That Finsac issue

[Karl]

That Finsac issue
Dennis Chung

Friday, May 20, 2011

IT seems as if the Finsac issue will never settle down, as it has been debated by both sides of the political divide and civil society since the 1990s. This is why I strongly supported the need for some study/ commission, as it is necessary to understand the causes of the greatest financial collapse in Jamaica. After all, this was the era that reversed Jamaica's economic improvement, as all data shows that up to the mid-1990s, the economic indicators were looking good and entrepreneurialism was strong.

In my view, it was therefore very important to do a proper study of the period and understand what went wrong, not to cast any blame but to understand fully an era that resulted in the beginning of our economic stagnation and debt crisis. And so I welcomed the commission of enquiry, but have always felt an objective, academic study of the period was necessary before any testimonies were taken.

This approach is essential in order to avoid what is happening now — a lot of crosstalk and blame being thrown around. For at the end of the day, what do we really achieve apart from political and other point scoring? Will we truly find out what went wrong, and even if we do come up with the truth, the whole truth, and nothing but the truth, will it be believed by most people? The sad truth is no. As we are seeing today, this Finsac issue is going to be argued along party, business, and banking lines.

It is therefore going to be even more difficult for us to arrive at the truth of what happened, and my prediction is that whatever report the enquiry comes up with will be believed by 50 per cent of the country, while the other 50 per cent will disagree disagreeing. So at the end of the day we will have ended where we started.

There is, in my view, some truth in what is being said by all sides to the story, but there are also half-truths and lies. The only way for us to salvage some objectivity and arrive at an answer, at this juncture, would be to set up a group to do an objective study, made up of the members that are acceptable by government, opposition business community and civil society. And this group must not include anyone who was affected by the meltdown, as it is too emotional a subject.

I will attempt to provide a synopsis of what went wrong, based on the research I did while writing my book.

The platform for the financial meltdown was created with the premature move to liberalise the Jamaican economy, as stated by Ralston Hyman.

The fact is that the economy and our resources were not ready for the onslaught of global competition. One reason we were able to achieve growth towards the end of the 1980s was the protection provided to the economy. It is not that our economy was much more efficient than today, but we were at the time restricting foreign exchange movement and therefore local producers were protected. This is why a fixed exchange rate regime could work then but couldn't work today.

With the coming of the 1990s and freer world trade, there was a push by organisations like the WTO and the IMF for countries to liberalise their trade policies and foreign exchange movement. In fact, one can remember that the mantra of the IMF was always to get competitive through currency devaluation. This, however, was never going to be easy for a country like Jamaica that had a broken market economy and an internationally uncompetitive private sector. Our labour force was also relatively unskilled and unproductive. So in the 1980s, for example, the only way to attract the garment industry to Jamaica was through cost incentives.

The liberalisation policies in the early 1990s, therefore, resulted in significant exchange rate depreciation followed by high inflation. Faced with high inflation, businesses, including banks, would invest in assets such as real estate and land that rose significantly in value each year, and when these assets were revalued on their balance sheets, the equity would always increase even without doing anything else but just holding them. Business owners borrowed money from banks at rates in the high-teens to low-twenties, and purchased real estate and US dollars, or if put into the business they would just increase prices every year and recoup from the poor consumer.

This, of course, was unsustainable and would have come to a stop either from government policy or deflation, as disposable incomes would have fallen in real terms sooner or later.

Faced with this situation, the government correctly used monetary policy, through high interest rates, to halt inflation and bring the exchange rate under control. The problem the government faced was that if it reduced interest rates, then the inflationary cycle would take hold again. So what should it do? And so it continued with the policy of high interest rates.

This was against a background of inadequate foreign exchange supply and reserves, low productivity, and an uncompetitive private sector. The correct move would be to reduce money supply, reform the public sector bureaucracy, and in the interim attract foreign exchange (borrow or FDIs) to stabilise the economy. The choice was to continue with the high interest rate policy, and the following were the resulting factors:
* Persons who borrowed at around 20% now saw loan rates of up to 90% and there was no way that businesses could support that interest cost, and it was therefore just a matter of time before the businesses started to collapse; and

* Asset values started to stagnate or decline, resulting in much tighter liquidity and declining capital reserves on the balance sheet of banks. Banks also faced much higher interest cost on overdraft facilities at the BOJ, which they needed to support the worsening liquidity situation.

There was a liquidity crisis and so the government had no option but to step in, through an entity such as Finsac, to provide liquidity support for the banks. So the truth is that it was the continued high interest rate policy that resulted in the liquidity drain, but there were other factors that set the platform for this, such as (i) poor financial regulations; and (ii) bad business practice, in terms of balance sheet, and more specifically debt and risk management both at the level of the business and banks.

