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COO highlights effect of US Economy on Local Credit Unions

Gerry Brooks, Group Chief Operating Officer was the feature speaker at the recently heald 52nd Annual General Meeting of the ANSA Mcal Group Employees Credit Union on  April 19, 2008. His address entitled  The Impact of the U.S. Recession on Trinidad & Tobago’s Financial Services Sector with Specific Emphasis on Credit Unions is featured below:


ADDRESS:


Allow me to start by congratulating the ANSA McAL Group Employees Credit Union on the occasion of your 52nd Anniversary.  Crossing the 50 year mark in corporate life is a testimony to service, relevance and is reflective of consistently good performance.  Your Board and Team are deserving of our fullest congratulations.  Well done! 


May I also convey my sincere thanks to your Board for inviting me to address you on this 52nd Annual General Meeting on the topic
captioned “Impact of the U.S. recession on Trinidad & Tobago’s financial services sector with specific emphasis on credit unions”.


IS THE U.S. IN RECESSION?  WHAT DOES IT MEAN FOR US IN THE CARIBBEAN AND TRINIDAD & TOBAGO?
Few, if any official headlines, have declared a U.S. recession.  Politicians and Policy makers alike have avoided baptizing current challenges a recession.  Instead, they have employed language such as:-  “U.S. mulls next steps in slowing economy”.  Another headline challenges: “How to plug a leaking economy?”  More recently, IMF articles speak to “Navigating the Financial Storm”.


The stark reality is that the U.S. economy has slowed dramatically – brought on by a crisis in the housing and financial markets.  In Miami, California, Atlanta, housing overbuild and speculation (aka “flipping”), coupled with relaxed lending and credit policies have fuelled a housing bubble which has burst.  It has exposed a sizeable underbrush of risky loans, relaxed lending standards and highly leveraged positions yielding billion dollar market and economic losses.


The U.S. – the world’s largest economy is forecast to grow .5%.  Optimists propose a high of 1.5%.  It has fallen precipitously from  2.7% GDP growth in 2007.  There will be quarters of negative growth in 2008 – even successive quarters.  Aggressive Federal Reserve Action (the equivalent of our Central Bank) in successively cutting rates by ½% to ¾% has been unable to prevent the housing slump, credit crunch and attendant market losses.


A snap shot of subprime related losses includes:-  Citigroup $18 billion; Merill Lynch $14.1 billion; UBS $13.5 billion; Morgan Stanley $9.4 billion; HSBC $3.4 billion.  The top five companies alone account for $58.4 billion or nine times T&T’s annual budget.  Put simply, the interest income at 10% annually could easily fund our country’s annual budget.


Losses have not been confined to Profit & Loss and Balance Sheet write downs.  Insurance companies have suffered while some entities have become M&A casualties.  Bear Stearns – sold to J.P. Morgan for $2.00 a share, well below its 52 week high of $160 a share.  In one weekend, a shareholder holding $1.2 billion of value moved to a mere $22 million.  Bear’s losses on sub prime bonds and other risky securities precipitated a classic bank run – as hedge funds and other players quickly moved assets away from the firm as its solvency came into question.  Enter the Fed with $30 billion in financing; supported by Bear’s least liquid assets (a great deal for J.P. Morgan) in an attempt to minimize systemic risks and other similar casualties.
Financial market turmoil is not confined to the U.S. and has spread across the Atlantic to Europe affecting Royal Bank of Scotland $2.6 billion, Deutsche Bank $3.2 billion and also Canadian Banks.  Important fire breaks in the system which should have held, failed,  when individual sub prime mortgages were bundled into packages of debt (called Collaterized Mortgage Obligations and Collaterized Debt Obligations) and sold to reputable financial institutions – some of which had interlocking exposures – eventual losses and write downs became both concentrated and inevitable.  Hammond & Associates have estimated mortgage related losses at between US$200 billion to US$400 billion.  The IMF’s assessment of loss is $565 billion. 


