# Manitoba Credit Union disaster calculation (play at home!)



## NorthernRaven (Aug 4, 2010)

Since some people seem to have strangely strong views on the stability of Manitoba credit unions (which do a nice little business in national online high-interest deposit products), but tend to wave around unquantifiable catchphrases like "housing correction", I thought I'd try and "blow up" one with some ballpark numbers. I took the 2013 asset sheet from one of the larger CUs, and plugged in some loss estimates. Instead of a single loss rate, I did a percentage of loans affected, and the loss rate for just those loans. 

CategoryAffectedLossCMHC Insured 0%0%80% origination50%30%85% origination (few)30%20%Consumer loans20%10%Consumer LOC20%10%Total Commercial30%15%

The assumptions are that insured mortgages don't take a hit - either they default and CMHC is on the hook, or they don't default and can be sold for something close to book value. Cash and investments are assumed liquid - most of this is in short-term deposit at CU Central Manitoba, which seems in turn to be mostly in government and federal bank bonds.

So for the main consumer category, the conventional <80% origination mortgages, the table says that 50% will default or be written down, by an average amount of 30%. Since there's at least 20% homeowner equity in these, that would indicate an resale value drop of something like 50%, which is probably fairly ridiculous for a diversified credit union portfolio in Manitoba, but I thought I'd give it a stern stress test. 

I invented some additional numbers for consumer loans and commercial loans/mortgages, and applied this against the chosen CU. The losses came out just under the reported amount of equity on the books - a bit short of $200 million. The CU would be liquidated, but wouldn't cause any long-term loss for the Manitoba guarantee fund. 

I'm tempted to turn the calculation into a quick-and-dirty online calculator, so people can plug their own numbers in and build their own armageddon.


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## james4beach (Nov 15, 2012)

One difference I've seen between credit unions and large commercial banks is the *leverage* employed by the institution: how much they've grown their balance sheet, versus their capital. It gives a measure of overall risk and vulnerability to deteriorating assets.

Less capital --> higher leverage --> easier to get wiped out and become insolvent

A quick (but pretty good) measure of leverage is using tangible equity. I use Basel III's common equity tier 1 (CET1) figure, versus assets -- not risk weighted, as explained in that article.

The Canadian Big Six banks are leveraged around 30:1 with TD for instance at 33:1

Methdology for credit unions and background is discussed in this document. For Assiniboine Credit Union of MB, for example, I calculate, in thousands$

assets = 3,553,315
tangible equity = contributed surplus + retained earnings = 174,487
leverage ratio = Assets / Tangible Equity = 20

(This is quite conservative and is apples-to-apples with what Basel III calls CET1, allowing a comparison between credit unions and big banks. Member shares are not considered capital, instead it's mostly retained earnings)

Thus at 20:1, Assiniboine Credit Union has lower leverage than the big banks at 30:1
Another way to phrase the leverage is


 ACU: a 5% drop in assets wipes out the bank's capital
 Big Six: a 3% drop in assets wipes out the bank's capital

For giggles, Deutsche Bank's figure (again based on CET1 so apples-to-apples) is north of 52:1, meaning less than 2% drop in assets wipes out the bank. DB is widely acknowledged to be undercapitalized and horribly over leveraged.

And keep in mind the Big Six banks have tons of exotic exposures that credit unions don't have, notably off-balance sheet derivative positions, we're talking trillions $ of notional exposure at the big banks and almost NIL at credit unions.

Thus in my assessment anyway, a credit union such as Assiniboine is more safely positioned than a big bank. The credit union has more capital, less leverage, and doesn't have the derivative exposures. Thus the credit union has more of a capital cushion to withstand market volatility and declining assets.

On the "cons" side, a credit union doesn't have an easy way to raise more capital. A large bank does: they issue more shares (diluting the shares and declining the share price). American banks in 2007-2008 rapidly raised capital by issuing tons of shares, causing their share prices to crash. If Canadian banks run into capital problems, inevitable when you operate with such high leverage, their shares will also become diluted or even crash. This is _why_ it's dangerous to invest in Canada's highly leveraged banks.


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## sags (May 15, 2010)

There is this Ministry of Finance announcement from August 1.

