The Governor From: Special Resolution Unit ( SRU ) of the Central Bank of Ireland (the Bank ) Date: 18 July 2014

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1 Resolution Report on the rationale for liquidation, and other matters relevant to a petition under the Central Bank and Credit Institutions (Resolution) Act 2011 (the 2011 Act ) for the winding up, of Berehaven Credit Union Limited ( BCU ) under the Companies Act, 1963 (the 1963 Act ) To: The Governor From: Special Resolution Unit ( SRU ) of the Central Bank of Ireland (the Bank ) Date: 18 July 2014 A. INTRODUCTION 1. This report (the Report ) is prepared in order to assist you in the performance of your functions under the 2011 Act in respect of the matters discussed herein. To the extent that this Report outlines a policy position or suggests a course of action, this is done for consideration and discussion purposes only and does not purport to represent an official policy view or decision of the Bank, whether for the purposes of the 2011 Act or any other purpose, and whether with respect to institutions named in this Report or generally. 2. The purpose of this Report is to outline the facts which may assist you to determine: (a) whether liquidation is the appropriate course of action in respect of BCU; and (b) whether the Bank has sufficient grounds on which to seek to have a liquidator appointed to BCU. Finally, the Report provides an overview of the need for the appointment of a provisional liquidator if liquidation is the approach to be taken by the Bank. 3. The key views expressed in this Report are that, in the opinion of SRU: 3.1 BCU has failed to comply with a direction made by the Registrar of Credit Unions under section 87 of Credit Union Act, 1997 (as amended, and hereinafter the CUA ) dated 4 June 2014 to maintain a regulatory reserve ratio (an RRR ) of not less than 10%; 3.2 BCU has further failed to comply with two earlier directions issued by the Registrar of Credit Unions dated 1 August 2012 and 27 February 2013 respectively and never remedied those breaches; 3.3 BCU is financially unstable and is at increased risk of corporate failure; 1

2 3.4 all appropriate options with respect to the restructuring, or transfer (whether voluntary or by means of a directed transfer under the 2011 Act), of the business and assets of BCU have been considered and are not capable of being implemented or are not financially viable; 3.5 in the circumstances, liquidation is the appropriate course of action to be deployed in respect of BCU; 3.6 the Bank has adequate grounds on which to petition under the 2011 Act for the presentation of a petition for the winding up of BCU under the 1963 Act; and 3.7 the Bank should make an application to the High Court (the Court ) under the 1963 Act for the appointment of a provisional liquidator to BCU in order to ensure an orderly winding-up of BCU in the interests of members, and creditors and in the public interest. B. BACKGROUND 4. BCU is a credit union based in Castletownbere in South West County Cork, founded in 1978 with a common bond encompassing the parishes of Castletownbere, Bere Island, Adrigole, Allihies and Eyeries. As at 30 June 2014, based upon the Prudential Return submitted by BCU to the Registry of Credit Unions ( RCU ), BCU had 3,500 members, total savings of c million and total assets of 11.4 million of which gross loans (pre-provisions) comprised c. 1.7 million. 5. RCU s concerns regarding BCU s financial position were first raised following receipt of BCU s Prudential Return as at 31 December 2009 which was submitted to RCU on 10 January The following table provides an overview of the information reported by BCU from September 2009 to September 2010: 2

3 6. From an analysis of the Prudential Returns submitted by BCU in 2009 and from a subsequent meeting between RCU and BCU, concerns arose that BCU was not reporting loans to connected parties correctly. 7. On foot of a request from RCU, BCU s Board appointed accounting firm Moore Stephens Nathans ( MSN ) to undertake an examination of BCU s loan book as at 31 July MSN began its review on 9 August While MSN was in the process of completing its initial loan book review and report, serious matters in relation to connected party loans were discovered. Further work was carried out by MSN in relation to these issues. The supplemental report was completed on 15 October 2010 (the initial loan book review report and the supplemental report are referred to collectively as the MSN Reports ). Key corporate governance issues relating to lending practices and reporting irregularities were identified in the MSN Reports, details of which are dealt with below under the section of this Report entitled SRU s assessment of the reasons for BCU s failure. 8. Arising from the issues identified in the MSN Reports, on 9 November 2010 RCU met with the Board and Supervisory Committee of BCU to discuss the finding of the MSN Reports. RCU informed BCU that resignations were sought from the Board. On 17 November 2010 RCU received confirmation of the resignations. 9. From February 2010, RCU has issued in total nine Regulatory Directions to BCU: two directed BCU to seek solvency support to restore its RRR to 10%; one directed BCU not to proceed with holding an AGM; and a further six directions curtailed the business activities of BCU principally by limiting its lending, limiting the investments it could make, prohibiting further expenditure on fixed assets and capping the maximum savings any member could have in BCU. In addition BCU was required to maintain a minimum liquidity level in excess of the minimum 20% statutory requirement. 10. From February 2010, RCU engaged with BCU in order to rectify the serious issues that had been identified in the credit union. In this regard, RCU engaged extensively with BCU in order to identify a suitable transferee credit union. This ultimately resulted in xxxxxxxxxxxxxxxxxx being identified. In order to facilitate the transfer of engagements process, RCU engaged with xxxx and the Irish League of Credit Unions ( ILCU ) in order to seek a transfer of engagement solution and it was agreed that BCU could progress to a transfer. 3