But what happened after Finsac exacerbated the problem? Finsac should never have taken control of the assets and businesses in the way that it did. What should have happened is what occurred in the US, after the recent financial crisis, which is that the government through Finsac should certainly have provided the liquidity support for the banks but should have (i) allowed control of the operations to remain with the private sector, if even a new management team was hired, which would deal with the assets instead of Finsac; and (ii) if the government was going to sell the debt it should have been offered to local entrepreneurs at that price, through an objective body.

There is a lot more that could be said, but space does not permit and any more details require financial analysis. What is clear, though, is that without an objective study we will never have significant acceptance of any findings, and that things not only went wrong with government policy but there was bad management practice in both the businesses and banks.

Dennis Chung is a chartered accountant and the author of "Charting Jamaica's Economic and Social Development - A much needed paradigm shift". His blog is dcjottings.blogspot.com

Email: dra_chung@hotmail.com



Read more: http://www.jamaicaobserver.com/busin...#ixzz1N0sCsryE

[Karl]

Total debt forgiveness would be disastrous - JRF

Total debt forgiveness would be disastrous - JRF

Published: Friday | May 20, 2011


Chief Executive Officer of the Jamaica Redevelopment Foundation Inc, Jason Rudd, testifying at Tuesday's sitting of the FINSAC Commission of Enquiry at The Jamaica Pegasus Hotel, New Kingston. - JIS

McPherse Thompson, Assistant Editor - Business
Jason Rudd, chief executive officer of the Jamaican Redevelopment Foundation (JRF), has backed government's handling of the non-performing loan portfolio acquired by FINSAC when it intervened in the financial sector during the 1990s, arguing that blanket forgiveness of debt would have been disastrous.

Had the government, under the administration of the People's National Party, simply bailed out the banks, forgiven all the loans and walked away, it would have created an environment where bank failure would be more desirous than success, he said.

"All borrowers and deposit holders of each and every failed bank would have looked forward with eager anticipation to the next financial crises, because it would mean that their assets were safe, but that their liabilities were washed away," Rudd said on Tuesday, while testifying at the commission of enquiry into the collapse of the financial sector at The Jamaica Pegasus hotel, New Kingston.

He cited economists' criticism of the then government for going too far to protect depositors, and who argued that by making sure that no depositor lost money as a result of the collapse, they were not held accountable for contributing to the crash by doing business with failing banks.

But Rudd countered that "although it sounds nice to those who lost property as a result of their inability to pay, a blanket forgiveness of debt would have ultimately been disastrous."

If the government - through the Financial Sector Adjustment Company - had forgiven the loans, "there would be far more ... Jamaicans that borrowed money from banks that did not fail (who) would have appeared before the commission to complain about the inequity of the government's forgiveness of debt only to those that borrowed money at a failed institution."

Using an analogy to reinforce the point, Rudd said: "Imagine if you were a borrower at a strong, healthy bank and have struggled for years to stay current on your loan and to maintain a good relationship with your lender.
"But then, your neighbour, who is not current on his loan, received forgiveness of his debt simply because he borrowed money from a failed bank."

According to the CEO, "again, this would have created an economic environment where bank failure is the desired outcome, and that would be a fatal blow to Jamaica."

Rudd also sought to answer critics who suggested that the loans, sold by FINSAC to JRF in 2002, should have been first offered to Jamaicans, noting that the portfolio was extended to "anyone and everyone" before his company.

In fact, he said, Beal Bank, which last year sold its stake in JRF, examined the portfolio and initially passed on the investment before the late JRF head, Dennis Joslin, brought it back to the table.

"The fact is that, no other company, Jamaican or foreign, was willing to take on this risk," Rudd said.

Part of the risk was that JRF could not guarantee what it would collect on the portfolio, which for years had been controlled by FINSAC and was considered 'seriously impaired'.

The chief executive said many of the debts had exceeded the realisable value of the collateral pledged as security and, as Patrick Hylton, former managing director of FINSAC, told the enquiry last week, it was a closely guarded secret that the portfolio was valued at 10 cents in the dollar.
It was kept secret so that borrowers would not use it to develop expectations as to what they should pay or to expect write-offs.

But Rudd said JRF has to date paid more than twice that amount for the loans.

He said JRF has so far paid the Jamaican Government more than US$70 million as part of the agreement, which calls for FINSAC to share in collections on a scale that rose as it grew higher, eventually to sharing 50 per cent of all collections net of expenses.

But Hylton had also explained that the 10 cents in the dollar referred to, reflected an assessment of the composite portfolio, from which there would be loans on which there would be almost full collection, while in relation to others it would be zero.

Rudd also challenged an unnamed borrower who, he said, told the commission that the discount he was offered was not enough in view of what the JRF paid for his loan.

"This argument lacks merit," said Rudd, arguing that "it would be ludicrous for the commission to make recommendations to limit or cap the profit that an entrepreneur can make on an investment."

