Overdraft woes put more pressure on already hard hit businesses

Accessing affordable credit on favourable terms is almost impossible for all but the best small business borrowers. Many are struggling with credit restrictions as their bankers reign in on years of loose lending.  

SME’s have significant challenges. Increasing delays in receiving payments when added to unsold stock has resulted in an endemic shortage of working capital and decrease in cash and liquidity. Rising defaults and insolvencies are leaving many without a key supplier and uncollectable bad debts. A drastic drop in demand for goods and services has been amplified as Government’s austerity programme undermined consumer confidence.

In a recessionary environment it is tremendously difficult for small businesses to grow their way out of trouble. And in a creditless environment, many viable businesses have no hope at all of surviving. Most cannot downsize as they are already small. With limited financing options they are heavily dependent on bank credit. Overdrafts, the principal small business working capital finance tool, are being rigorously re-assessed by bankers anxious to limit their exposure in a recessionary economy.

In many cases businesses are being forced to refinance all or part of their overdrafts as term loans. While it’s always been prudent banking practice to require businesses to fund the long term working capital element of their cash flows through term lending, today, this policy has become a risk limitation tool to manage out boom-time hardcore debts built up in overdraft facilities.

Bankers have two problems. The first relates to allocating scarce capital to unused overdraft limits. They will be inclined to roll back on limits to better manage their capital. The second relates to SME lending risks which are continuing to worsen. From experience, bankers know that as most small business owners are not financially sophisticated, they will gamble for resurrection by using overdrafts to fund their bad debts. All too often by the time the overdraft is called in, the business is already bust. To counteract this problem bankers insist that businesses convert hard-core overdraft debt into term loans and reduce their overdraft limit. The danger is that aggressive overdraft hardcore management by bankers will undermine viable businesses.

A recent story of AIB insisting on businesses having to match their overdraft limits with cash deposits – termed compensating balances, was denied by the bank which said it was not its lending policy to require compensating deposit balances for business overdrafts. When asked if it was reducing outstanding limits to better manage its capital, an AIB spokesperson said “reducing the number of outstanding limits is not at all part of the motivation or the decision making process when converting overdrafts to term loans.” He explained, “when a hardcore builds up in an overdraft, its standard practice for the bank and for the customer that the overdraft or a portion of it be converted to a structured term loan to better facilitate the repayment of borrowings”

While banks may not have a formal policy of requiring overdraft compensating balances, it’s likely that when reviewing and renewing overdraft limits, their managers are pressing businesses to place money on deposit with them.

As banks have responded by toughening up on credit terms, business trade bodies have been pleading for a range of responsive measures from the Government since 2008. The Government’s response has been to insist banks lend money to small business and to establish the credit review office to second guess banker’s unfavorable loan decisions. It’s fair to say that its response has been about as useful as a foot pump on the Titanic.

Access to financing has always been one of the most significant challenges for SME establishment, growth and survival. Since 2008, the Governments’ meek response to a funding crisis facing small business contrasts starkly with small business support systems introduced in other countries. Elsewhere, countries have implemented extensive measures for SME’s, including credit guarantee schemes designed to allow banks to make good loans to good borrowers. 

Other measures include export credit guarantees, credit mediators who mediate between businesses and their bankers, favourable tax regimes such as accelerated depreciation schedules, employment subsidies, faster payment by state and public bodies and payment forbearance in “profit insensitive taxes” paid regardless of whether or not a business is making a profit. These measures target three areas: stimulating demand for goods and services, preventing depletion of working capital and liquidity and helping to maintain capital investment levels.

Months into a new administration, we have yet to see a cohesive policy response to the immediate and long term funding problems faced by viable small businesses. The only reference from this Government so far has been a suggestion that something may be done for viable businesses that are threatened by their owner’s boom-time property gambles. While a job protection measure, it falls well short of the imaginative response needed if small businesses are to be an engine of economic recovery.

A version of this article appeared in the Irish Examiner, Business Section, Monday 26^th September 2011.

Slimmed down credit unions should grasp reform opportunities

After delaying consolidation for years, credit unions are about to have it foisted on them.

Central Bank officials are making ready to apply regulatory triage by taking dozens of non-viable credit unions into care. Using its extensive resolution powers, the bank can appoint special managers to take over the running of credit unions, remove their boards and managers, order the takeover of one by another and where required, temporarily fund balance sheet rehabilitation costs.

While there’s mention of numbers shrinking from 409 to about one hundred, fewer than fifty are likely to be viable operations at this time. These numbers are the outcome of boom-time complacent sectoral leadership and poor governance when credit union balance sheets were increasingly exposed to risks. Concerned only to maximise saver’s dividends, their boards of directors and managers did not invest in building sustainable businesses and balance sheets capable of withstanding the economic recession.

 

Consequently, to prevent them pouring petrol on fires they built in their own backyards, close to three hundred credit unions have had their lending capacity restricted by the Central Bank. 