4 11. Between February 2011 and April 2013, RCU engaged in discussions between xxxx and BCU in relation to a potential voluntary transfer of BCU s undertaking to xxxx under the CUA, which it was intended would have been supported by Savings Protection Scheme ( SPS ) funds to be provided by ILCU. However issues arose which required clarification before the transfer of engagements could be finalised which ultimately led to xxxx informing RCU on 16 April 2014 that it was withdrawing from the voluntary transfer. 12. On 25 April 2014, RCU approached the Credit Union Restructuring Board ( ReBo ) to determine whether it could facilitate a restructuring solution in relation to BCU, however, on 5 June 2014 ReBo informed RCU that it would not be in a position to do so. 13. Subsequently, on 25 June 2014 RCU received an from BCU, attaching a letter from BCU (relating to the direction issued by the Registrar of Credit Unions under section 87 of the CUA dated 4) dated 25 June 2014 stating that given the inability of the Credit Union to comply with the current directive [sic] of the Central Bank of Ireland, the Board of Berehaven Credit Union now formally requests that the Central Bank would facilitate a voluntary directed transfer of Berehaven Credit Union to another Credit Union. In the alternative, if this is not possible, the Credit Union realises that there are other options available and if a direct [sic] transfer to another Credit Union is not possible, the Board have discussed the other options that are available and seek the Central Bank s assistance. The Board is committed to fully co-operating with the Bank to bring the situation to a successful conclusion for the benefit and protection of all of the members of the Credit Union and their savings. Bid process 14. The MSN Reports highlighted significant issues which were of concern to RCU. While discussions between BCU, xxxx and ILCU were on-going, RCU saw a voluntary transfer as a means of ameliorating those concerns. RCU s view in this regard was based on commitments from ILCU to provide SPS financial support to xxxx in respect of the transfer of BCU (including a commitment to deposit the required monies in an NTMA bank account).when it became clear that xxxx was no longer prepared to pursue those discussions, RCU sought a further review of BCU by accounting firm MKO Partners ( MKO ) see below. On 27 June 2014, when a draft MKO report highlighted further regulatory issues (which BCU still had not 4

5 addressed), RCU issued a letter to SRU formally referring BCU to SRU as a resolution case, and requesting SRU to assess the resolution options available under the 2011 Act. 15. In a letter dated 1 July 2014 Patrick Casey, Acting Deputy Head of SRU, wrote to you setting out the financial position of BCU. It was noted in this letter that the two options available in respect of BCU were a directed transfer under the 2011 Act and a liquidation of BCU under the 2011 Act. In that letter it was proposed that a competitive bid process be carried out, in accordance with the document entitled Criteria for Establishing Eligible Bidders for a Credit Union Transfer Bid Process (the Criteria ) which you had previously approved on 10 February 2014, in order to determine if there were suitable and willing bidders for a transfer of the assets and liabilities of BCU and to determine the amount of any financial incentive that may be required (the Bid Process ). It was indicated that following the Bid Process you would be in a position to consider whether a transfer would be preferable to an immediate liquidation of BCU. On the same date you responded acknowledging that before you would be in a position to assess properly whether a transfer or liquidation would be preferable you would need to know the amount of any financial incentive that may be required by a potential transferee to engage in a transfer of BCU. You authorised the carrying out of the Bid Process in accordance with the Criteria. 16. The Bid Process was carried out in accordance with the Criteria, to: (a) (b) (c) determine the aggregate of the market value of all of the assets, less the market value of all of the liabilities, of BCU, for the purposes of Section 28 of the 2011 Act; to identify eligible bidders, having regard to the Criteria, and to determine the amount of any financial incentive that may be sought by such bidders; and to comply with the requirements of relevant European State Aid approvals (in the event that a financial incentive is required to be made from the Credit Institutions Resolution Fund (the Fund )). 17. SRU applied the Criteria on 4 July 2014, and identified three credit unions who were suitable potential transferees for BCU (the Eligible Bidders ). SRU contacted each of the Eligible Bidders and subsequently one of the Eligible Bidders, being xxxx, indicated that it was interested in examining a possible transfer of BCU. The two remaining Eligible Bidders, being xxxxxxxxxxxxxxxxxxxx xxxx and xxxx xxxx xxxx xxxx xxxx, indicated that they were not interested in examining a possible transfer of BCU. 5

