The Government of Jamaica established FINSAC Limited in January 1997. At that time, a number of Jamaican banks and insurance companies were experiencing liquidity and solvency shortfalls and erosion in customer confidence. FINSAC was formed with a broad but explicit mandate to restore depositor and policyholder confidence in the financial sector.
Upon its formation, FINSAC embarked upon a planned three-phased course of action. The first phase, intervention required the infusion of fresh capital into the ailing banks and insurance companies. This course of action has, to a large extent been successfully completed, and, has ensured that depositors and policyholders are safe. The other phases are the Rehabilitation phase and the Divestment phase.
I should point out that while we have strategically identified, our program of activities in three distinct phases, there is in reality considerable overlapping.
FINSAC through this process of intervention and stabilization of the financial sector, invested approximately $77 billion in rescuing troubled financial institutions and is now well immersed in the rehabilitation phase of its operations.
This phase (the rehabilitation phase) entails the restructuring and reorganization of those entities that are considered to be viable, the workout and restructuring of the non-performing loan portfolio and divestment of other non-core assets including hotels and inappropriate real estate assets.
There is still a lot to be done in building on the foundation of the stability we have achieved, as there are some important issues that need to be resolved both at the macro economic as well as the micro economic level.
Among these are the debt management issues facing FINSAC and the country, as well as underlying liquidity issues within the financial sector.
Year 2000 compliance issues and the strengthening of both the regulatory and legislative framework are also critical to the rehabilitation process. Some of these issues are extremely time sensitive and require urgent attention through to final resolution.
The point must be made that FINSACs intervention was not an immediate panacea for the majority of these companies. The rehabilitation process is complex and it will take time for results to be realized.
There are several critical work streams which are being pursued within the rehabilitation phase. These comprise the following divisions:
FINSAC has purchased approximately $20billion of non-performing loans. This represents a major portion of FINSACs investments to date. They also represent an important means of recovering a part of the total investment made. The million-dollar question facing us is how much of these debts can we expect to get back. FINSACs answer is - as much of it as is humanly possible, because those dollars belong to Jamaican taxpayers, and we are committed to protecting their interest.
FINSAC has established a Non-Performing Loan Unit, which has been charged with the mission of maximizing the net realizable value from collections, sale of assets and loan restructuring as quickly and as fairly as possible.
The loans appear to be highly concentrated and are fairly well backed by collateral, which for the most part comprises real estate. Based on the collateral pledged against most of the non-performing loans, it is expected that there will be some shortfall given the current state of the real estate market. We have run several models of expected recoveries under various scenarios on a discounted cash flow basis. It is however our intention to better those numbers.
To maximize our ability to recover the optimum on a net present value basis the non-performing loans, FINSAC has developed an organizational structure that supports workout teams.
The unit comprises the workout teams, the Administration and Control sub-unit as well as a legal sub-unit. The unit receives support from the other areas in particular the Asset Management division which will provide assistance with the management of repossessed assets for handling and disposing of assets held as security for loans.
Remuneration is divided between a basic salary which reflects compensation for achieving the expected value of loan recovery with an incentive for collecting amounts in excess of expected values. Based on this methodology it is anticipated that the administrative cost of recovery will be approximately 5% all collections.
The strategy being used by the unit is the maximization of recovery of non performing loans by utilizing a proven methodology e.g. structuring focused workout groups, pursuing debtors in a responsible but aggressively consistent and fair manner. The unit exhausts all avenues in identifying the best way to collect the loans. The methods of recovery used by this unit includes where viable a degree of restructuring, however, it may inevitably require the sale of assets/collateral. It is important to note that the main aim of the unit is consensual recovery and the sale of assets is used only after all other options have been explored.
The rationale for the purchase of the non-performing loans is to facilitate the:
DEBT MANAGEMENT AND LIQUIDITY
The Debt Management exercise has been undertaken with a view to make certain key determinations as follows:
Internally we have developed various models projecting different treatment of the financing obligations to which we are committed. We have examined the consequence of the payment of interest on FINSAC Notes by the further issuance of Notes and the implications for the National debt. The current policy of paying interest through the issuance of more notes instead of cash payment or redemption of the notes, compounds the interest cost factor and is not sustainable into perpetuity.
We are aware of this however, and have only built this flexibility into our agreements with the intervened institutions to give us some time to properly develop an appropriate liquidity provision redemption program.
