Technology Adoption and the Performance of Irish Credit Unions. Donal McKillop

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1 Technology Adoption and the Performance of Irish Credit Unions Donal McKillop Monday 24th February 2013

2 Outline A Strong Performing Credit Union Movement: The US Movement A Poor Performing Credit Union Movement: The Irish Movement How Efficient are Irish Credit Unions? Technology Adoption and Irish Credit Unions Going forward Rationalisation The Way Forward?

3 US credit unions (profile) December 2012 December 2008 Number of credit unions 6,956 7,966 Members 95.07m 89.91m Total assets $1,034.9bn $825.8bn Loan to assets 59.0% 69.7% Loan to savings 68.6% 83.2% Return on Assets 91 bps 31 bps Capital ratio 10.4% 10.9% Liquidity ratio 17.5% 14.6% Average credit union assets $148.8m $103.7m Delinquency (60+ days $)/Loans 1.15% 1.37% Average shares /members $9,358 $7,694 Average loan balance $12,685 $12,624 Employees per million in assets Members/FTE

4 US credit unions loan profile (2012) <$5m $10m- $20m- >$100m $20m $100m credit card/total loans 1.3% 4.0% 5.2% 6.7% All other unsecured/total 23.2% 14.1% 7.4% 3.9% loans New vehicle/total loans 21.1% 16.3% 10.9% 10.3% Used Vehicle/total loans 37.4% 31.8% 26.4% 18.1% First mortgage real Estate/total loans 3.6% 15.6% 29.5% 42.6% Other real estate/total loans Member business loans/total loans 3.2% 9.4% 13.0% 12.3% 0.5% 1.2% 3.5% 7.5%

5 US credit unions performance ratios (2012) Average credit union assets <$5m $10m- $20m $20m- $100m >$100m $2.1m $11.2m $47.3m $621.4m Return on Assets -17bp 20bp 48bp 98bp Operating expense 398bp 373bp 371bp 308bp Capital ratio 15.8% 13.4% 11.3% 10.3% Liquidity ratio 36.1% 29.4% 23.1% 16.6% Delinquency (60+ days $)/Loans 2.80% 1.70% 1.36% 1.12% Average shares /members $3,090 $5,055 $6,839 $10,034 Average loan balance $5,242 $7,087 $9,089 $13,422 Employees per $m assets Members/FTE

6 Number of US credit unions

7 Tables show that... Most of the loan book is secured with 75.5% of loans of the smallest credit unions (<$5m) secured and 89.4% of loans of large credit (>$100m) secured Small credit unions can engage in mortgage and real estate lending through their stakes in CUSOs. As size increases there is a shift away from car loans to mortgages and member business loans Size appears to bring positive benefits An increase in ROA, and decreases in the operating expense and delinquency ratios; An increase in average shares per member and average loan outstanding; A marked reduction in excess liquidity holdings and excess capital A reduction in the number of employees required to service assets but trend reversed when servicing members.

8 The decline in numbers? a five year view Stated reason for disappearance 1. Financial or managerial difficulties 2. Expansion Mode of disappearance Acquisition Liquidation P&A Total Lack of sponsor support Loss/declining membership Poor management Poor financial condition Lack of growth Inability to obtain officials Expanded services Reorganization or restructuring Conversion to or merger with FCU Conversion to or merger with FISCU P&A with FCU P&A with FISCU Conversion to or merger with NFICU Corporate restructuring Total

9 Merger determinants the US credit union story Research by Goddard, McKillop and Wilson suggests:- Greater risk of being acquired if the credit union has (i) a smaller asset size (ii) untapped membership potential (iii) been around longer (iv) reduced profitability (v) more liquidity (vi) a lower capital to asset ratio (vii) a lower loan-to-asset ratio Level of bad debt write-offs or proportion of non-interest income has no role to play in the probability of being acquired Internet usage also a key determinant Credit unions with no website are most likely to be acquired, followed by those with an informational site followed then by those with an interactive site and then transactional site. Internet usage also a key determinant

10 Irish credit unions 403 credit unions; 357 (88.6%) community credit unions; 46 (11.4%) industrial credit unions. They have assets of 13.78bn; 32% controlled by the 29 largest credit unions (those with assets greater than 100m). Member penetration highest Monaghan %; Offaly %; Waterford 86.31%; Carlow 85.18% Lowest Sligo 21.11%; Roscommon 31.62%; Clare 52.72%; Mayo 57.00% Dublin 56.26%; Cork 79.42%; Overall 65.61% Raises questions about the impact of mergers on the membership size of new entities!!!