6 18. Following its initial expression of interest, xxxx signed a non-disclosure agreement with BCU and the Bank. 19. On 10 July 2014, xxxx submitted a term sheet which set out its non-binding bid. The bid submitted by xxxx stipulated that a financial incentive payment would be required to be made from the Fund to reflect the extent of the capital reserve shortfall of BCU that would be required to be assumed by xxxx pursuant to any transfer order. In order to avoid any dilution of its own existing reserve position in percentage terms (xxx%x in its March 2014 prudential return), xxxx stipulated that it required a cash financial incentive of xxxx xxxx. xxxx further stipulated that its bid was conditional upon the completion of full due diligence with respect to the assets and liabilities of BCU. 20. In a letter to you dated 15 July 2014, SRU noted that, based on a preliminary analysis, it appeared that the level of cash financial incentive sought by xxxx would indicate that a directed transfer of the assets and liabilities of BCU to xxxx on the terms of its bid would be more costly than a liquidation of BCU. SRU noted that it would prepare this Report, in which it would include more detailed analysis in this regard, along with a summary of BCU s regulatory history, its current financial position, and consideration of the grounds for liquidation under the 2011 Act and whether SRU considers that the grounds are met. 21. In a letter to SRU dated 15 July 2014, you requested the preparation of the Report, to enable you to decide whether a liquidation of BCU is the appropriate course of action for the Bank to take in this case. C. CURRENT FINANCIAL POSITION OF BCU Table - Analysis of Financial Position of BCU based on information submitted in the audited/draft financial statements for the years ended 30 September 2009 to 30 September 2013 and the BCU Prudential Return for quarter ended 30 June

7 22. A credit union s loan book is a key driver of profitability in its business. BCU s loans to assets ratio has been contracting since September 2009, falling from 67.5% as per the financial statements at September 2009 to 15.3% in June 2014, representing a consistent reduction in its loans outstanding. Concurrently BCU s total assets have reduced by 33% between September 2009 and the June 2014 prudential return. The contraction in total assets and the loans to assets ratio of BCU was contributed to in part by a write off of c. 3.5 million of loans as bad debts in its 30 September 2012 year end accounts. Furthermore, due to a contraction in domestic property prices, BCU booked impairments on its fixed assets resulting in a current carrying value of 635K. Since September 2008, the financial position of BCU has continued to deteriorate due to: o a declining loan book (gross loans net of provisions) from c million as at 30 September 2009 to c. 1.7 million as at 30 June 2014; o fixed asset impairments (booked in the year end accounts for 30 September 2011, 30 September 2012 and 30 September 2013) totalling 0.34 million; and o gross loans greater than 9 weeks in arrears, increasing from 8.1% at 30 September 2009 to 36.6% as at 30 June

8 23. The Credit Union Act 1997 (Section 85) Rules 2009 (the 2009 Rules ) requires all credit unions to maintain a RRR of not less than 10%. The Regulatory Reserve Ratio for Credit Unions, an RCU guidance document issued to credit unions in August 2009 (the 2009 Guidance ) provided that, where credit unions did not have adequate reserves to meet the RRR by 30 September 2009, transitional arrangements would apply to credit unions to meet the RRR within the shortest timeframe possible, but no later than 30 September BCU s RRR at 30 September 2009 was 11.6% and subsequently it dropped to -5.5% as at 30 September Accordingly, BCU did not comply with the RRR requirements from 30 September 2010 onwards. BCU s RRR continued to deteriorate to -6.2% as at 30 September Although there has been a slight improvement subsequently (due in part to the contraction in BCU s total assets, and therefore in the level of reserves it needs to hold to meet its RRR requirement), BCU s RRR at 30 June 2014 stood at -3.8%, and it therefore remained in breach of the 2009 Rules at that date. 24. The Prudential Return as at 30 June 2014, which was submitted to RCU on 15 July 2014, outlined that BCU had negative net assets of 55,200 and required 1.3 million in additional capital in order to comply with the 10% RRR requirement. BCU s total loans stood at 1.7 million, its total assets stood at 11.4 million and its loans in arrears greater than 9 weeks stood at 36.4%. BCU s RRR at 30 June 2014 stood at -3.8%. As outlined below, RCU has issued three directions to BCU under section 87 of the CUA since 2009 arising from serious concerns over the financial position of BCU. D. SRU S ASSESSMENT OF THE REASONS FOR BCU S FAILURE 25. We believe it is important to understand the underlying cause of BCU s difficulties which ultimately led to the deterioration in its financial position. 26. As noted above, the MSN Reports highlighted issues including lending practices and reporting irregularities during On foot of continuing RCU concerns regarding the financial position of BCU, and a concern that the voluntary transfer of engagements with xxxx had not concluded, accounting firm MKO was engaged by RCU to undertake an inspection of BCU and to produce an asset review report as at 31 January MKO provided a draft version of its report to the BCU Board for comment prior to its finalisation on 1 July 2014 (the MKO Report ). Both independent third party reviews highlighted key issues surrounding the internal controls and governance of BCU. It is clear from the 2014 MKO Report that the BCU Board has not fully addressed key issues concerning its 8

9 governance and internal controls (when material concerns regarding those matters had previously been highlighted to the BCU Board in the MSN Reports in 2010). 27. The aforementioned independent third party reviews identified significant and pervasive weaknesses in the areas of lending practices, credit control, internal control environment (including in the financial reporting and control area) and loan provisioning practices. 28. Those reviews have highlighted that the BCU Board has failed to maintain adequate internal controls and governance. The common issues and concerns identified by independent third parties are as follows: Lending practices Inadequate assessment of borrower ability to repay Inadequately documented credit assessment of borrower ability to repay Credit concentration risk high level of lending to a low quantum of borrowers Lending to members in arrears on their existing borrowings Irregular practices concerning loans to officers of BCU including in respect of loan approval Inadequate anti money laundering procedures including a failure to establish the identity of the borrower and the address of the borrower Inadequate credit control practices and procedures Inadequate documentation of rationale for arrears Inadequate evidence that BCU was actively taking action to recover loans in arrears Inadequate documentation on the loan file of the rationale for restructuring loans Internal control weaknesses Inadequate segregation of roles and responsibilities Inadequate assessment of BCU s share to loan transfer activity Failure to report loans to connected parties (including to officers of BCU) The use of multiple names for individual member loan accounts Concessionary repayment terms being provided to certain borrowers Failure to maintain a list of loans where temporary loan restructuring arrangements were in place on the current and/or previous loan 9

