Maximising Recoveries Some observations Andrew Campbell

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.

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.

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.

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 In many jurisdictions liquidation processes are inefficient and hampered by out of date laws.

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

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?

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.

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.

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.

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.

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.

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.

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.

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.

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.

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?

A different approach is taken in the International Financial Reporting Standards which provide that a financial asset……is 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..

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.

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.

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.

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.

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

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.

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.

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.

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