sábado, outubro 06, 2012

Debt workout 101 - Creditors sometimes lose money

Debt Workout 101 part- 19 :   
Creditors sometimes makes mistakes and therefore MUST sometimes lose money
The (inescapable) reality of loans losses in banking:
Expected losses, include risk premium in loan pricing, provisions

Unexpected losses, absorbed with general loan loss reserve and sufficient  bank capital

Example:  100 housing mortage loans
  • Bank A:  1,5% losses
  • Bank B:   5% l osses, tighten credit policies and procedures)
  • Bank C:   10% credit restructuring andworkout, shareholders to the rescue  to replace lost capital
  • Bank D:   20% losses, subprime, close BAD bank, taxpayers to the rescue of the depositors 
Who’s got the debt problem: 
If you owe 100…€ and can’t pay, you have a problem
If you owe 1000…€ and can’t pay, the bank has a problem

Initial debt workout strategies
  • Individual creditor cancel  credit lines, asks for repayment, increase pricing, ask for additional security, call on existing third party guarantees
  • Borrowers find new creditors, ask for restructuring
  • General debt workout
  • Borrower suspends payments, seeks bankrutpcy protection
  • General all-creditor renegotiations
  • Sharing of losses, depending on relative bargaining power 
Source:  PPP Lusofonia  - Debt Workout 101

Case 1:  Young couple asks for 80M to buy house for 100M
Creditor overestimates creditworthiness of borrowers and house collateral value at 150M, offers 120M (Basel weight 50% )
Borrower accepts 120M, buys house for 100M, furniture, takes vacation …
Unemployment rises, house prices/collateral prices fall first to 90M then to 70M, borrower loses job, divorces, etc

In economic recession, options 
  • Borrower  to sell house for 90M, retain 30M debt (total debt 120M) to repay from other sources over 10 years (or earlier if they sell the car)
  • Borrower to sell house for 70M,  agree to repay 25M from other sources  over  20 years  and the  creditor forgive 25 M 
In economic depression, options
Ii couple both become unemployed due to colapse of housing market/construcion sector
  • Press  rich parents/uncle to take over repayment of loan for the sake of the grand-children 
  • (ex-post third  party payment guarantee or substitution of creditor)
  • Borrowers abandon the house (mail the keys to the bank), rip out the doors…
  • Bank sells gutted house for 40M, takes loss for 80M
  • Taxpayers pay: Unemployment benefits, emergency housing, higher health costs 
  • Recapitalize the banks 
Case 2.  Transport financing and the debt crisis
SOE state owned company borrowed by issuing  bond
2007 Euribor+15bp
Loss making SOE rail company issues €500M,  5-year bond Schuldschein, bullet,  without Govt guarantee, taken by int’l pension fund investors
      …xx   CRISIS xx…
Local bank takes 90-day funding from ECB to make loan to rail company to repay maturing bond issue at par, though trading at deep discount

No debt relief for borrower,  external debt overhang remains
Credit exposure shifted from private investor to  official creditor

Case 3.  PPP project  PF  funded  by  EIB 
2005  funding Euribor+1%
50% by EIB with guarantee on-first-demand from prime-rated banks (AA-), including local banks
30% local bank debt, with external (unmatched) funding, at Euribor
20% equity
        …xx   CRISIS xx…
Project distressed, traffic shortfall – 30%
Sovereign and  banks down-rated (BB)
Local bank funding cost rises to Euribor+3%
EIB requires cash collateralization of bank payment guarantee (local banks borrow from ECB to place on collateral with EIB)
Local banks with negative interest margins (Euribor +2%), sell (impaired) PF loans at deep discount

No debt relief from borrower
Local banks in stress, urgent recapitalization need to stem deposit run, capital flight

See more Debt Workout 101 - parts 1 to 16
Os credores também se enganam