Monday, April 16, 2012

Ireland keeps looking for ways to get banks to use their capital to absorb losses

One of the major problems with the Japanese model for handling a bank solvency led financial crisis and its emphasis on protecting bank book capital levels is that it makes it very difficult to get banks to recognize the losses on their balance sheets.

Ireland has tried a number of approaches including pressure from its central bank.

According to an Independent article, the latest effort involves setting up a trust.  In return for a reduction in the mortgage principal balance, the borrower would give the trust a percentage of the ownership of the property.  When the property is sold, the trust would receive its proportional share of the proceeds in excess of the then outstanding mortgage principal balance.  The beneficiary of the trust would be the banks.

I am not going to say whether this is a good or bad idea, but rather just note that the idea's sponsors are promoting the idea as a way to get the banks to use their book capital to address the losses.

THOUSANDS of homeowners who are in trouble with their mortgages could see their monthly repayments fall by up to a third if innovative proposals from international financial-services group IFG are accepted by the banks and the Financial Regulator. 
Under the proposed debt-for-equity scheme, the amount owed by borrowers to their banks would be reduced in return for the handover of a share of their homes to an independent trust....

Speaking to the Sunday Independent, IFG chairman Frank Ryan said that while his company's debt-for-equity swap plan did not amount to debt forgiveness, it would enable both banks and their borrowers to "get out the other side" without suffering the effects of bad mortgages. 
Citing in its proposal the example of an individual struggling to meet a €1,190 monthly repayment on a €220,000 mortgage, IFG says that a debt-for-equity swap -- in which 35 per cent of the home is given over to a trust -- would see the mortgage drop to €145,000. 
Repayments on this reduced principal would fall by €405 a month to a more manageable €785. 
Outlining the scheme's anticipated benefits for homeowners, IFG -- which counts Aer Lingus chairman Colm Barrington amongst its directors -- says that it will help to remove the fear of repossession, ensure continued tenure in the home and spread the problem of the mortgage over a long period. 
Referring to the scheme's potential impact on the balance sheets of banks, IFG says it would improve the status of a large swathe of loans.... 
Asked to describe the type of mortgage holder that IFG's plan would suit if it was introduced, Mr Ryan said: "It will only suit a segment of the market who have an income. 
"It's not debt forgiveness, but it is completely equitable to the point in time where someone was exposed to the property market, so it helps people in proportion to their level of exposure. 
"If you bought a property at the height of the market, you would get greater help than if you bought two years before or two years after the peak."... 
Under the IFG proposal, borrowers signed up to the scheme would be not allowed to sell their homes for five years. Between years six and 10, the proceeds would be used to pay off the outstanding mortgage, with any remaining proceeds paid to the trust to a maximum of the amount transferred to it at the date of the original debt-for-equity swap. Put simply, the trust would only be repaid its original investment. 
The proceeds of any sale after the first 10 years of the deal would go to pay off the mortgage, with any remaining proceeds divided between the borrower and the trust, based on their share of ownership. 
Asked where the proposed trusts or SPVs (special purpose vehicles) buying up the equity in borrowers' homes would source their funding, Mr Ryan said: "The banks will use their provisions to fund the SPV, and the SPV will act independently of the banks....
"All we're saying is that they should use them. The provisions aren't there to be admired. This is a practical application of them."

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