Sometimes you need vulture funds to swoop - there's no moral hazard
The term "vulture fund" is a metaphor used to compare investment funds to the behaviour of vultures "preying" on debtors in financial distress by purchasing the debt at a discount to make a large gain.
The "vulture fund" industry in Ireland began in 2011, with the sale of €400m of loans by Bank of Scotland's. By 2013 we'd seen the emergence of whole loan residential mortgage portfolio trades. Since then massive sales by Nama, IBRC's liquidators and Ulster Bank all added the trend.
In total, Ireland has witnessed completed portfolio trades of €62.9bn. Further loan sales will continue in 2016.
Deutsche Bank, Apollo, Cerberus, Lone Star, CarVal and Goldman Sachs emerged as the main purchasers.
New investor money regulations, introduced in 2015, and due to be implemented from April 2016, relate specifically to the administration and management of loans to Irish individuals and SMEs in order to ensure these entities follow statutory protection requirements when loans are transferred to an unregulated purchaser. While this legislation has an effect for all servicing agents operating in the market, it is unlikely to be significant. So what are the pros and cons of dealing with a vulture fund, and what is the best way to deal with them?
They are fiercely commercial and pragmatic, and can arrive at quick decisions, unlike some of the mainstream banks who can struggle with concepts such as "moral hazard". The biggest pro, from a borrower's perspective, is that they are prepared to actually write off debt, close the file and move on. Just because a bank sells a loan does not weaken the contractual position of the borrower. The fund buys the loan with its existing terms and conditions.
The Consumer Protection (Regulation of Credit Servicing Firms) Act 2011 gives protection to consumers. In addition, the full range of Personal Insolvency and other legal debt resolution mechanisms remain fully in place.
A borrower with a mainstream bank might be given some credit for being a loyal customer, absolutely no credit is given for such loyalty by a vulture fund.
Like vultures in the wild, these funds have a stronger stomach to take on more difficult cases. They have no concern about maintaining jobs in rural areas or trying to develop a long term relationship with customers. Their objective is simple: obtain the maximum return. They can be faster to issue proceedings and appoint receivers.
I would not use the term "aggressive" to describe their conduct, as such a term could imply an element of unprofessionalism. I would describe their conduct as being very "tough", very clinical and professional.
An issue for some borrowers is the timescale funds operate to. The typical life cycle of a fund is just five years, so borrowers will not be given an extended period of time to pay back the loans. Accordingly, some borrowers are effectively "pushed" into insolvency.
Having a loan sold to a vulture fund can be very frustrating and stressful for the borrower. Once a loan is put into a "Data Room" it can be as long as another 12 months before the borrower gets an opportunity to sit down with a decision maker. The new decision maker will have no prior knowledge of the issues surrounding the loan or personalities involved. The vulture fund obtains only a copy of the facility letter, a copy of the mortgage deed and current contact details for the borrower. The borrower will need to update the fund on any issues arising, and re-commence any settlement negotiations that had been previously going on.
dealing with a vulture fund
Some debtors feel that the funds should accept what they paid for a loans, with, say, an added 10pc for a profit margin. Unfortunately, the funds do not operate on that basis.
Irish vulture funds can be categorised into two types: the "short haul" who have purchased commercial debt, and the "long haul" who have purchased "home" property mortgages.
"Long haul" funds act much like mainstream banks, given the constraints imposed by the Mortgage Arrears Resolution Process. They are further constrained by the recent amendments to the Personal Insolvency Act 2012, whereby the creditors' previous "veto" to Personal Insolvency Arrangements ("PIA") has been considerably weakened. We do find it surprising the number of borrowers and professional advisors who are unaware of the benefits of Personal Insolvency Arrangements when it comes to dealing with the banks and funds. Short haul" funds are different. They have a tight timeframe and are less patient. Most of the loans bought are already in default, which enables them to "call in" the loans almost immediately.
One of the first steps that any borrower should consider is whether they are eligible for a "no veto" type PIA. The new legislation allows debtors to utilise Examinership-type voting principles in a certain type of personal insolvency.
If the borrower has no unencumbered assets and does not have high earnings, it should be possible to negotiate a quick settlement with a "short haul" fund. However, few of the "long haul" funds will do debt forgiveness on a family home: unless the borrowers are prepared to sell. Borrowers with assets and/or a high income will face a tougher battle! Many cases are resolved by presenting a proposal that shows how the fund can achieve a better realisation than from a bankruptcy of the borrower. On the basis that the fund acts commercially, it should accept such a proposal.
Any proposal should address any tax advantages. For example, we frequently have cases in which a capital gains tax liability arising on the sale of one property can be sheltered by a capital loss on the sale of another property.
In isolated cases funds reject "reasonable" proposals, perhaps because they lack full understanding of the complexities of the security documentation and the importance of the borrower's co-operation in selling the assets. We sometimes come across cases where the very busy decision maker has only read, say, the last six months correspondence, and has missed nuances in earlier correspondence, and therefore arrives at a flawed decision.
Jim Stafford is a partner with Friel Stafford