_The Government’s comprehensive risk management framework seeks to keep Canada’s financial system strong by reducing the likelihood that an institution would fail. *In the highly unlikely event of a bank no longer being viable, the proposed Taxpayer Protection and Bank Recapitalization regime would help ensure bank shareholders and creditors bear losses, rather than taxpayers.*_

http://www.fin.gc.ca/activty/consult/tpbrr-rpcrb-eng.asp


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## lonewolf (Jun 12, 2012)

Thanks, James

For very interesting info on credit unions.

I heard that the government gives a tax advantage to banks over credit unions. A tax advantage should not be allowed it should be a level playing field. Back before the 2008 financial crises I heard the Conservative Government wanted to allow the Canadian banks to be able to take on more risk like the United state banks. (they were stopped by the other parties) Don't know exact details, But it is just wrong to allow them to take on this kind of risk, & be backed by the tax payer. 

When using other peoples money to make yourself a profit, the banks have no incentive to make good on their IOUs. The credit unions run by members do have an incentive that it keeps it money safe.

@ some point in the future perhaps the masses will wake up & no one will deal with banks.


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## NorthernRaven (Aug 4, 2010)

The members shares on the books for a Manitoba CU as equity technically may or may not meet the Basel CET1 definition (it seems to be about the redemption rights), but are included in Manitoba's definition of regulatory capital. Including those, your Assiniboine leverage ratio would be 17.3, and the CU I chose would be 16 - Manitoba limits this multiplier to no more that 20 (i.e. minimum 5% capital/assets).

As for bail-in/recapitalization, that's federal, and likely doesn't apply to provincially chartered credit unions. I think also that it only applies to identified "too big to fail" institutions, not all federal banks?


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## james4beach (Nov 15, 2012)

NorthernRaven, you are correct that there's some debate about whether member shares should be included for CET1 equivalence. Yes it's about redemption rights.

I was just using the most conservative definition for this pass. You're right, leverage drops further if you include member shares.

By the way I also calculated Steinbach Credit Union's leverage [ 17:1 ] and it's lower than Assiniboine's even sticking to the conservative interpretation. So these are Manitoba's two largest credit unions and their CET1 leverage ratios are both much lower than the large banks.

The big banks have a huge advantage unfortunately: too-big-to-fail status and CDIC. This totally distorts the banking market and makes depositors less fearful of large bank failures.


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## james4beach (Nov 15, 2012)

By the way, the regulator likely uses a figure based on risk-weighted-assets which isn't quite the same as what I posted. Just make sure you do apples-to-apples comparisons between different banks.

Either way though, MB credit unions are better capitalized than Canada's major banks. And they have far less (or nil) hidden derivative exposures.


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## NorthernRaven (Aug 4, 2010)

james4beach said:


> By the way, the regulator likely uses a figure based on risk-weighted-assets which isn't quite the same as what I posted. Just make sure you do apples-to-apples comparisons between different banks.


The numbers are regulatory capital against actual assets - the 5% minimum for Manitoba - the reciprocal of which is the leverage multiplier. The risk-weighted capital requirements are a minimum of 8%, but many Manitoba CUs tend to be more like 10-12%, and Assiniboine is over 14%.


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## james4beach (Nov 15, 2012)

Wow, so Manitoba regulators use actual assets instead of RWA. That's incredible and very admirable!

The commercial banking lobby doesn't let the big bank regulators do this (lobbyists heavily push for RWA because it's much more open to interpretation).

I still continue to think that MB credit unions, in pure banking terms, are less risky than large commercial banks. The only factor that keeps much more of my deposits in the Big Five is that they have federal guarantees and too-big-to-fail religious status.


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## NorthernRaven (Aug 4, 2010)

james4beach said:


> Wow, so Manitoba regulators use actual assets instead of RWA. That's incredible and very admirable!


The Manitoba regs have 3 threshold minimums for a CU:

a) its total regulatory capital shall not be less than 5% of the book value of its assets; 
b) its retained earnings shall not be less than 3% of the book value of its assets; and 
c) a tiered level of capital shall not be less than 8% of the risk-weighted value of its assets as defined in the 
Regulations to the Act.


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## birdman (Feb 12, 2013)

The only unfortunate thing is that unlike British Columbia the Manitoba provincial government does not guarantee 100% of deposits.


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## Charlie (May 20, 2011)

lonewolf said:


> I heard that the government gives a tax advantage to banks over credit unions.