Exacerbating the challenge is the reality that cash strapped banks … have curtailed lending activity contributing to even further slow down in the U.S. economic activity.  Goldman and Sachs estimates there could be as much as a US$2 trillion pull back in lending.  A key dynamic will be U.S. consumer confidence.  There are also other associated risks in the market, including, US$45 trillion dollars of counter party risks which could deepen the crisis. 


WHAT’S THE PROGNOSIS? 
It is unclear whether the market has bottomed.  Declaration or not of recession – the economy and the markets have been wrestling with this new environment over the last 9 months.  Fed action has been decisive and the Congress has launched a US$168 billion package.  Some argue this quantum is insignificant at economy and at the individual householder level.  (amounting to $170 approximately per household).


Positively, however, the ten recessions which have occurred since WW11, have had a mean duration of thirteen months in terms of stock market effect.  To exceed this mean, one has to go back to the 1929 depression.  My own view is that the 2008 year will be a difficult year for the U.S. financial markets and housing markets.  Third and Fourth Quarter GDP forecasts for the U.S. may usher in some improvement but will be a roller coaster ride. 2009 is expected to be a better year.  From a housing perspective, the market will not recover until mid 2009 – the housing overbuild/inventory needs to be worked through before housing starts to recover.


Interestingly, at the global level, the world economy’s dependence on the U.S. – formerly the engine of growth has declined remarkably.  It is “no longer a case of the U.S. sneezing and the world (Canada included catching a cold)”.  At the global level, after the best five year span for global growth in a generation, world economic growth is projected to slow to 3.7% after growing at a 4.9% clip in 2007.  {The IMF argues there is a 25% chance 2008 growth will decline to 3% which the IMF rates as a global recession}.


Growth in the Euro zone is forecast to slow to 1.4% in 2008, (slipping from 2.6% in 2007).  This is not a healthy situation as European Central banks try to balance inflation and growth.  There is a case for more decisive policy and monetary action.  Central and Eastern Europe, however are projected to continue to enjoy better growth rates at 4.9%. 


Positively, emerging markets and developing economies are projected to continue their robust expansion.  Economies like China and India, which now have a significant effect on global growth are projected to maintain their high long term growth trend at 9.3% and 7.9% respectively.  The growth momentum in these countries has been underpinned by strong productivity gains, improvements in terms of trade predicated on healthy commodity prices, strong domestic demand and a disciplined macroeconomic policy frameworks with relatively easy access to capital. For many emerging and developing economies in Asia, South America and Central Europe, the issue has become how to decouple their economies and to maintain a safe distance from industrial nations and their challenges while driving above average long term growth and containing the inflation genie.
 
HOW WILL THE U.S. RECESSION AFFECT TRINIDAD & TOBAGO?
To obtain a better appreciation of the effect of a recession on Trinidad & Tobago, the issue must be examined both from a T&T perspective and from a Caricom perspective.  The U.S. represents the single most significant trading partner with Caricom outside of intra Caricom trade.  At the macro level regionally, 2007 year real GDP growth levels varied from 2% in Jamaica to 5.7% in T&T.


The 2008 outlook is still reasonably optimistic – varying from 2% in Jamaica to +5% in T&T.  However, a slowing U.S. economy and the threat of an outright recession will affect the region.  Spillovers are inevitable and there will be a transmission effect.  It may immediately and adversely affect two important financial flows critical to the economy of Caricom countries.  I speak here of (a) Remittances and (b) Tourism flows.  In the case of a slow down in the U.S. economy, employee layoffs (especially the most vulnerable where frequently Caribbean people are located) will mean the reduction of potential remittance income and/or vital foreign exchange flows.  These flows are either the most important or second most influential sources of foreign exchange in many Caribbean territories including Jamaica and Guyana.  For example, the annual average remittance figure for Barbados is $221 million.  Without remittances the Caribbean will be dealt a cruel blow.