Last week, in what was probably an orchestrated campaign, trade body representatives and local politicians publically criticised the Central Bank, claiming it was driving people into the arms of moneylenders. They got their response in Taoiseach Enda Kenny’s robust defence of the Central Bank’s interventions to protect savers funds. Its interventions, which also include insisting credit unions account properly for asset values and come clean on losses, are driving the need to stabilise the network by consolidating it down to a viable and sustainable size.

Consolidation is an inevitable outcome of credit union maturity. In the U.S., Canada and Australia while numbers of credit unions have been declining for years, customer numbers and branches have grown. In these countries, induced by crisis events far less serious than here, consolidation was driven by governments and their regulatory agencies. And credit union leaders responded positively. Consolidation allowed them to realise scale economies to invest in modern technologies and establish the centralised shared services required to offer a full range of high quality financial services. The same is true of co-operative banking consolidation in mainland Europe.

Today we are seeing similar crisis induced, regulatory leadership by the Central Bank’s experienced credit union regulator the Registry of Credit Unions. It has acted to control investment and lending risks and while insisting on proper reserves, has permitted loan modifications and established a robust resolution system to enable the sector to survive and prosper. It has done so in the face of objections by credit union representative bodies who blame external forces and regulatory intervention for causing financial instability problems. The reality is that the root cause stems from credit union board rooms. An aging generation of long serving directors and their managers focused solely on maximising savers dividends and ignored the sustainability of the credit union itself.     

Crisis induced, regulatory imposed consolidation won’t work unless it’s framed within a broader strategic context. At a recent conference for managers and auditors, Professor Ray Kinsella spoke of the need to “bail in” credit unions as distinct to “bailing out” banks. At this conference, I illustrated one possible “bail in” approach when I presented on my paper “A Co-operative Banking Strategy for Ireland” recently submitted to the Commission on Credit Unions. It’s available on my blog, billhobbsie.blogspot.com.

Credit unions are economically important as they mobilise household savings as loans and socially important as they help create community social capital. Guided by a philosophy, which is best seen in their consumer advocacy values, the fundamental business purpose is to provide high quality financial services at fair prices to anyone who wants them. By excelling at this purpose they build the capital reserves needed for business sustainability, and realise their wider societal objectives. They are a vital store of intergenerational, monetary capital and facilitator of community social capital.  

As yet, credit union leadership has not come up with a “bail-in” strategy that makes sense. With the Government and Central Bank intent on stabilising the sector, credit unions need to stop looking at this as a threat and realise the opportunity it proposes.  

       

A version of this article appeared in the Irish Examiner, Business Section, Monday 19th September 2011

Pressing need for consumer debt tsar

The Government should appoint a Debt Tsar to build and oversee a national debt management regime capable of settling billions in un-repayable consumer debt.

Despite our Dickensian debt enforcement system being hopelessly inadequate, the official response has been to tweak the system to solve a problem it was never designed to deal with. This myopic response has seen regulatory officials trying to get lenders to use poorly designed extend and pretend mortgage solutions assembled by “expert” groups.

It’s high time to stop “tweaking”. The scale and scope of consumer indebtedness is so large nothing short of a co-ordinated national response will do.

Imagine an adult population the size of Cork City owing at least €13bn more than will ever be repaid. This money is owed to hundreds of separate creditors who are all individually pursuing repayment. As every financial fragile household has a distressed mortgage and a number of equally distressed debts, they are being peppered with collection letters and phone calls every month. Some are receiving multiple phone calls daily. Many have had their mortgages modified, mostly on interest only terms as their mortgage lenders pretend the debt is being managed. Three in 10 households risk losing their homes. If they do, they will still owe on average €90,000 each on top of thousands more in unsecured debt.

Nine out ten people do not have the skills or know-how to deal with their indebtedness. Most are still in denial as are their lenders. While some but not all banks are sticking to the Central Bank’s troubled mortgage code, court lists are groaning under the weight of theirs and others legal actions which will only ever recover cents in the euro on unsecured loans.

Imagine a national debt management agency and system that would ensure consumers and creditors reach responsible settlement agreements – while limiting tax payers’ costs. Designed for a more benign economic environment, the Law Reform Commission set out a major component part of a national blue print. Its design, which did not consider mortgage debt, would see a responsible, non-court based debt settlement system with a new bankruptcy regime for hopelessly insolvent individuals. People would reach a binding collective agreement with their many unsecured creditors to repay what they could over a period of time after which any balance outstanding would be forgiven.

But dealing with troubled mortgages separately from other debts is like trying to make an omelette without breaking the egg. The totality of household indebtedness must be considered and agreements established to manage mortgage and other debts at the same time. Any debt resolution agent should holistically establish two component plans; a mortgage resolution plan and an unsecured debt settlement plan which could include for un-repayable mortgage debt. 

The Central Bank cannot act as a debt resolution oversight agency as its mandate cannot cover the full breadth of consumer indebtedness. Consumers also have distressed utility bills, tax debt and other legally enforceable debt. In recent commentary the Central Bank acknowledged this, when in ruling out regulating for specific mortgage resolution solutions, it raised the notion of a debt settlement agency.

