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FINSAC Limited
A Jamaican Think-Tank
Wyndham Montego Bay, 30/10/98

OVERVIEW

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 FINSAC’s 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:

  1. NON-PERFORMING LOAN WORKOUT
  2. DEBT MANAGEMENT
  3. INSTITUTION REHABILITATION

BANKS
INSURANCE COMPANIES
REGULATORY REFORM

NON-PERFORMING LOANS

FINSAC has purchased approximately $20billion of non-performing loans. This represents a major portion of FINSAC’s 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. FINSAC’s 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:

  • Creation of the good bank / bad bank scenario, where banks which disbursed loans will be relieved of the responsibility and focus on loans which add value to their institution;
  • Centralization of loan portfolio to identify common debtors and ensure that there is a single platform for negotiations
  • Rehabilitation of distressed sectors through proper management of portfolio to ensure viability and proper management;
  • Co-ordination of security, which is shared by several institutions; in order to determine the value of the security and whether the value can cover combined loans.

DEBT MANAGEMENT AND LIQUIDITY

The Debt Management exercise has been undertaken with a view to make certain key determinations as follows:

  • To quantify the implications of FINSAC’s debt for FINSAC itself as a corporate entity and the implications for the Jamaican economy as a whole. In terms of the wider economy, the considerations centre firstly around the fiscal implications, and on tracking the cost of financial sector rehabilitation relative to projected GDP.
  • To identify the rate and timing of the build up of FINSAC’s debt obligation to better inform the asset realization strategy. Questions as to whether to dispose of particular assets now or hold and improve on value through the rehabilitation process over time, are best answered when the debt structure and its accompanying costs are known. With this knowledge asset recovery strategies can be better informed.
  • To measure the impact and further implications for liquidity that FINSAC Notes carries for FINSAC institutions and the wider financial sector.

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 FINSAC’s 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.

INSTITUTION REHABILITATION

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 bank’s 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.

FINSAC’s 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:

  • The elimination of duplication and the alignment of capital expenditures of each institution.
  • The facilitation of a systematic rationalization and integration of key functions and activities.
  • A reduction in the challenge of finding appropriate management for multiple institutions by having in one entity a high level of relevant skills and capabilities, which can be shared among the institutions.
  • The provision of opportunities for significant cost reduction the creation of new business required to achieve profitability.
  • The creation of the critical mass and efficiencies to make the institutions attractive enough to interest potential purchasers and shareholders.
  • The use of common technology, which is vital, in view of the Year 2000 and replacement cost challenges facing these banks and insurance institutions.

DIVESTMENT

 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:-

  • The implications for solvency of the institution which sells its assets at an undervalue to receive limited cashflow (which it might not necessarily need) rather than seeking to improve the performance of the asset as part of the process of institutional rehabilitation.
  • Consequently, assets disposal except in instances where there is a cash crunch, must be informed by least cost or value maximization strategies.
  • The fact that on some of the assets there may be debt obligations of a senior nature.
  • The fact that where assets are inappropriate or represent a continuing drain on the institution no effort is spared in disposing of these assets including significant discounting.
  • The fact that even if we were prepared to sell assets at a discount it would be inappropriate to signal to the market that there is a fire sale. I know that the RTC has often been mooted as an institution that engaged in a fire sale of assets. I have personally read the charter, mission statement and objectives of the RTC and there was a clear policy mandate given to them to avoid fire sales.
  • The fact that there are often contractual arrangements and in some cases litigation which impede immediate sale.

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 level of foreign involvement;
  • Consumer protection; and
  • Government support

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:

  • Financial grouping were permitted, but regulators did not require consolidated financial statements so that inter-group transactions could not be traced adequately by markets or a single regulator. Prudential safeguards between the affiliates in a group were not in place to prevent and detect abuse.
  • Insurance companies were not required to set aside reserves for short-term deposits, yet were allowed to issue deposit-like policies by the OSI.
  • Relatively low barriers of entry into banking, allowing a number of new entrants with relatively little capital and even less skill.
  • Unequal tax on consumers for different financial products that created tax arbitrage opportunities with distorted incentives.
  • Unequal reserve requirements on different financial institutions that created regulatory arbitrage opportunities.

