Debt Restructuring – Breaking the Debt Bind
January 31, 2013
Fiona Muldoon, Director of Credit Institutions and Insurance Supervision at the Central Bank delivered a stinging rebuke to the audience at last year’s Irish Banking Federation conference. She summarised the Banking community’s inactivity in dealing with problem loans as being the stuff of denial and the relationship between the Central Bank and the various Banks as being akin to a parent struggling with a difficult teenager.
What was refreshing about the delivery given by Ms Muldoon was not the content itself, but the fact that it was delivered by a core member of the State’s apparatus for regulation and oversight of the Banking sector. All of us who deal with indebted businesses and individuals on a daily basis recognise only too well the descriptions of the ‘Wait and See’ and ‘Extend and Pretend’ approach described by the Central Bank Director.
In our experience debt settlements have been achieved, but only in circumstances where the borrower holds significant leverage in the negotiations. With the right set of circumstances and a carefully planned approach settlements can be reached, however these agreements are very much on the fringes of the overall debt mountain.
Meaningful debt restructure arrangements, that offer more than just an extension of an interest-only period, have been painfully slow in coming to fruition. Banks have been fearful of the impact deals they make with individual borrowers will have on their broader loan books and cite a fear of strategic default as a rationale for sitting on their hands.
However the mood music has begun to change and a number of the main players in the Irish banking landscape have for the first time started to seriously take-on the issue of problem loans. Debt restructuring solutions are beginning to emerge and we expect 2013 to be a year of significant progress in dealing with this issue driven by a number of key dynamics.
Pressure for Income
When loans go bad, banks classify them as impaired, provide for a loss in their P&L and hold the assets on their balance sheet until disposed of. Any interest received on impaired loans is no longer treated as income by the bank, but rather is applied as a recovery of the capital outstanding on the banks’ books.
The scale of loans that have already been classed as impaired and the continuing trend of further impairments have created a situation where banks are generating zero income for a large proportion of the assets on their balance sheets.
As Irish banks continue to implement a deleveraging agenda which sees the sale of many income producing ‘non-core’ elements of their businesses the pressure on these banks to increase their revenue from their remaining assets will continue to intensify. This pressure is further augmented by the significant cost to Irish banks of sourcing deposits.
This pressure for income will provide significant incentive for banks to restructure bad loans to ensure that income can be recorded on the resulting performing assets.
Personal Insolvency Act
The Personal Insolvency Act is likely to be a ‘game changer’ in the world of debt negotiation. The Act has been both lauded and criticised from many quarters, but no matter what your view on whether the proposed resolution processes are too friendly to the interests of debtors or creditors, its very existence is likely to have a significant impact on how problem debts are resolved.
The revised bankruptcy code, with a shorter period of time before the bankrupt can re-emerge, will create a real option for people as they deal with personal insolvency. Bankruptcy is unlikely to ever be the preferred option for an insolvent borrower, but if the pain of this route is bearable it adds real power to the borrower’s negotiating position.
It remains to be seen whether banks will actively engage in negotiating debts through the proposed Personal insolvency Arrangements or Debt Settlement Arrangements or whether they will use their blocking votes to scupper most schemes. However even if the banks don’t actively engage in this process the existence of the schemes themselves and the newly available option of debtors choosing to declare bankruptcy will in itself force the hands of banks to actively negotiate.
Ireland may well be unique with regard to the degree of state control and influence that now exists in our banking system. With the state as a significant shareholder, you could be forgiven for making the assumption that the government’s focus would be on ensuring that the banks’ profits and ultimately the return to the state were maximised. However large swathes of the electorate are faced with the issue of insolvency and debt they cannot repay. As austerity measures introduced through successive hairshirt budgets increase the pain the pressure on the political class to address problem debt will continue to intensify.
The state is also faced with the problem that a large proportion of the population are stuck in a bind of debt. This element of the population is typically in the age category that would, in normal circumstances be the most active in generating economic wealth. This creates a problem of lack of investment in the economy and continued trends of poor consumer spend and unemployment numbers. This reality is not lost on our overseers in the Troika who as part of the bail-out programme insisted on a reform of the Bankruptcy code to provide real solutions to this malaise.
The collapse of the Irish banking system has been a most painful experience for the Irish state and its people. It has resulted in the state plugging the system with a truly mind blowing amount of capital that has resulted in the Irish bank rescue programme being the most expensive bank rescue on a per capita basis ever undertaken.
Even today, some €62bn later there is still some scepticism that Irish banks have been provided with sufficient capital to deal with al the losses that will be incurred on bad loans. Whether the number is sufficient or not to fully solve the problem, it is sufficient enough for the banks to get on with the business of crystallising losses and taking on debt restructuring in a meaningful way.
The Restructure Agenda
The circumstances are now right to bring real momentum to debt restructuring. We have experienced a protracted period of Mexican Stand-off between bank and borrower but now have the opportunity to deal with problem debt in a commercially beneficial and socially acceptable way.
The banks continue to state that each loan will need to be individually considered. They are right of course, circumstances surrounding each loan will have individual characteristics and that will need to be negotiated. This is not a problem that can be solved in one easy action, but with a real sense of purpose from the Banks and the right approach adopted by borrowers the Restructure Agenda is now firmly underway.