JRF bought the non-performing loans portfolio at a discount, not a portfolio of discounted loans or one of performing loans, he said.

Nevertheless, Rudd said JRF has, in recognition of the debtors' hardships, voluntarily imposed on itself interest rate caps and entered into compromises at the expense of its own bottom line, and without any legal or other requirement to do so.

mcpherse.thompson@gleanerjm.com

[Karl]

Non-performing loan management after the intervention

Non-performing loan management after the intervention

Published: Friday | May 20, 2011


Patrick Hylton





This is the third instalment of the written statement by Patrick Hylton, former managing director of FINSAC Limited, to the commission of enquiry examining the operation of the bailout agency.

In relation to non-performing loans I make the following observations.

The proliferation of these loans, along with an over investment in real estate, underperforming equities, as well as fairly substantial holdings in non-core businesses, characterised the asset side of the balance sheets of the failed or failing financial institutions.

It is from the cash flows of these assets that these financial institutions would normally be able to fund their continuing operations, including payments to depositors, policy-holders and pensioners.

The distressed status of these institutions reflected the fact that too many of these assets were either under or non-performing creating for the institutions a severe liquidity shortfall, consequential losses and, ultimately, their insolvency.

FINSAC intervened in many of these institutions by issuing FINSAC notes as that was the only significant means of recapitalisation FINSAC had.
We also purchased, in most instances, these non-performing or underperforming loans at face value as a purchase at market or current value would have automatically resulted in the return to insolvency of the intervened companies.

The fact is that once it was decided that depositors/ policyholders would be repaid in full notwithstanding the massive insolvency of the intervened institutions, FINSAC had no other option - other than the use of FINSAC notes - for effective intervention, as we would not have had the cash resources to do a cash purchase or injection of any relevance or significance.

FINSAC notes, while addressing the solvency problem, could not deal with the liquidity problem and FINSAC was now the significant shareholder in these companies.

The only means of generating cash to redeem FINSAC notes or to pay some interest with cash, in the short term, so that these institutions could continue as going concerns, was to realise on the same underperforming assets that were acquired from them.

FINSAC also needed to move quickly in the asset realisation and disposition process given the fact that FINSAC notes accrued interest at market rates which, at the point of intervention, were somewhere in the region of 30 per cent.

Initially after purchasing the loans, FINSAC left them with the intervened institutions for collection with Finsac's involvement mainly reviewing and approving workout strategies.

collection a challenge

At the time, it seemed a logical approach given that FINSAC itself had no collections infrastructure and, in any event, logistically, a physical transfer to FINSAC would take time.

Collections through the intervened institutions, however, proved a challenge for a number of reasons:
a) It became a distraction for their management's time which needed to be focused on their own rehabilitation.
b) It was clear that in some instances, officers of the intervened institutions either were or felt compromised in as much as they had recommended or approved some of the loans when they ought not to have done so.
c) It would be easier to consolidate and do workouts in relation to debtors whose borrowings spanned several of the intervened institutions if their loans were consolidated. This borrowing across institutions was found to be a common feature.

Accordingly, FINSAC, towards the end of early 1998, went about setting up a non-performing loan unit, properly structured and staffed to undertake these activities.

To aid collections officers and to as far as possible ensure consistency, transparency and accountability, FINSAC engaged in a process of valuing each loan using an appropriate framework, as well as developing and implementing a loan policy and procedures document.

A summary of the Standard Policies for NPL Workouts, which includes a summary of the framework, was in pages 40-43 of Finsac's 2000 annual report.

The operations and policy framework of Finsac's Non-Performing Loans Unit were reviewed by an expert provided by CIBC Canada who, while being complimentary of the work done, made some recommendations for improvement, several of which were implemented.

The philosophy underpinning our collection efforts was a preference for consensual agreements with litigation and the realisation of security being a last resort.

An examination of our public statements, annual reports, etc, underscore this point. A detailed examination of all loans managed and worked within this unit will confirm that this was by far the dominant approach.

Quite apart from the fact that from a common-sense perspective it suited us to firstly seek a consensual settlement or agreement, there was another powerful reason for seeking agreement.

It is that we also recognised from the outset that a bad debt did not automatically make the debtor a bad person.

There may have been issues of bad judgement or bad timing or bad idea or rapidly changing circumstances which may have impacted persons or their businesses. The important thing was to seek to understand the circumstances and try to accomplish some reasonable compromise.

significant compromises

While there was no explicit undertaking to bail out borrowers — which would have compounded the moral hazard problem associated with waiving repayment requirements and the cost of the financial-sector intervention — the reality of the circumstances conspired to effectively result in significant compromises to debtors at taxpayers' expense.