10 Specific weaknesses in respect of financial reporting and controls BCU s general ledger is manually prepared and is paper based Weaknesses in the preparation of management accounts No documented policies and procedures relating to the internal financial reporting control environment No individuals suitably qualified in accounting were involved in the preparation of monthly management accounts No fixed asset register High risk bank and cash control practices Loan provisioning practices Inadequate methodology in relation to the application of loan provisioning Miscellaneous 29. SRU has concerns regarding the on-going stability of BCU arising from the MKO Report. The MKO Report was provided to BCU in draft form initially. BCU was given two weeks to review the draft MKO Report and make any submissions. On 23 May 2014, RCU received a submission from BCU, setting out its response to a number of the issues identified in the draft MKO Report. The draft MKO Report was subsequently amended to reflect some of the comments provided by BCU (for example, in relation to on the level of unattached shares). BCU did not disagree with the issues raised in the draft MKO Report in relation to the breach of the Regulatory Directions from 1 August 2012 and 27 February 2013 relating to maximum loan size per member. BCU provided additional comments on a number of issues in its response; however, these comments did not directly contradict the findings of the draft MKO Report. The main conclusions of the draft MKO report were not materially affected as a result of the submission received from BCU. High risk of corporate failure 30. The submissions received from BCU in relation to the MKO Report were considered, and the MKO Report was finalised thereafter. The final version of the MKO Report was issued to BCU on 1 July The MKO Report contained the following observations: 10

11 The pervasive nature and aggregation of the risk observations noted represent a significant risk to BCU s stability that may result in corporate failure and Failure to address matters noted in this report will result in the significant risk of further loss in members funds being compounded. 31. In light of the findings set out in the MKO Report, it is the view of SRU that: 31.1 the MKO Report highlights very serious concerns regarding the high risk of corporate failure arising due to material corporate governance failures which have not been remedied by BCU or its board of directors; 31.2 the MKO Report indicates that BCU is at risk of corporate failure, which could lead to a disorderly collapse in its business, leading to a run on deposits, which could have serious implications for the credit union sector as a whole; 31.3 for the foregoing reasons, it is very difficult to see any circumstances in which BCU would be in a position to raise sufficient capital to enable it to comply with its obligations to maintain an RRR of not less than 10% (and indeed BCU confirmed this in a letter to RCU dated 25 June 2014); 31.4 in circumstances where all transfer options (voluntary or directed) have been exhausted, it is essential that the instability of and other issued faced by BCU is addressed as a matter of urgency; and 31.5 in light of the preceding matters it is clear that some action has to be taken in relation to BCU and that, in circumstances where a transfer is not a viable solution, the Bank should consider petitioning for the liquidation of BCU in the interests of its members and the public interest. E. GROUNDS FOR LIQUIDATION 32. Under the 2011 Act, the Bank may present a petition for the winding up of a credit institution (including a credit union) under any of five grounds. These grounds, which are set out in Section 77 of the 2011 Act, are as follows: 32.1 that in the opinion of the Bank, the winding-up of that credit institution would be in the public interest; 11

12 32.2 that that credit institution is, or in the opinion of the Bank may be, unable to meet its obligations to its creditors; 32.3 that that credit institution has failed to comply with a direction of the Bank (a) in the case of the holder of a licence under section 9 of the Act of 1971, under section 21 of that Act, or (b) in the case of a building society, under section 40 (2) of the Building Societies Act 1989, or (c) in the case of a credit union, under section 87 of the Credit Union Act 1997; 32.4 that that credit institution s licence or authorisation (as applicable) has been revoked and (in the case of the holder of a licence under section 9 of the Act of 1971) that it has ceased to carry on banking business; 32.5 that the Bank considers that it is in the interest of persons having deposits (including deposits on current accounts) with that credit institution that it be wound up. 33. In the opinion of SRU, four of the above grounds are relevant to the Bank s consideration as to whether it has grounds to petition for the winding-up of BCU, namely that: 33.1 BCU is, or in the opinion of the Bank may be, unable to meet its obligations to its creditors; 33.2 BCU has failed to comply with a direction of the Bank; 33.3 it is in the interests of persons having deposits with BCU that it is wound up; and 33.4 a winding up of BCU would be in the public interest. 34. SRU s analysis as to each of these grounds is set out in detail below. UNABLE TO MEET THE OBLIGATIONS OF ITS CREDITORS 35. According to the Prudential Return submitted by BCU to RCU for the period to 30 June 2014, BCU s total liabilities exceeded its total assets by 55,220. This represents a 1.3 million regulatory shortfall to BCU s RRR requirement of 10 per cent. 36. As noted above, on 4 June 2014 the Registrar of Credit Unions issued a letter to BCU in which BCU was directed to raise its RRR to 10% of its total assets. In a reply to RCU dated 25 12