11 Irish credit unions Size Breakdown by Assets 2012 {Assets < 20m} 211 (52.4%) {Assets 20m to 40m} 84 (20.8%) {Assets 40m to 60m} 49 (12.2%) {Assets 60m to 100m} 30 (7.4%) {Assets > 100m } 29 (7.2%) Key Ratios (averages) 2012 (2006) Average credit union size (assets) $34.2m Loan to assets 34.0% (47.45%) Liquidity ratio (regulatory guidance > 20%) 47.38% (37.49%) Return on Assets 0.6% (3.3%) Capital ratio 13.0% (11.5%) Arrears (as % of gross loans) 19.27% (6.30%) Cost to Income 88.7% (49.5%) Total loans 5.6bn Maturity structure (less than 5 years) 84% 11

12 Irish credit unions The most critical issue is the loan to asset ratio which is extremely low. During 2012 it fell from 40% to 37%; throughout the first half of 2013 it fell further to 34% falling further to 31% by end While the economic downturn has without doubt caused deterioration in the loan to asset ratio this should not mask the fact that Irish credit unions have been under lent in both good times and bad. 2001(61.1%); 2004 (48.5%); 2006 (47.5%); 2007 (49.2%); 2008 (52.1%); 2009 (47.6%); 2010 (44.5%); 2011 (40.8%); %; December %. WOCCU suggests that net loans/total assets should be somewhere between 70 and 80% and clearly Irish credit unions fall far short. Reasons for this may relate to the range and term of loan products, their relative cost and the technology interface used in their delivery (and of course the economic downturn). Credit unions have an inordinate volume of funds tied up in liquid assets (47.38%) growth in savings drives growth in total assets but if loans are not growing as quickly as savings then the institution will have high liquidity and low earnings. (WOCCU, 2003)

13 Irish credit unions : An efficiency analysis Both parametric and non-parametric methods are used to construct a cost frontier from which relative efficiency scores are measured. Formally the problem could be set out as follows- x vector of y vector of w vector of inputs, x R These are used to define a credits unions total cost function. m S outputs, y R input prices, w R m min w' x : x V( ) C( y, w) y

14 Empirical results DEA analysis Input Cost Efficiency Maximum Minimum Mean Standard Deviation Percentage of Efficient Credit Unions 5.24%

15 Empirical results - stochastic analysis Net Cost Efficiency (excludes environmental variables) Mean Gross Cost Efficiency (includes environmental variables) Standard Deviation Minimum Maximum Spearman s Rank Correlation Coefficient for Parametric Inefficiency measure and Non-parametric efficiency measures P-value =0.000

16 Irish credit unions : An efficiency analysis Two approaches produce different industry averages for cost efficiency, the non-parametric being more pessimistic. Both indicate there is room for improvement. Performance assessment highlights potential leaders in the move to a mature industry and areas where the most performance enhancement can be achieved Operational environmental variables have a greater influence on inefficiency than structural or organisational variables Potential areas for improvement to economic performance(through cost reduction)- interest rate spread, institutional asset return, technology, tighter common bond ( occupational ).

17 Irish credit unions and technology Increased Customer Flexibility IT Adoption in a Financial services Provider Improvement in profitability Potential Cost Savings

18 Irish credit unions and technology Customer Flexibility Automated distribution channels. (E.g. ATMs, phone-based) Provision of information and services using web-based technology Potential cost savings Management of Information(Collection, storage, processing and transmission) Process automation. Paper based processes Labour intensive processes Profitability improvements Increased revenue through service charges. Lowering of processing costs.

19 Irish credit unions and technology In late 1990s the ISIS project was established. ILCUTECH Standard Information System. Financed by a levy on each credit union. GOALS: Knit together 33 different IT systems. Support spread of ATM services. Enable electronic fund transfer among credit unions. Project abandon in 2001 due to: Unanticipated cost increases. Withdrawal of a number of larger credit unions.

20 Irish credit unions and technology Improvement in IT infrastructure in Ireland: Fibre optic Metropolitan Area Networks Ireland still lags behind OECD average for broadband providers per capita. There is a renewed attempt by the ILCU to promote an integrated technology solution. IT development programmes pursued on an individual credit union basis. Resulting in a number of disparate IT systems.