With this in mind we have assessed the impact, pros and cons of alternative debt management strategies and have determined alternative approaches in the management of FINSACs debt obligations. We have also examined institutional requirements with the intention of addressing their liquidity needs on a proactive basis.
The issues of divestment, debt management and liquidity of the FINSAC Notes are closely intertwined. The proposed restructuring programs for the majority of the entities, address the issue of their solvency, but, since a significant portion of their assets will be FINSAC paper the provisions I mentioned before for liquidity management will be important. These provisions will naturally have fiscal implications however the relevant authorities are well of them.
In addressing the areas of rehabilitation and divestment I know that that there is a great deal of interest in these phases of our operations, particularly, as it relates to the speed of divestment and the transparency of the process.
Having reviewed the options available to us for the proper supervision, rehabilitation and divestment of the institutions which we hold in trust, FINSAC has taken the decision to establish a new management structure for certain financial institutions in which we have an interest. Such a management structure offers the best way to bring stability to the financial sector and allows for the capture of economies of scale and synergies.
The new structure features insurance and a bank holding company, each with a management team that oversees the operations of the FINSAC-held institutions. Both holding companies have similar organizational structures, designed to ensure maximum accountability to FINSAC and ultimately the public purse.
The management of the holding companies has been charged with ensuring that the banks and insurance institutions operate as efficiently as possible and that the changes needed to rehabilitate them are in fact made
The banks holding company is comprised of the following institutions: Citizens Bank/Horizon, Eagle commercial bank, Island Victoria Bank and Workers Bank. A similar approach is being considered for insurance companies rehabilitation.
FINSACs Union Bank entities has been subjected to a detailed diagnostic review by Citicorp Information Technology Industries Limited. The Year 2000 preparedness of these institutions is linked with, and has been incorporated in the choice of information technology solution for the merged institution. The objective under this project is for the merged institution to be compliant by June 1999.
FINSAC undertook a local and international search for senior level personnel who are highly experienced, possess successful track records in the management of financial institutions, to head these holding companies. (A management team, under the auspices of TransAmerican Financial Services, J.V. which has met with Bank of Jamaica approval, has been selected and contracts finalized).
The primary objective of establishing the holding company is to bring about a highly efficient, stable and well-managed single group of financial institutions.
There are a number of advantages which will be derived from the proposed structure as we look towards future divestment opportunities. We have done valuations of Union Bank under various scenarios and are pleased to note that once the relevant financial levers are adjusted and proposed synergies are achieved Union Bank will be a very viable and valuable entity.
Streamlining the institutions will bring about a number of benefits, which include:
On the issue of divestment, there is a school of thought that suggests FINSAC has invested in a large portfolio of real estate assets, which it has not been successful in divesting. This is not strictly true, the link to ownership of these real estate assets are equity investments FINSAC has in a number of non-core institutions holding real estate assets.
These institutions have full authority and responsibility to dispose of these assets, and it is indeed a condition of the agreement for support with FINSAC that they should rapidly seek to divest of these non-core or under-performing assets. The facts are however that their attempts at disposal have met with limited success.
I know there are many who advocate a fire sale of the assets of these companies. To those persons I would point out a number of things:-
FINSAC is committed to a program of divestment and has put in place mechanisms and established discreet projects utilizing in some instances the services of large brokers and asset disposal specialist, who have considerable experience in these matters, with a view to advising us on an appropriate mechanisms and for taking these assets to market in a structured manner. These efforts really represent alternative or parallel approaches to the asset disposal efforts of the institutions.
There are two immediate areas where recovery values are being maximized, namely the non-performing work out unit and the sale of rehabilitated institutions. E.g. Eagle Unit Trust, which sale has been negotiated at $121.3m, Blue Cross of Jamaica which as soon as the legal entanglements were ironed out was disposed of for US$3M. Citizens Bank Guyana has also been sold for $____m. In the case of the Wyndham and the Courtleigh
Hotels, negotiation is advanced and is expected to close in the near future.
REFORM OF REGULATORY FRAMEWORK
Another area of the financial sector that demands urgent attention is the Regulatory Framework that guides the operation of financial sector entities. Market forces such as technology, innovation and increasing product sophistication influence the behaviour of financial institutions by changing and creating new opportunities to increase profitability.
One of the benefits arising from regulatory reform is that institutions operating in a properly regulated environment will be better positioned as attractive divestment prospects to foreign investors as the risk of systemic failure and possible contagion will be reduced.