It's actually the opposite. Although some of the credit union advantage is being phased out. And there are good policy reasons to give CUs an advantage -- so I'm just pointing out that your impression wasn't quite right -- not running to the defense of the banks!

And on stability -- I'm still much more comfortable with the banks. National (and international) diversification vs geographic concentration. Size. Access to capital markets. Not that I think either is at risk. I bank with a credit union. I borrow from a bank. I own lots of bank stock.


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## NorthernRaven (Aug 4, 2010)

frase said:


> The only unfortunate thing is that unlike British Columbia the Manitoba provincial government does not guarantee 100% of deposits.


I think this is more of a cosmetic thing than people might realize. Section 271(5) of the BC act says that the government "*may*" guarantee indebtedness the deposit insurance corporation incurs to repair the fund. That doesn't sound like the corporation has an automatic unlimited government guarantee. Assume BC is governed by the WeHateCreditUnions party when an unimaginable implosion wipes out the entire equity of the credit union system; presumably they could refuse to back the corporation and let everything burn in flames. 

Of course, in the real world this is ridiculous, and the government will go to pretty much any measure to keep the system afloat, merely because it is the least-bad alternative. Similarly, in Manitoba, the DGCM is established by legislation, acts as a regulator, and so on. Presumably as a matter of philosophy, moral hazard considerations, etc. they prefer to emphasize that the government is not legally responsible for guaranteeing the deposit fund, but I don't think you'll find most of the other provinces actually stating anywhere that they are legally obligated to backstop their funds without limit. 

I tried to track this down a couple of years back - from the Ontario auditor-general's office I got the following about their guarantee agency, DICO:
_DICO is in fact classified as a “Trust” and therefore its results are not consolidated in the Province’s financial statements (Public Accounts). Typically, an agency is classified as a Trust when the government is under no obligation to finance their operations, but rather that responsibility rests with the agency’s stakeholders._

The one exception seems to be Alberta - their legislation has wording something like "_The Credit Union Act provides that the Government of Alberta will ensure that the Credit Union Deposit Guarantee Corporation's obligation to depositors is carried out._", which sounds like something lawyers could use to hold their feet to the fire, after the asteroid hits.


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## birdman (Feb 12, 2013)

Here is the link which explains the guarantee and who guarantees it:

cudicbc.ca/pdf/cudic/CUDICGuide.pdf

I would expect the act says the government "may" guarantee deposits and they have elected to do so. They presumably could also change their mind and say "No". The deposit insurance corporation which guarantees the fund is a statutory corporation whose operation is overseen by the Financial Institutions Commission.


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## NorthernRaven (Aug 4, 2010)

That's actually just a promotional blurb that doesn't answer the underlying question. CUDIC is a "statutory corporation" which guarantees the deposits, has powers to assess CU members, borrow money, and so on, all dandy; it is the corporation which is responsible for the guarantee. Come the Very Bad Day, the fund is exhausted, emergency levies aren't enough, and the insolvent corporation needs to borrow a big bundle to maintain the guarantee. The question is, is the corporation's liability ultimately a liability of the BC government, even if the government (that WeHateCreditUnions party, remember) actively rejects doing anything at all unless legally compelled. 

That is where 271(5) comes in. The government "may" guarantee the required borrowing by the corporation, but in theory it could refuse. Probably no more likely than it would drown kittens or kill babies, but there doesn't seem to be any direct indication that it must, unlike, say, the FDIC being backed by the "full faith and credit" of the US. The fact that a mechanism is provided to give a guarantee is in itself that the corporation's liabilities aren't provincial liabilities by default.

Here's the phrasing from Manitoba's guarantee pamphlet, with "Manitoba" replaced with "British Columbia". I can't see anything that would make it incorrect for the BC case.

*DOES THE GOVERNMENT OF [SUP]MANITOBA[/SUP] BRITISH COLUMBIA ALSO COVER DEPOSITS?*
_No. There is no legislated requirement for the [SUP]Manitoba[/SUP] British Columbia government to provide financial support to the [SUP]DGCM[/SUP] CUDIC._

Again, in reality, Manitoba no less than BC would likely find that providing bridge financing is going to be much cheaper than letting the provincial credit union system be wiped out. But in both cases it would be a financial and political decision, not a legal obligation, as far as I can see.