The other critical concern is in the area of tourist arrivals.  There are two potential drivers here.  On the one hand, the dual effect of reduced consumer confidence and reduced disposable income from tightened credit and/or loss of jobs in the U.S. will reduce potential U.S. tourist arrivals.  Economic choices have to be made.  This is also likely to be affected by the June 2009 requirement for U.S. tourists to travel with passports.  (Less than 20% of North Americans have a passport).  Both can have a deleterious effect on economies dependent on tourism.  Positively, however, the relative depreciation of the US dollar against the Euro, Canadian dollar and Pound Sterling may stimulate tourist arrivals from these territories mitigating the effects of the U.S. market.  What is clear is that country marketing and destination marketing must be proactive and must target these new opportunities now.


Managing Caribbean economies in this new environment, as well as the negotiation of key trade agreements will be critical to the fortunes of the region and by extension T&T.  If we ever needed to accelerate the CSME thrust, it is now.   At the T&T level, a possible U.S. slowdown/recession raises several important implications for us at the policy choice, country and sectoral level.


MARKET/INVESTMENT LEVEL EFFECTS
At the market and investment level, both individual and institutional investors have suffered losses during the last eight month period commencing September, 2007.   During that time, all major stock indices declined sharply – the Dow, Nasdaq, S&P portfolios have shed billions in value.  The D.J.I.A. surrendered YTD (4.9)%; Nas Daq YTD (7)%; S&P YTD (12)%; and MSCI EAFE YTD (6.5)%. Local portfolios invested in U.S. or International Holdings – equities, hedge funds, value stocks have suffered a pull back in performance – a rough back of the envelope calculation suggests that this could well exceed TT$200 million conservatively.  At the regional level, this figure may well exceed TT$1 billion.  Very few, if any portfolios, have been left unscathed.  Investments is not a spectator sport … we are all in the arena and we have all lost value.  Remember, the second schedule of the Insurance Act permits overseas investments – this brings both benefit and downside.  This is likely to be reflected in reduced First Quarter earnings of several financial services players and funds which have an international component – marked to market.


WHAT’S THE WAY FORWARD?
Given the current circumstances, there is really only one choice …. Rebalance the portfolios by transitioning to a more appropriate portfolio and recovering value in the context of a market upswing … when it occurs.  The outlook for 2008 is enhanced volatility and a far more challenging investment environment.  The bull market run from 2004 to 2007 is over!  A new paradigm, market orientation and portfolio management style is required.  Credit Unions as investors must obtain sound, professional, objective advice.  Strengthen and engage your Investment Committee and act relying on prudent advice. 


The U.S. market pull back, has had the effect of repricing U.S. equities to a more acceptable P.E. (level).  It has also led to some contagion in other key equity markets in Europe and other emerging markets.  In this scenario, many local and regional money managers have reevaluated Caribbean equity Market and debt opportunities.  Over the last three years, P.E. multiples on regional exchanges have fallen substantially – some argue corrected themselves.  On the TTSE, the P.E. market average of 20-22 in 2004 is now down to 12-15 as a market average.  In short, good stocks are relatively undervalued and can be obtained at excellent prices historically.  There are buying opportunities locally and regionally – as companies demonstrate enhanced dividend streams whilst constantly churning out good performance.  An excellent example is the ANSA McAL share!   Relook your portfolios, top up and rebalance as appropriate.  Income flows can be enhanced to partially address the challenge described by your Chairman in his 2006 Annual Report where he said “Members were now saving more and borrowing less, which resulted in high liquidity and very few options for reinvestment”. There are investment opportunities if your Committee acts now on the appropriate advice to manage the investment elements of your portfolio. 


WHAT OTHER EFFECTS DOES THE U.S. RECESSION HAVE ON THE T&T’S ECONOMY FINANCIAL SERVICES SECTOR?
The effects of the U.S. slowdown and the global financial turmoil are far more profound than simply investment and portfolio losses.  The depreciation of the U.S. dollar by 27% against the Euro, 14% against the Yen and approximately 20% against the Pound has exacerbated the impact of inflation on the local economy and also on regional economies.  In 2007 and recently in 2008 – inflation crossed the 10% threshold.  Counter balancing that and positively, the recent record high oil prices exceeding US$114 a barrel and high gas prices enhance our revenue streams.


