Maximising Recoveries

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Maximising Recoveries

• Some observations
• Andrew Campbell

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• As noted in the Claims and Recoveries Paper banks
  can and do fail.
• In fact in recent times bank failure has been
  very common in many countries throughout the
  world.

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• Although the main function of a deposit
  insurance system is to ensure that depositors
  receive compensation in accordance with the rules
  of the system.
• It is vitally important to understand and
  recognise their role and interest in the
  liquidation proceedings of the failed bank.

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• Deposit insurance systems vary considerably and
  range from being simply a paybox to being a
  regulator and a liquidator (receiver) of the
  failed bank.
• The nature of the role given to the deposit
  insurance agency, from the legal perspective has
  important consequences in the ensuing liquidation
  of a bankrupt bank.

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• The deposit insurance agency, as the major
  creditor in the liquidation proceedings, will
  seek to ensure that recoveries are maximised.
• In many jurisdictions liquidation processes are
  inefficient and hampered by out of date laws.

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• This can hinder rather than help in maximising
  asset values.
• Liquidators powers may be very limited.
• Liquidator may lack incentive to maximise asset
  values.

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Function of DIA

• The position of the deposit insurer in all of
  this will depend on its function.
• Is it a paybox only with no right to
  participate in the insolvency proceedings?
• If so, is there any way it can assist?

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• Where it has a paybox only function it will be
  involved in the liquidation proceedings as a
  creditor.
• From a legal perspective the DIA will be required
  to pay out the appropriate amount of compensation
  and then to stand in the shoes of those
  depositors as an unsecured creditor in the
  liquidation proceedings.

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• Subrogation - the DIA will take the place of the
  compensated depositors with the result that it
  ranks as an unsecured creditor in the liquidation
  proceedings.
• May however be given priority over other
  creditors see US, Canada and Switzerland.
• This can assist in maximising recoveries.

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• In this type of system it will be the liquidator
  who will be responsible for gathering in the
  estate of the failed bank and ultimately making
  distributions to creditors.
• Such a DIA will normally have no legal standing
  to become involved in maximising recoveries of
  assets.

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• The liquidator may have no powers to do much to
  maximise recoveries and may also lack any
  incentive to do anything other than wind up the
  liquidation estate with maximum speed.
• In some systems the liquidator will actually
  have an incentive to take things slowly to
  maximise its fees, but not to maximise asset
  recoveries.

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• The broad function DIA in general should be
  in a position to be pro-active in maximising
  asset values for the estate.
• See, for example, the wide legal powers given to
  the Federal Deposit Insurance Corporation in the
  US.

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• A barrier to the introduction of such an agency
  in many jurisdictions is the perceived conflict
  of interest which is thought to exist in allowing
  a creditor, and in the case of the deposit
  insurance agency probably the major creditor, to
  act as a receiver or liquidator.

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• This is a fundamental principle of insolvency
  laws in many jurisdictions.
• Models for this type of approach, such as the
  Federal Deposit Insurance Corporation in the
  United States and the Canadian Deposit Insurance
  Corporation in Canada, provide an opportunity for
  the DIA to attempt to maximise asset values both
  in the pre-closure and post-closure phases.

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Recovering asset values

• In many, if not most, bank failures there will be
  a problem with impaired assets.
• These will often be found in the banks loan
  portfolio.
• Non-performing loans and how to deal with them
  can be a problem.

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• Collecting in and selling off the assets.
• Paying liabilities out of the proceeds.
• There may be insufficient assets to repay the
  full amount of compensation that the DIA has paid
  out.

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Non-performing loans

• What is an NPL?
• Asian Development bank the accepted
  international standard for classification of
  loans as non-performing is 90 days or more
  overdue.
• Why are they such a problem?

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• A different approach is taken in the
  International Financial Reporting Standards which
  provide that a financial assetis impaired and
  impairment losses are incurred if, and only if,
  there is objective evidence of impairment as a
  result of one or more events that occurred after
  the initial recognition of the asset (a loss
  event) and that loss event (or events) has an
  impact on the estimated future cash flows of the
  financial asset.that can be reliably
  estimated..

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• In some jurisdictions a quantitative approach is
  taken and this would include the number of days
  overdue while in others the approach may be based
  on qualitative factors such as available
  information on the borrower.

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• May be difficult to sell impaired assets.
• There may not be a market in the country.
• May be very difficult to value.
• The general rule is that assets should be
  disposed of as quickly as possible.

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• With NPLs the general rule will usually not
  apply.
• May be potential for increase in value if the
  impaired loans are held while value maximisation
  is attempted.

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• How to deal with NPLs?
• Special vehicle asset management company.
• Receiver/liquidator?
• Either way it is likely to take a considerable
  amount of time to complete the process.

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• Effective management of these assets may create
  far greater value over the longer term than would
  be achieved by an immediate sell off.

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Some Conclusions

• To give the DIA a role in the bankruptcy
  proceedings should assist in maximising value.
• What should this role be?
• Ideally will also be involved prior to the
  commencement of bankruptcy proceedings.

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• There is a need to have a policy in place for
  dealing with non-performing loans before and
  after proceedings commence.
• If the bank is not being sold as a going concern
  then removing the bad assets and selling off the
  good as soon as possible.

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• Much will, of course, depend on the market for
  the sale of such assets.
• If there is little hope of selling distressed
  debt then holding it and attempting to increase
  value may be the only realistic option.

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• As the Claims and Recoveries Paper notes there
  are various factors which affect the management
  and disposition of such assets.