The fundamental choice that faces us as policymakers, is the degree of openness in our financial markets that is desired. We may in fact choose from alternatives ranging from a completely closed financial system to a completely open system. The degree of openness that is desired or even permitted will depend on choices among a set of related levers such as:
The inability of the local regulatory bodies to fully anticipate and head off financial crises is due to existing inconsistencies in regulations and the slate of regulatory arbitrage opportunities. There are noticeable examples:
Jamaica will need to adopt regulations that embrace a more open but prudently supervised financial market. This position entails in part:
A fully overhauled regulatory framework for Jamaica will not be achieved in the near term. We must face up to a considerable supervision challenge, involving a significant increase in regulatory capabilities, affording financial sector supervisors increased powers and authority to demand information from institutions and to share this information among themselves on a confidential basis.
Changes to the legislature are also needed. Specifically these must address amongst other things, legislative power to supervise and demand full and timely disclosures, to issue, cease and desist directives, and finally, to require the application of more aggressive GAAP or other internationally accepted accounting practices.
The intention of regulatory reform is not limited to enhancing existing regulations but must also address how we co-ordinate the inter-relationship between the bodies which regulates the financial sector.
Mention must be given to the efforts of the special project established under the joint auspices of, and jointly funded by FINSAC and the Inter Development Bank. These efforts have been specifically geared towards the management of FINSACs investment in the insurance sector, the strengthening of insurance regulations and the overview of pension funds in Jamaica.
The project team is working closely with staff from the OSI to ensure that this office is being trained in the new methodology as it is being prepared, and to ensure their suggestions are included in the development of new financial statements and reporting requirements.
The team has interviewed and established lines of communication with all stakeholders in the insurance sector, including insurance sector umbrella organizations, the Institute of Chartered Accountants, chief executives and the regulatory authorities.
To date the team has also successfully completed the following:
However, due to ownership and other issues, the life insurance sector rehabilitation does not move as quickly as the banking sector.
FINSACs mandate in all this, like the banking sector, is to achieve the institutional arrangements within the insurance industry that allow for a sound sector, which ensures that surviving institutions move forward as viable going concerns.
MONITORING & EVALUATION
FINSAC will address the present inadequacies in management and supervision - both quantitative and qualitative - of the banks and financial institutions under its control, through its Monitoring & Evaluation division.
An appreciation of the cost of instituting reactive corrective measures to control/repair the damage caused as a result of improper/inadequate management and supervision in the financial sector will underscore the importance of this division. Adequate and proper management and supervision of banks and financial institutions would contribute significantly to the otherwise inevitable failure of the financial sector.
FINSAC, therefore, sees the following as amongst its future roles:
FINSAC recognizes that the traditional evaluation of financial data relies on historical information. As a result, any identified problem areas may have already proven to be very costly. It is therefore necessary, in addition to evaluating performance, to have in place a monitoring and control environment that will address these risk areas from a proactive standpoint. With this in view, FINSAC, through its Monitoring & Evaluation division, will proactively institute and oversee the maintenance of the following:
The objectives of M&E, therefore, will be to:
These objectives will be achieved by the following means:
YEAR 2000 ISSUES
The Year 2000 poses a significant challenge for financial institutions because many automated applications will cease to function normally as a result of the way date fields have been handled historically. Failure to address this issue in a timely manner will result in financial institutions experiencing operational problems or be threatened with bankruptcy leading to the disruption of financial markets.
Year 2000 is not just challenging because the issues are internal to our banks. Banks have many automated linkages and interdependencies with correspondents and customers. Similarly, banks rely on third party service providers or vendors for many applications. These applications not only need to be made compliant but also must be thoroughly tested within each bank to assure that they perform properly for the particular environment and application interfaces found in each institution.
Complicating the resolution of the Year 2000 issue on a global basis are the differing situations found in many markets and countries around the world which has lead to competing demands on scarce technical resources.
FINSACs institutions are in different stages of preparation for Year 2000 compliance. With a total of 158 companies under its control, and with a severe limitation as to available time and resources, the decision as to which entities are targets for Year 2000 compliance is highly selective and based on the attending risks.
There are a large number of non-core entities slated for liquidation as they are insolvent and their rehabilitation could not be justified on the basis of the cost and the minimal positive value creation. The current thinking therefore is that there is little to be gained from a Y2K program for these entities.
As a consequence of this position, the Monitoring and Evaluations department has been mandated to undertake a detailed review of FINSACs roster of companies with the objective of assessing the risks associated with non-compliance.
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