One proposal would see a debt settlement/management agency led by a debt tsar empowered by Government to build an integrated national debt management regime. Implementing the Law Reform Commission blue print and working closely with the Central Bank and other state agencies, it would set binding rules to drive the business processes required to resolve and settle billions in un-repayable household debt. These would include specifying the range of solutions, setting mandatory terms and conditions and ensuring absolute transparency. With a mandate broad enough to capture the totality of consumer/creditor relationships and debt solutions, it should be established on an independent footing, similar to the central bank.

A version of this article appeared in the Irish Examiner, Monday 12^th September 2011.


A stylised consumer/creditor relationship is illustrated in the diagram below:

People have debts with multiple creditors not only lenders. These creditors may pursue debts using legal debt enforcement procedures. The Central Bank through its consumer protection codes requires  the firms it regulates to comply with rules of conduct (excluding credit unions). These codes do not apply to other creditors nor cover multi-lender relationships. 


The proposed Debt Tsar and resultant debt management system is illustrated below:

Here a national debt resolution agency would oversee the totality of the consumer/creditor non-judicial debt enforcement/settlement relationships. The model includes two elements (1) a mortgage resolution process based on the waterfall concept through which people would resolve their troubled mortgage debt and (2) the LRC's non-judicial debt settlement process. The debt resolution agent would work with the Central Bank and other state agencies to strengthen consumer protection codes and establish clear rules of engagement regulating for binding multi-creditor debt settlement arrangements. This approach could include for a mandatory requirement for consumers and their creditors to engage in the process.


The waterfall concept for mortgage resolution would see a cascade of interventions driven by loan affordability which would be based on a realistic assessment of income sustainability. The diagram below illustrates one version of this:

The risk of a borrowers' run is growing

If this Government does not get to grips with an unprecedented consumer debt crisis, there could be a borrowers’ run on the banks. They happen when ordinary people, realising how weak banks are and becoming suspicious of political interference in arranging cosy insider deals, stop repaying their loans. Mass defection from “willing to pay” to “won’t pay” has the same disastrous effect as a depositor run.

In pouring cold water on any suggestion of an organised personal debt settlement/forgiveness regime, Government heightened public disquiet.

Furthermore, when ruling out a mortgage forgiveness programme, Minister Michael Noonan said his cabinet colleague Richard Bruton was looking into doing something to help viable “family firms” whose owners lost money on “property plays”.

While ring-fencing viable businesses from their owner’s property losses may be a worthy job protection measure, it could also be construed as a political party acting in the interests of its traditional farmer, business owner and professional classes support base.

Unless there’s a national debt settlement regime that people can trust in, such worthy initiatives could amplify the risk of a borrowers’ run. It’s inevitable that there will have to be some form of debt resolution agency to oversee the forgiveness of anything up to €16bn in direct and indirect un-repayable consumer debt. And, as it will have to be a regime that people can trust, it must be free from political, institutional and sectional interests and influence.   

Leaving debt settlement to be dealt with through current institutional arrangements risks undue political interference, cosy insider deals and serious social unrest. Maintaining that vulnerable people should be left to deal with their banks on a case by case basis is a political cop-out.

Such a national debt resolution/settlement agency should be independent from the Government and Oireachtas, similar to say the central bank and judiciary. Its mandate would be to establish the ground rules for and oversee the execution of a national debt management system and its quasi-judicial processes through which where ordinary people settle debts through multi-lender debt settlement agreements. While this may seem a prescription for another monolith such as NAMA, the alternative scenario is less palatable.

Firstly, the judicial debt collection system with its antiquated legal framework, including inhumane bankruptcy laws, is wholly unsuited and incapable of dealing the scope of solutions and magnitude of agreements required to work out billions in unaffordable debt.

Secondly, creditors not only include state funded banks but other credit institutions and utility firms owed money by indebted consumers. As each firm will have its own debt collection policy, some may act to favour some customers over others, cutting them better deals. Already there’s an emerging disparity with some banks said to be agreeing to debt forgiveness while others continue to pile on legal debt collection pressure.

Thirdly, Government officials have had three years to get to grip with the problem. Not only has the consumer debt can been kicked down the road through extend and delay forbearance tactics – everyone is trying to kick the can onto someone else’s patch.

Last week Government’s compassionless commentary starkly contrasted with the horrendous personal stories told on the Joe Duffy show by honest people. Mr. Noonan talked of yet another interdepartmental “expert group” which, while taking into account bankers’ institutional interests, once again does not include for robust consumerist representation.

Similarly constituted, the previous “expert” group failed to meaningfully address the unprecedented scale of a consumer debt crisis for which there are no international precedents to draw on. While established to consider mortgage and personal debt it focussed exclusively on mortgage “arrears” and not the wider systemic crisis. Still it may be the case the new “expert group” will finally come up with a meaningful response. Many suspect all it will do is to cobble together another set of sticky plasters. If so, it may be only a matter of time before ordinary people decide enough is enough and trigger a borrowers run.  

 A version of this article appeared in the Irish Examiner, Business Section, on Monday the 5^th September 2011.