The truth is that there were hundreds of millions of dollars and possibly billions of dollars of write-offs. In many instances where the circumstances dictated no other reasonable alternative, this would include some level of principal on the loans.

Another fact is that FINSAC approved significant write-offs on hundreds, possibly thousands, of debts based on the principles and policy framework within which it operated, taking into account the high rates of interest that had been applied to the facilities.

This was only pragmatic if FINSAC was to be successful in quickly and successfully raising funds to support its activities.

These principles were applied irrespective of colour, creed, race, religion or political persuasion.

The annual report for each year contained statements from the chairman, myself as CEO, and Audrey Robinson, as head of the Asset Management Division.

Where it was necessary to resort to litigation, Finsac's track record in pursuit and in defence of such litigation initiated by FINSAC or brought against it was exemplary. So far as I can recall while I was involved with Finsac, we were wholly successful in the vast majority of cases, and at least partially successful in the few cases in which we did not entirely succeed. This was partly due to the fact that where we were aware that Finsac's position could not be legally sustained, we resolved the matter without the need for it to be tried in the courts.

The FINSAC Oversight Committee also played an important role in seeking to find resolution strategies for non-performing loans of businesses that fell within the National Industrial Policy - that is, those in the productive sector.

There was also special consideration given to owner-occupied residences. An attempt was made to be consistently more lenient in those cases so as to avoid having substantial numbers of persons lose their primary place of resident.

My own view is that in order to make a determination as to whether or not FINSAC treated debtors fairly would require a careful and detailed analysis of the majority, if not all, of the tens of thousands of loans that FINSAC purchased.

This would include those loans that were reviewed by the Oversight Committee, as well as those that sought to take advantage of the special window of opportunity that was offered and publicised in the media in 2001, as these represented special efforts to give people an opportunity to resolve problem loans.

The process of loan workout by its nature involves intense negotiation.
Even though I recognise the importance of every single loan, customer, and their experience, I do not think that if we have 20 complaints out of the tens of thousands of facilities handled that such a set of circumstances can lead to any reasonable conclusion regarding whether FINSAC was generally fair to debtors and the extent to which the approach to treating all debtors was similar.

In any financial institution, the experience is that persons whose loans are non-performing and are aggressively pursued are those with the most complaints.

To my mind, the only fair way to accomplish that is to have every single debtor's file open to the scrutiny of the commission, and perhaps the public. If this is done then the original loan circumstances, the record of the negotiations which took place, the rationale for Finsac's approach, as well as the response of the debtors will be public knowledge so that an informed position can be adopted.

There is another important reason for such an approach to be taken. The fact of the matter is that to the extent that these loans were purchased by the Government and funded with taxpayers' money, then every dollar of write-off reflects a benefit at taxpayers' expense.

In those circumstances, taxpayers should be informed of who the beneficiaries were and the magnitude of the benefit they received.
That, too, is why we considered it necessary for our approach to write-offs to be well structured and carefully justified, with that justification documented, in all the circumstances.

In every case where a compromise settlement was reached, there would be a memorandum or case summary outlining the details. Those memos and case summaries represent a good starting point.

To the extent that the facts demonstrate very significant discounts and write-offs approved or offered by Finsac, where appropriate and necessary, then the impact of high interest rates on the borrowers' ability to repay is somewhat mitigated.

FINSAC had a powerful incentive to discount rates apart from its own need for cash. The fact is that the rate of accrual on FINSAC notes, and hence the need to redeem or reduce issuing them, also served as a discount factor.

FINSAC also had very urgent cash needs to enable us to assist with the liquidity needs of the intervened institutions.

One of the issues I observed was several borrowers who would eventually come in and negotiate settlements which involved significant discounts on the sums outstanding.

Several would initiate payments as agreed and then default again, seeking new and further compromises.

Even though this may have, on occasion, been as a result of deteriorating circumstances or initial projections, it was also our experience, admitted by some borrowers, that there were persons who used this as a strategy to try and get a better deal.

Moral hazard was alive and well within the non-performing loan portfolio.

Continues Sunday.
business@gleanerjm.com

'Moral hazard was alive and well within the non-performing loan portfolio.'

[Willi]

Self serving drivel from a vulture capitalist!

[Assasin]

"Nevertheless, Rudd said JRF has, in recognition of the debtors' hardships, voluntarily imposed on itself interest rate caps and entered into compromises at the expense of its own bottom line, and without any legal or other requirement to do so."

That is how bad it is. They can charge anything they want. They are an authority to themselves. That is what Karl call "good business".

[Muadib]

Chen Young and Crawford are in exile.. PJ and Omar were rewarded with 3 more Terms... and vociferous defense by you and your 'people'....

[Rockman]

Yep,and he has completely ignored the fatal role his drop from the sky company played.
Govt. isn't allowed to determine how much profits..