Jamaica will need to adopt regulations that embrace a more open but prudently supervised financial market. This position entails in part:

  • Increased participation of foreign institutions to attract long-term capital and skills;
  • Restrictions on cross-sector activities among banks, securities, and insurance companies should be removed and replaced by prudential safeguards.
  • Retention of the deposit insurance legislation that has been enacted, but should be the subject of a post crises review to ensure that the problem of moral hazard which plagued most deposit insurance schemes, is minimised.

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.

Insurance Projects

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 FINSAC’s 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:

  • Performance Benchmarks have been established for all the FINSAC insurance companies, all the companies are being measured against these standards;
  • These standards form the basis for the early warning ratios that will be used by the OSI;
  • The establishment of all monthly reporting forms for life and general companies have been completed; all FINSAC life insurance companies are now required to utilise these new methods of reporting.
  • SWOT analyses have been completed on all the FINSAC companies as well as a review of the past 9 years financial statement data on all the life and general insurance companies;
  • The computerization of the reporting and the annual filing forms of the OSI
  • An initial review of insurance law regulations and pension law requirements has been completed. These have been submitted to the ministry of Finance and planning. Draft investment guidelines have been proposed and are being sent to representatives of all the interested parties for comment;

However, due to ownership and other issues, the life insurance sector rehabilitation does not move as quickly as the banking sector.

  • The main components of the project still to be completed are as follows:
  • Drafting of new insurance law and regulations – this is scheduled to be completed by the end of the year;
  • Full reorganization of the Office of the Superintendent of Insurance to create a self funding unit structured in a manner that will best serve the industry and the public while protecting policyholders’ interests;
  • Development of a law to regulate private pension funds in Jamaica.

FINSAC’s 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:

  • The monitoring and evaluation of performance and compliance.
  • The development and /implementation of mechanisms and the evaluation of efficiency by/with which the risks inherent in the products/services and operations of banks and financial institutions are adequately and properly addressed, both quantitatively and qualitatively.

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:

  • Mechanisms that will facilitate efficient and proper corporate management.
  • Mechanisms that will facilitate the monitoring of operating performance and compliance.
  • An appreciation and understanding of risk management by bank management and the tools/mechanisms by which to address it.
  • Corporate governance is guided by the critical importance of risk management

The objectives of M&E, therefore, will be to:

  • Ascertain whether each FINSAC-controlled financial institution (target entity) has an appropriate mechanism in place to monitor and control risk exposures inherent in a financial institution’s product and service offerings and in its operations.
  • Assist in developing an efficient and effective accounting system and control environment within each entity.
  • Ascertain whether the accounting and reporting mechanisms of each entity facilitate the monitoring of its operations, its management efficiency, and its compliance with relevant statutory/regulatory requirements, corporate policy and Workout Agreements, and recommend improvements as appropriate.
  • Monitor and evaluate the manner in which each entity has discharged its fiduciary, statutory and corporate responsibilities. Recommend corrective action where appropriate.
  • Monitor/evaluate operations, records and recording mechanisms to ascertain whether operations are executed, recorded and reported in accordance with Workout Agreements and with best industry and accounting practices. Recommend and supervise corrective action where appropriate.

These objectives will be achieved by the following means:

  1. Design and implement improvements in the accounting and control environment of each entity, and periodic review/revision thereof, that would:
  • Contribute towards ensuring the accuracy, reliability and completeness of the recording and reporting functions of each entity.
  • Reduce the opportunity for, or possibility of, fraud and error.
  • Ensure that all product & service risks and operational risks are addressed
  • Regular flow of financial statements and reports from the target entity to FINSAC, and the evaluation thereof, to ensure compliance with statutory and regulatory requirements and with Workout Agreements.
  1. Test-check the accuracy, reliability and completeness of financial statements and reports submitted by each entity to FINSAC.
  2. Monitor and evaluate operational performance and management efficiency.
  3. Ensure the periodic review and revision, where necessary, of benchmarks/dictates of corporate governance.
  4. Adequately staff the Monitoring & Supervision division of FINSAC with qualified, competent and sensitized personnel with high integrity.

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.

FINSAC’s 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 FINSAC’s roster of companies with the objective of assessing the risks associated with non-compliance.

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