13 June 2014, the Board of BCU stated that it was unable to comply with the requirement to raise its RRR to 10%. 37. The financial position and performance of BCU has deteriorated over the last six years: Financial Performance 37.1 Its loan interest income has fallen from 1.15 million in the financial year ended 30 September 2008 ( FY 2008 ) to 304k in the financial year ended 30 September 2013 ( FY 2013 ); 37.2 Its total income has fallen from 1.24 million in FY 2008 to 482k in FY 2013; and 37.3 Its cost to income ratio (excluding exceptional items) has risen from 48 per cent in FY 2008 to 101 per cent in FY Financial position 37.4 Its total assets declined from 17.8 million in FY 2008 to c million in FY 2013; 37.5 Its gross loans declined from 13.1 million in FY 2008 to 2.3 million in FY 2013; and 37.6 Its net assets declined from 2.7 million in FY 2008 to million in FY The decline in its financial performance in particular reflects the fact that BCU s asset mix has evolved from being heavily loan biased historically to being cash and investment biased more recently. Given credit unions are heavily dependent on loans as income generating assets (with cash and investments yielding low returns), BCU s ability to generate sufficient surpluses to grow its income and cover its costs is highly constrained. The decline in its income generating ability can only be addressed by growing its loan portfolio again on a basis that is profitable. In the current climate with low credit demand it is questionable whether this is feasible, and BCU s recent track record in respect of credit performance would question its capacity to do so. Therefore, it is unlikely that BCU will be able to address its current financial difficulties by trading its way back to a solvent position and further capital would be required if the loan portfolio is to grow and there is no obvious source for that capital. 39. Notwithstanding its lack of capacity to grow its income generating assets, it is possible that BCU could become balance sheet solvent by cutting its operating cost base to generate surpluses. However, it is also quite possible given the weaknesses in its governance and 13

14 internal controls and its continuing financial deterioration, that its position may deteriorate further. Without any reasonable prospect of external assistance, the Bank could not permit it to trade in breach of its RRR requirement for an extended period. This is particularly so when all efforts to assist BCU to find a solution to its difficulties have been unsuccessful. In addition, if it becomes necessary for BCU to recognise further bad debt provisions with respect to its loan book, this could also result in a further serious deterioration in its already precarious financial position. 40. Were the Board of BCU to decide to realise the value of its assets in service of meeting its liabilities to its creditors, it is reasonable to assume that the excess of its total liabilities over its total assets would exceed 55,220 (which represents the excess of BCU s total liabilities over its total assets as at 30 June 2014). Even if BCU were able to realise the full carrying value of its total assets which amounted to 11.4 million as at 30 June 2014 (according to BCU s Prudential Return), at a minimum it is likely that some third party expenses relating to the asset disposal would be incurred. On that basis, it is reasonable to expect at a minimum that an increased excess of total liabilities over total assets (above the 55,220 figure as at 30 June 2014) would materialise under such a scenario. 41. On balance, factoring in BCU s recent financial performance and position and its constrained capacity to ameliorate its position, SRU believes that: 41.1 BCU is currently marginally insolvent on a balance sheet basis, although it is able to meet its obligations to its creditors on a day-to-day basis; 41.2 there is a substantial risk that BCU s balance sheet position could deteriorate unless the corporate governance and other issues identified in the MKO Report are resolved as a matter of urgency (and SRU has no reason to believe that such a resolution is likely to occur); and 41.3 the corporate governance and other issues faced by BCU are not currently publicly known, and unless they are addressed urgently, the nature of those problems could become public knowledge, leading to a disorderly collapse in its business with the consequence that BCU would be unable to meet its obligations to to its creditors. 42. Accordingly, although SRU does not believe that it can be said that BCU is currently unable to meet its obligations to its creditors, SRU is nonetheless of the view that the Bank has reasonable grounds to form the opinion that BCU is at material risk of such a circumstance 14

15 arising. SRU is also mindful of the fact that BCU remains in substantial breach of its RRR requirements, has been for some considerable time and has demonstrated no capacity to rectify this serious non-compliance. BREACH OF DIRECTIONS 43. As set out above, one of the grounds for liquidation is that the credit institution failed to comply with a direction of the Bank made pursuant to section 87 of the CUA. 44. On foot of regulatory concerns, RCU issued a series of regulatory directions to BCU to address certain key issues. RCU has identified breaches by BCU of one existing direction and two expired directions, all of which were issued pursuant to section 87 of the CUA. The expired directions related to, among other things, restrictions on the size of loan that BCU could issue to members. BCU continues to be subject to directions regarding the size of loan it can issue to members. Current Direction Breaches Direction Dated 4 June On 4 June 2014, the Registrar of Credit Unions issued a letter to BCU in which BCU was directed to comply with the following requirements: 45.1 The Credit Union must raise its RRR (as defined in the Credit Union Act 1997 (Section 85) Rules 2009) to 10% of the total assets as at 31 March 2014 and in order to do so must raise an amount of 1.35m in solvency support, as a matter of urgency. This solvency support must be in place no later than 4pm on 25 June 2014 and this support must be provided in cash form and lodged to a bank account in the name of the credit union The credit union must, in relation to maintaining its RRR at 10% as required under the Credit Union Act 1997 (Section 85) Rules 2009, prepare a statement in writing by 25 June 2014 of the steps it will take to ensure continued compliance with its obligation to maintain its Regulatory Reserve Ratio (as defined in the Credit Union Act 1997 (Section 85) Rules 2009) at 10% of the total assets. 15