21 Services Offered based on website survey Year 2007/ /2010 Live web sites Membership Application Online Account Access Online Loan Application Loan Application download Loan Calculator Annual Report Online Online General Enquiry NR 98 Privacy statement NR 100 Directors Login NR 15 Salary Deduction Electronic Fund Transfer* OTHER TECHNOLOGY ADOPTIONS Phone Banking Phone a Loan ATM-local ATM- Nationwide 8 10

22 Credit Union Characteristics and Website adoption COMMON BOND LOCATION SIZE Occupational Community Urban Rural Small (< 10M) Medium ( 10M- 40M) Large (> 40M) No Website Informational Interactive Transactional Total Websites adopted Adoption Rate 61% 53% 66% 42% 20% 56% 89%

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24 What drives IT adoption in credit unions? Operational Traits Size (total assets )* Common bond structure* Location Affiliation (trade body) * Labour cost Diversification(Non-interest Income) Loan book* Potential Membership Traits Employment status* Age* Accessibility (broadband access)* Familiarity Gender Education

25 Adoption effects over time Using financial data from the period 2002 to 2010 we investigate the average effects of adoption on a credit union s: Performance Returns on Assets Spread (Loans rate-dividend rate) Investment rate (Investment Income/Total Earning assets) Loans to assets Costs Cost to Income Labour costs( as percentage of total costs) Capital costs ( as percentage of total costs)

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27 Irish credit unions and technology: A final comment ICT technology adoption appears to be piecemeal. ICT adoptions by individual credit unions has benefits Lower spreads, driven by lower loan rates and higher dividend rate ICT adoptions by individual credit unions has costs Increased labour and capital expenditures

28 Rationalisation the future Type one One form is where small poorly performing credit unions are acquired by more robust organisations Smaller, volunteer run, under performing credit unions long term survival is most in question These credit unions may also be technologically weak (as proxied by a poor web presence informational website at best These credit unions will probably transfer their engagements to: create a more financially viable credit union; safeguard members savings; and/or better cope with the regulatory environment

29 Rationalisation the future Type one Experience from elsewhere would suggest that in most instances the advantage to the acquiring credit union will be questionable and, in the short term at least, the underlying fundamentals of the acquiring credit union may suffer. But members of the credit union that is acquired are likely to realise operational and service benefits Acquisition may be in part driven by the cooperative ethos which extends both within and outwith the single entity credit union business arguments voiced against the merger may be trumped by the co-operative family argument Restructuring Board may have a role in facilitating and mitigating costs but..???

30 Rationalisation the future Type two The second form is between small to small/medium credit unions (assets up to 20m). Credit unions are inextricably linked to the community which formed and nurtured them. Therefore a strong desire within these communities not to lose their credit union. For this reason one small credit union may merge with another small credit union in a nearby locality, with each credit union hoping that this ensures the maintenance of their local identity. Negative merger drivers are likely to be regulatory compliance burdens, volunteer burnout, staff retirement and difficulties in staff recruitment.

31 Rationalisation the future Type two Positive merger drivers would include the desire to provide members with a wider range of services and products. The US analysis would suggest that with an increase in size comes A more appropriate level of capital and liquidity ratios An increase in average saving per member and loan outstanding A reduction of operating expense and an increase in the return on assets For example moving from a credit union with assets of $11million to one with assets of $47million would Increase ROA by $2,800 for every $1 million increase in assets Experience elsewhere suggests such mergers are likely to be a staging post for a later merger with a larger credit union.

32 Rationalisation the future Type three The third form will involve relatively strong, medium size credit unions (assets of 40million and above). These may be considered a coming together of equals, although this does not necessarily mean that the credit unions are of equal asset and membership size. Amalgamations work best if the two partners bring something different and something significant to the table so that each gains from the other s strength.

33 Rationalisation the future Type three A merger among equals is usually entered into to accomplish an identified strategic business objective. Such a merger can create the necessary volume of business required to offer higher cost financial products and services. Many products and services cannot feasibly be offered by most small to medium sized organisations due to heavy start up costs and sizeable administration and manpower costs. For example, US credit unions with assets $10 - $20 million: 42% offer first mortgages; 48.9% offer second mortgages; 9% pay-day lending; 3.2% micro business loans; 11.1% offer member business loans For example, US credit unions with assets $100 - $200 million: 96% offer first mortgages; 93% offer second mortgages; 9% pay-day lending; 21.2% micro business loans; 65.1% member business loans Also for US data moving from a credit union with assets of $47million to one with assets of $621million would Increase ROA by $4,000 for every $1 million increase in assets