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## birdman (Feb 12, 2013)

NothernRaven: Here is the detail from the Financial Institutions Act which seems to deal with the issue of any shortfall in the Deposit G'tee Fund. I agree that due to interpretation and vagueness of the legislation is such that in the case of total financial collapse that somehow the government may be able to avoid stepping up to the plate.

271 (1) If in the commission's opinion the fund is impaired, or is about to be impaired, the commission

(a) must so inform the minister by written notice, and
(b) by order may assess each credit union an amount not exceeding 1/12 of 1% of the total of all deposits with the credit union as at the date of the credit union's immediately preceding financial year end.
(2) An assessment ordered under this section is in addition to any assessment made under section 268 and must not be ordered more than once in any one calendar year.
(3) Section 268 (2) and (4) applies to an assessment ordered under subsection (1) of this section.
(4) If, at any time during the 12 months immediately after an assessment is ordered under subsection (1), the fund in the commission's opinion is impaired, the commission must report its opinion and the reasons for that opinion to the minister, who must refer the report to the Lieutenant Governor in Council.
(5) Despite section 72 of the Financial Administration Act or the regulations referred to in that section, the Lieutenant Governor in Council, if in concurrence with the commission's opinion that the fund is impaired, may
(a) specify the amount that the Lieutenant Governor in Council considers necessary to repair the fund, and
(b) direct that the Minister of Finance on behalf of the government enter into a guarantee of indebtedness that the deposit insurance corporation incurs to repair the fund
(i) on terms approved by the Lieutenant Governor in Council, and
(ii) not exceeding the amount specified under paragraph (a).
(6) If the Minister of Finance receives a direction under subsection (5), the Minister of Finance must enter into the guarantee in accordance with the direction.
Investment by deposit insurance corporation


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## NorthernRaven (Aug 4, 2010)

That's what I was looking at, and it doesn't seem "vague" at all. There's *no* indication of a guarantee or requirement to support the fund, except by a positive decision and act by the government. It would appear to be no different than the situation in Manitoba, where again some actual, non-required decision by the government would be needed to back any DGCM debt. The only difference is that in BC it would appear that the government is explicitly authorized to provide the backing if it wants too, while the Manitoba government _might_ have to pass some sort of emergency legislation (but perhaps not, I have no idea what powers they might have to issue guarantees or make financial commitments).

I still haven't seen anything that would indicate that BC (or most provinces, except Alberta) are effectively different than Manitoba.


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## NorthernRaven (Aug 4, 2010)

Just a bit further - checking the BC public accounts, CUDIC is reported only in the informational notes only, not the statements, as a Trust under Administration (similar to public guardian, law court and other trusts, "_because the province has no equity in or power of appropriation over these trusts. The province administers these trusts on behalf of third parties according to the terms of the underlying trust arrangements_." Actual crown corporations, like the BC liquor distribution corp, _do_ go on the books. This is similar to the treatment in, for instance, Nova Scotia or Ontario. 

Meanwhile, the Manitoba accounts report the DGCM, similarly, in a note as a trust, whose equity is restricted and unavailable for general purposes, and refers to it as a "Government Business Enterprise" along with Manitoba Hydro, the lotteries corp, etc. I might accept the possibility that *all* provincial deposit systems are somehow inherently guaranteed by virtue of being legislated and run by the government, but there seems to be absolutely no indication that Manitoba and Saskatchewan (which has similar disclaimers of government backing) are any different from BC or Ontario or Nova Scotia.

Finally, all the provincial deposit guarantee corporations I looked at pay federal income tax. However, true provincial crown corporations ("agents of the Queen in right of the province" is the technical term, I think) would be exempt. This would weigh against any argument that guarantee corps have implicit government guarantees of their obligations. CDIC, on the other hand, _is_ an agent of the crown. So, if you have some irrational fear of Manitoba credit unions or an approaching doomsday, feel free to flee to a federal bank or trust, but you won't be any better off insurance-wise if you go to another province's CUs...


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## james4beach (Nov 15, 2012)

I hope anyone with such fear of MB (or other province's) credit unions flees now, and not later when times are bad.

I never assumed the provinces back any of the credit unions.

Remember, however, that there's also Credit Union Central which can provide liquidity to Manitoba credit unions during times of distress. They have $2.7 billion in their liquidity pool (mind you, this is down from $3.2 billion last year). Preventing bank failures and surviving a run on the bank is largely a matter of being able to provide enough liquidity.


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