16 46. On 18 June 2014 BCU advised RCU by way of that it had formally applied to the Administration Committee of ILCU seeking solvency support of 1.35 million to be placed in an account in the name of BCU in order to raise its RRR to 10% of the total assets. 47. In a letter to RCU dated 25 June 2014, the Board of BCU stated the following: 47.1 Given the inability of the Credit Union to comply with the current directive [sic] of the Central Bank of Ireland, the Board of Berehaven Credit Union now formally requests that the Central Bank would facilitate a voluntary directed transfer of Berehaven Credit Union to another Credit Union. In the alternative, if this is not possible, the Credit Union realises that there are other options available and if a direct [sic] transfer to another Credit Union is not possible, the Board have discussed the other options that are available and seek the Central Bank s assistance The Board is committed to fully co-operating with the Bank to bring the situation to a successful conclusion for the benefit and protection of all of the members of the Credit Union and their savings. 48. BCU was required to raise its RRR to 10% of the total assets as at 31 March In its letter of response dated 25 June 2014, the Board of BCU acknowledged that BCU was unable to comply with this Direction referring to the inability of the Credit Union to comply with the current directive of the Central Bank of Ireland. Furthermore, BCU did not provide the required statement in writing setting out the steps BCU will take to ensure continued compliance with its obligation to maintain its Regulatory Reserve Ratio at 10% of total assets. 49. Given the foregoing, it is clear that the Direction issued on 4 June 2014 was breached by BCU, and that BCU remains in breach of that Direction. Previous Direction Breaches Direction Dated 27 February On 27 February 2013, the Registrar of Credit Unions issued a Direction letter to BCU in which BCU was directed to comply with, inter alia, the following: 50.1 The Credit Union is prohibited from making any payment to any member of the credit union by way of loan where the outstanding balance due by the member to 16

17 the credit union for all loans made to that member, whether made jointly or on the member s own account, were the loan to be made, would exceed the sum of (a) The amount of shares in, or deposit with, the credit union held by that member (whether held jointly or on the member s own account), and (b) 3, This Direction was due to expire six months from the date of being issued. The Direction expired on 27 August On 17 May 2013, between the date of the issue of the Direction on 27 February 2013 and the date of its expiry on 27 August 2013, a loan was granted in respect of Account Number xxxxxx in the amount of 5,000. The shares in this account amounted to 1, Therefore the loan was 3, in excess of the member s share amount. 53. This breach was identified in the MKO Report. The draft MKO Report was put to the Board of BCU, and an opportunity was given to the Board to comment on the MKO Report in advance of finalisation. The breaches identified above were not refuted by the Board in its submissions of 23 May Given the foregoing, SRU is of the opinion that the Direction issued on 27 February 2013, and which expired on 27 August 2013, was breached by BCU and that this breach was not remedied. Direction Dated 1 August On 1 August 2012, the Registrar of Credit Unions issued a Direction letter to BCU in which BCU was directed to comply with, inter alia, the following requirement: 55.1 The Credit Union is prohibited from making any payment to any member of the Credit Union by way of loan where the outstanding balance due by the member to the Credit Union for all loans made to that member, whether made jointly or on the member s own account, were the loan to be made, would exceed the sum of (a) The amount of shares in, or deposit with, the Credit Union held by that member (whether held jointly or on the member s own account), and (b) 3,

18 56. This Direction was due to expire six months from the date of being issued. This Direction expired on 1 February On 6 November 2012, between the date of the issue of the Direction on 1 August 2012 and the date of its expiry on 1 February 2013, a loan was granted in respect of Account Number xxxxxx in the amount of 4,000. The shares in this account amounted to Therefore the loan was 3, in excess of the member s share amount. 58. Both of these breaches were identified in the MKO Report. The draft MKO Report was put to the Board of BCU, and an opportunity was given to the Board to comment on the MKO Report in advance of finalisation. The breaches identified above were not refuted by the Board in its submissions of 23 May Given the foregoing, SRU is of the opinion that the Direction issued on 1 August 2012, and which expired on 1 February 2013, was breached by BCU and that this breach was not remedied. 60. In summary, SRU is of the view that: 60.1 BCU has committed clear breaches of directions previously issued by the Bank under section 87 of the CUA and those breaches were not remedied and BCU does not deny having committed these breaches; and 60.2 BCU is currently in breach of a direction issued by the Bank section 87 of the CUA by failing to maintain an RRR of not less than 10%, and has shown no capacity to take steps to comply with this direction. INTEREST OF PERSONS HAVING DEPOSITS 61. One of the grounds for liquidation set out in section 77 of the 2011 Act is that it is in the interests of persons having deposits in the credit institution. SRU has set out below why it is of the view that, on balance, it is in the interests of persons having deposits in BCU that BCU is liquidated. Members are not aware of the current circumstances of BCU 62. BCU members have not received a dividend since 2009, dividends being, in the case of credit unions, the equivalent of interest payments received by depositors in banks and other credit institutions. In circumstances where the average annual inflation rate since 2009 has been 18