The demand for biofuels and devastating weather patterns have led to an upsurge in food prices.  Add to that the China/India effect.  Record high and rising energy prices, increased demand from China and India have pushed commodity prices to record levels.  Tight global energy markets, supply shocks and geographical concerns could further spike food and commodity prices beyond their current highs.  We in the Caribbean must utilize the large tracts of land in Belize, Guyana and even Trinidad to reintroduce the culture and business of agriculture.  Food security and containment of food inflation is critical and it must be coordinated at a regional and Caricom level!


On the inflation front, local water, electricity, labour rates and port increases magnify the inflationary effect for business and citizen Joe.  For business, every head of cost has risen exponentially – increasing cost per unit and eroding competitiveness.  Therein lies a significant danger for our economy for if our manufacturing competitiveness slips – it places fourteen years of economic growth and future economic growth at risk.   A major platform of diversification is threatened as well as a significant employer of people.  It also exposes the financial services sector to systemic risk if segments in the manufacturing sector fail.  As a country we must strengthen our work ethic to support ongoing modernization of plant and equipment.  It is critical that the philosophy of productivity inform wage increases.  Tripartite agreements must move to create an enabling environment to ensure future competitiveness of our key sectors.  This is critical!


Equally insidious is the inflationary spiral at the consumer level. Each visit to the grocery is met by another round of price increases.  Home prices are at historic highs with the adventurous demanding more! A significant cause of the U.S. recession has been relaxed lending policies and the failure to exercise effective credit management.  It happened here in the 70’s and 80’s when the real estate bubble burst.  It can happen again!  Vigilance and care is required at your credit Supervisory Level.  Member and Shareholder education are critical to promote prudent choices to reduce risk at the shareholder and member level.  It is a chain commencing with prudent exercise of membership judgement.  Your loan portfolio is built one loan account at a time.  It is one of the key lessons emerging from the crisis in the U.S. financial crisis.


Equip your Credit Union now to manage when the current prosperity cycle is replaced by leaner times.  Fourteen years of economic prosperity must wane!  While a GDP average of +7% over five years is excellent.  2007 GDP has slipped.  Average oil prices of $72.32 for 2007 is a god send!   But daily oil production has slipped from 144,000 b.p.d. to 123,000.  What goes up must come down!  With an inflation rate at 7.9%, an annualized homicide rate of +371 per annum and a work ethic that is slipping, economic correction and adjustment will be tough!  Tougher than the 80’s.  Ensure your organization DNA, business process and portfolio are resilient to ensure your business model is robust and relevant for any cycle.


May I also therefore encourage you to reach out to the spectrum of ANSA McAL professionals to join your Board and Committees.  You have the word of our Parent Board that we will actively encourage their participation.  They will add to the rich bank of experience, diversity and intellectual capacity on your Board that is critical to operating in a new legislative and financial services environment.  Can a platform for shared services be explored with you and other like minded credit unions?  Should you not meet with Tatil and offer a new range of investment/insurance products?  How do you equip your people to market your services more intelligently and aggressively?


Embrace and exploit information technology to attract, retain and engage members.  Send all notices on-line and perhaps even member statements.  This is more timely, use your website and unveil a menu of on-line services and innovations in this area.  Communicate directly with your members and reactivate dormant accounts.  Review investment, savings and lending products and bundle them creatively.  Look at the evolving character of your membership and shift both the product construction and service paradigm.  Ensure your business architecture can withstand fraud and help shape the legislation that will govern your movement.  Inappropriate legislation adds costs, bureaucracy and can cripple you.  Compliance is costly.  Its infrastructure and technical innovation are vitally important to cost effectiveness and efficiency.


In reading your Annual Report, our Group Chairman conveyed his excitement about the real prospect of our Credit Union surpassing its goal of establishing a net asset base of TT$100 million by 2010.  You have done well.  (You share the same DNA as ANSA McAL).  I commend you and encourage you to stay focussed.  I congratulate your Board and your President on the quality of your stewardship and the bold changes undertaken by your Credit Union and wish you success in your pursuit of V’10 and beyond.


I thank you.