policies and controls are in line with good practice and regulatory requirements. For weaker entities migrating to a stronger risk and governance platform, the need for continuation of any restriction on that entity will be reviewed as part of the consolidation process.

As the sector’s consolidation gathers pace, not surprisingly the more straightforward merger opportunities may soon be complete and future cases will face additional difficulties. For example, there may be a shortage of willing and strong transferees in some areas, while some credit unions may look beyond traditional boundaries to find a suitable partner in order to secure longer term viability. If restructuring is a serious consideration for your credit union it is important to consider these difficulties and see if less obvious but potentially more stable solutions may be found.

Importance of the Post-Restructuring Period

As I said earlier, the aim of consolidation is to ensure a safer credit union sector and enable future growth and development. It is essential, therefore, that time is taken in the post restructuring phase to ensure that the promises made are delivered on. These may include, for example, aims with regard to growing lending responsibly, attracting new active members, cost reductions and/or new product offerings. Credit unions should also continue to focus on adapting strategic plans to changes that arise in their overall environment. We at the Registry agree a Risk Mitigation Programme (RMP) to be put in place with the merged credit union. Typically, this will be set out targets to be achieved within a clear timeframe. For example, the RMP may set out targets for three to six months of the merger, for operational systems and controls, governance structures, and suitable day to day operations. Within six to nine months of the merger, we will review whether the merged entity is meeting the targets set and typically also review the balance sheet to see if any stresses are emerging. Credit unions will also need to determine whether they are meeting their targets and objectives, with reasons for not doing so investigated and changes made to plans based on these reviews.

In the post restructuring period, it is critical that the merged operation retains a clear focus on strategic planning for long term viability. It is important to be clear that the transfer is not an end in itself. Rather, it is the first step on a path to enhanced viability, growth and development.

Resolution

Where we have serious concerns about governance at a credit union, about the failure to address business problems and to plan for the future, or any other matter which poses risks to the safety of members’ funds, we require the credit union to urgently undertake the changes necessary to deal with these problems. The solution may be a series of business, governance, management and operational changes, or a link up on a voluntary basis with another credit union, and / or a financial injection.

There are, as you have seen, situations where voluntary restructuring does not prove possible, appropriate or timely to resolve the difficulties at some credit unions. In these cases, the Central Bank must move to resolution, to protect members’ funds and safeguard the financial stability of the sector. The failure of a credit union is not necessarily a sign of similar problems in other credit unions, but it has the potential to damage public confidence in the sector. This, in turn, may impact negatively on strong credit unions with viable business plans, or on weaker credit unions who are trying to find a way forward.

Where a voluntary transfer proves not to be possible, a credit union’s difficulties may be addressed by directed transfer, using the powers set out in the Central Bank and Credit Institutions (Resolution Act) 2011. The Central Bank is committed to taking the appropriate resolution action where necessary. In the resolution actions the Bank has taken so far, we have shown that we are determined in the first instance to find credit union- based solutions that protect members' funds and facilitate the continuation of credit union services. That will continue to be our aim as far as that is possible.

Seeking the liquidation of a credit union is used in situations when all other resolution measures are unviable or inappropriate and where we have serious concerns for the safety of members’ funds. As resolution actions may require the use of public funds, the actions must be taken in the public interest. It is incumbent on us to ensure that our resolution actions – whether directed transfer or liquidation or other – represent the best overall outcome, from the perspective of protection of members’ funds, the stability of the sector and the potential cost to the taxpayer from the resolution action.

Summary

Let me finalise my remarks by acknowledging the significant restructuring work underway by ReBo and credit unions, and the general stability of credit union operations and services throughout this phase. The need to continue and keep up pace in 2015 is also clear. This is particularly in view of the continuing weakness in many of the key financial measures of health for the sector, which I set out above. The important objective is to ensure that restructuring achieves better outcomes for current and prospective members, enhances the financial soundness of credit unions and acts as an enabler for future growth and development, setting the sector up for a viable and successful future.

Thank you very much.