19 greater than 0%, in effect BCU members are indirectly out of pocket, and indeed they would benefit from a higher rate of return by putting their money into another credit institution paying dividends or deposit interest, especially where there is no viable possibility of BCU providing a return in the future. 63. Given its severely weakened financial position, and to prevent the potential destabilising consequences that might arise were this position to be made public, BCU has been unable to hold an AGM since As a result, members of BCU have no understanding of its current or recent financial position or performance, and have no knowledge of the impact of loan and fixed asset impairments eroding its regulatory capital base and resulting in a balance sheet shortfall. Furthermore, members have no understanding of BCU s poor governance and management, which represent the root causes of its problems. Nor are BCU s members aware that both voluntary and directed transfer processes have been pursued but that no viable alternative to liquidation is available. 64. There is no prospect that BCU will either be able to pay a dividend or hold an AGM in the foreseeable future because in order to hold an AGM, it will be necessary for BCU to disclose details of its financially precarious position to its members, which could result in the rapid destabilisation of BCU, and potentially lead to a run on deposits. A pay-out permits depositors to obtain alternative retail financial services 65. It is not possible to identify the number of members of BCU with alternative banking relationships with other credit institutions. However, it is likely that a portion of the members of BCU do not have access to other bank accounts. As such, the liquidation of BCU is likely to lead to some members of BCU not having access to alternative retail financial services. However it is important to note that members of BCU may be able to avail of alternative retail financial services locally, given that there is an AIB branch in Castletownbere, and a Post Office close by. This means that once members have been paid out through the Irish Deposit Guarantee Scheme 1 (the DGS ), they have the potential to 1 The DGS was put in place under the terms of EU Directive 94/19/EC which stipulated that all Member States would bring into force the laws necessary to establish and operate a Deposit Guarantee Scheme. DGS was set up under the European Communities (Deposit Guarantee Scheme) Regulations 1995, as amended. On 11 March 2009, EU Directive 2009/14 stipulated that the maximum coverage level of all EU Deposit Guarantee Schemes be set at 100,000 with effect from 31 December However, the Irish Government had already announced the increase to 100,000 with immediate effect from 20 September 2008 and gave legislative effect to this in the European Communities (Deposit Guarantee Schemes) (Amendment) Regulations 2009 on 24 June

20 avail locally of retail financial services from one of the other deposit-taking institutions within the existing BCU common bond. 66. Finally, in terms of the interests of persons having deposits in BCU, xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx. Access of members of BCU to their deposits 67. In a liquidation, all eligible deposits (in the form of members savings) would be covered under the DGS up to 100,000 per person. Any members savings not covered by the DGS would only be repaid by a liquidator if liquidation resources were sufficient to repay all savings which are not covered by the DGS. Having reviewed a savings file for BCU dated 31 March 2014, it would appear there are no deposits which are incapable of being paid out under the DGS. If any BCU depositors are deemed to be ineligible under the DGS, they will rank as general creditors of BCU in liquidation. Whether or not there are depositors that are ineligible will be determined following a formal invocation of the DGS in accordance with the DGS Regulations. 68. Following liquidation, DGS would make a compensation payment to duly verified eligible depositors by means of a crossed cheque (i.e., a cheque that could only be lodged, not cashed) posted to members addresses within 20 days. There are a number of possible adverse consequences associated with this course of action. The 20-day period during which savings may not be accessed would be likely to cause inconvenience to many members, and may result in hardship in some cases. For members who do not have access to an alternative bank account, lodging cheques in order to access their cash would be practically difficult. There is also a risk of delays in reimbursement if, for example, BCU had incomplete records or incorrect addresses for some members. However, as mentioned there is an AIB branch in Castletownbere in which members of BCU may be able to open an account xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxxxxxxxx 69. On balance, however, and notwithstanding the concerns outlined in the preceding paragraphs, SRU is of the opinion that it is in the interests of depositors that BCU is liquidated for the reasons set out earlier in this section. 20

21 PUBLIC INTEREST 70. SRU is of the view that, on balance, a liquidation of BCU is in the public interest for the reasons set out below. Liquidation is less expensive than transfer 71. The purpose of the 2011 Act is set out in section 4 of the 2011 Act. Section 4(b) of the 2011 Act provides that one of the purposes of the 2011 Act is: to provide for a resolution regime for such credit institutions that is effective in protecting the Exchequer, the stability of the financial system and the economy. Having regard to this purpose, SRU has undertaken an analysis of the potential costs of a transfer compared to a liquidation of BCU, which is summarised below. Cost of transfer 72. As part of the bid process, xxxxxx submitted a bid on 10 July 2014 requesting a cash financial incentive of xxxxxx (subject to the completion of full due diligence). For the purposes of this cost comparison analysis, xxxx xxxxxxx represents the cost of transfer. Cost of liquidation 73. We have sought to assess the cost of liquidation based upon the following key assumptions: 73.1 factoring in the location of BCU, tangible fixed assets are sold at a 30% discount to their current carrying value of 635,000, less assumed transaction costs of 2 per cent, implying net proceeds of 436,000; 73.2 all other assets, excluding member loans, are recovered in full; and 73.3 total assumed liquidation expenses (including liquidator fees, staff redundancy costs, legal costs, ancillary costs (travel and accommodation etc.) and a liquidation contingency) are 400,000. Calculation of the estimated cost of liquidation The estimated cost of liquidation is calculated by taking the cost of the pay-out by the DGS in respect of eligible deposits, adding liquidation expenses (as outlined above) and deducting 2 This approach assumes that during the life of the liquidation, the income generated from assets equals the operating costs incurred, on a cash neutral basis. 21

22 the expected proceeds received from the realisation of BCU s assets (loan book, investment and fixed assets) of BCU. Given that the DGS funds the payment of monies due to eligible deposit holders, the DGS itself becomes a general creditor in liquidation taking the place of those deposit holders. 75. There is no true comparable precedent in the UK or Ireland 3 since the recent financial crisis (that is publicly accessible) outlining the potential discount on the sale of an unsecured loan portfolio by a liquidated entity against which to benchmark the expected recovery on BCU s loan book in the context of a liquidation. In the absence of such a precedent, and based on the above assumptions, we have assessed the variable cost of liquidation compared to the actual known cost of transfer on a going concern basis. In that regard, for the purposes of this analysis the cost of liquidation is estimated by assuming differing assumed rates of recovery from the BCU loan book, in addition to factoring in the previously stated liquidation assumptions. The current value of BCU s loan book on a going concern basis 76. As at 30 June 2014, in its prudential return BCU had total gross loans of 1.7 million. The value of BCU s loan book, after attached shares and the current stock of bad debt provisions were subtracted was 0.2 million. This amount is a proxy for the expected amount of new money that can be recovered (or additional value that can be realised) on the BCU loan book from borrowers, excluding recoveries of attached shares. In percentage terms, this represents 13% of BCU s gross loans outstanding. Impact of liquidation on loan recoveries 77. It is difficult to quantify precisely the impact of a liquidation event as part of a desktop analysis. Having already outlined the expected possible level of recovery from borrowers in terms of new monies recovered on a going concern basis based on its prudential return, we assess below what the likely recovery level in a liquidation scenario would be. 78. It is reasonable to assume that in practice a liquidation of the BCU loan book will achieve a relatively lower level of loan recovery overall compared to the recovery on the portfolio on a going concern basis in other words, a lower level of new monies recovered from borrowers. This reflects a number of key factors that would impact on borrower recoveries: 3 Only disposals by liquidated entities in Ireland and the UK are considered comparable for these purposes factoring in commonality of banking, legal, and business approaches and systems. 22

23 78.1 reduced repayments would likely result from a liquidation given a bias of borrowers towards other lenders that continue to operate on a going concern basis. Borrowers would want to develop a longer term banking relationship with such lenders, and would therefore prioritise repayments to them; 78.2 a liquidator would be unlikely to extend new credit to borrowers, which would have a negative impact on the capacity of some borrowers to continue to meet their ongoing loan repayment obligations, as well as the knock on impact on borrower repayment priorities towards other lenders; and 78.3 under any potential sale of the loan book, a third party buyer would seek to price the purchase on a heavily discounted basis reflecting a perceived risk of diminished repayments from borrowers. The third party would demand a higher rate of return (in terms of a cost of funds) on any such investment reflecting the perceived increased risk, thereby lowering the overall valuation of the loan book upfront under any net present value assessment of future cash flows. 79. We believe, factoring in the above issues, that the likely outcome on a liquidation is that the loan recovery level will be substantially less than the value which would be attributed to the loans in a transfer on a going concern basis. While the extent of that discount is not quantifiable at this point is it reasonable to expect a much lower percentage recovery in terms of new monies from borrowers in a liquidation as compared to the expected going concern loan recovery level of 13 per cent of gross loans (excluding recoveries of attached shares) outlined above. Cost comparison of transfer versus liquidation - Direct cost comparison 80. The following chart outlines the costs of transfer (based on the xxxxxx bid amounting to xxxxxx xxxxxx) and liquidation, based on varying levels of loan recovery in the latter case. 23

24 Chart: Costs of liquidation versus cost of transfer Note: (1) the above analysis ignores any advisory costs incurred by the Bank itself in using its resolution powers under the 2011 Act, whether under a transfer or a liquidation scenario. 81. As the above chart demonstrates, irrespective of the level of loan recovery in terms of new monies recovered from borrowers and one would expect low loan recovery levels in a liquidation as outlined above liquidation is in all loan recovery outcomes significantly less expensive than transfer. Conclusion of cost comparison 82. As noted above, there is no loan recovery outcome which results in a cost of liquidation that is more expensive than transfer. Even at a zero recovery on BCU s loan portfolio (which is 24