The new way to deal with mortgage debt

The judge was not happy. A “vulture fund” that had bought bad mortgages from banks questioned the legality around how a couple went about seeking a remedy to their severe financial problems.

The couple in question, musician-composer Frank McNamara and his wife Theresa Lowe, the TV presenter-turned-barrister, are among the best known people to have turned to the country's still-being-tested personal insolvency regime to deal with Celtic Tiger-era debts they cannot repay.

"It doesn't seem to me to be a fatal error," Mr Justice Denis McDonald told Rudi Neuman Shanahan BL, for the fund Tanager, when he raised a query around the swearing of an affidavit back in 2017.

When counsel for the fund, owned by US private equity giant Apollo, pushed the point, the judge – keen to hear a case repeatedly mentioned in his list but never resolved – became more forceful.

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Mr Justice McDonald described it as “a very unmeritorious technical objection” to be raising now, and said he encouraged practitioners to be “constructive”.

Family home

The case proceeded and the court heard that the McNamaras were seeking to have almost €3 million of their total debts of €3.7 million written off, including the bulk of Tanager’s €2.2 million debt.

The debt, bought from Bank of Scotland (Ireland), was secured on the family home in Dunshaughlin, Co Meath. The couple proposed an arrangement whereby Tanager's mortgage would be reduced to €550,000 and €100,000 shaved off with a lump sum and other debts settled with a further €136,000 payment.

The couple’s barrister Keith Farry BL argued in court that Mr McNamara’s once-lucrative work as a orchestral conductor in the US had dried up, that he was owed more than €1 million in music royalty payments and that he borrowed to tide him over what he thought were temporary financial troubles.

Their rescue plan was being proposed as a “personal insolvency arrangement”, or “PIA”: a type of financial escape mechanism created by the Government through post-crash legislation to help borrowers deal with tens of billions of euro in troubled mortgage and personal debts they were never going to be able to repay.

Despite being in existence since 2013, the personal insolvency legislation has been used by only a small fraction of the large number of distressed mortgage cases stuck in the system but it is fast becoming a viable solution for the heavily indebted.

The dilemma facing the system is that the courts are still trying to make the six-year-old regime work in practice – in face of objections from banks and other mortgage providers, many of the objections technical in nature.

In the McNamaras’ case, Farry argued that the fund had “raised every technical objection under the sun” but failed to say that the proposed deal was unfair or worse than if the couple were bankrupted.

Procedural challenges

This is not unique to this case. Technical and procedural challenges have been thrown up by big creditors in cases coming into the High Court’s personal insolvency list as banks seek to block write-downs.

As a consequence of this paralysis in the system, the Government introduced an appeals mechanism in 2015 called the "section 115a" court review where, if the High Court found that an arrangement was fair and reasonable, it could block the so-called "bank veto" in the appeal of Circuit Court cases.

Over time, the High Court has ruled in test cases, forcing lenders to accept debt write-downs of mortgages to or near the current market value of property, with many such PIAs being approved without the stress, cost and time of going near a court.

As a consequence, approved PIAs soared from 126 in 2014, to 619 in 2015, 697 in 2016, 733 in 2017 and 959 last year.

Mitchell O’Brien, a Dungarvan-based personal insolvency practitioner – or PIP as they are known in the business – handled 24 cases over a two-month period this year where he secured an average debt write-down of €232,000 – or €5.6 million in total.

“It only ends up in court where it is a new solution that creditors aren’t willing to engage with. We have four PIAs approved this week already with Start Mortgages,” he said, noting a change among lenders.

But the process has been slow going and creditors are still trying to block proposed deals.

"Circuit Courts have been somewhat reluctant to make hard decisions but going to the High Court there is a body of precedence slowly building up," said Ronan Duffy, a director of Derry-based personal insolvency practitioners McCambridge Duffy, one of the most successful firms devising PIAs.

Duffy says his firm have five of the most active PIPs – the financial engineers who solve these complex debts cases – in the country and they have almost 190 live appeals waiting to be heard.

Workable solution

The firm calls the objections “kitchen sinks” because that is what many lenders and vulture funds throw to defeat proposed PIAs on minor issues with no bearing on the commerciality and sustainability of a deal.

Debt-for-equity solutions – where a lender takes a stake in the home in exchange for reduced mortgage payments – is seen as the last big battleground issue, and a workable solution for many older, low-income borrowers stuck in a debt hole. Cases proposing this solution have stalled, again on technical issues.

“The reality is we don’t have to fight the same fight over and over again too many times. There aren’t too many other very innovative solutions to be developed after debt for equity is tied down,” said O’Brien.

The large amount of distressed mortgage debt held by investment funds complicates matters.

The short-term strategy of “vulture funds” – buy the debt, grab the asset, turn a quick profit – is in direct conflict with the long-term nature of the suite of proposals originally envisaged under the 2012 debt crisis legislation.

In the McNamaras’ case, Tanager put it baldly when one of the fund’s executives Angela O’Brien – in unusually frank terms for a distressed-debt investment fund – said that the fund typically agreed to a debt write-off to a home’s market value only “in circumstances where the security property is either surrendered or voluntarily sold, which ensures that the true market value of the property is achieved”.

Or, as Farry put it in court on Monday: “They simply don’t do long-term restructuring.”

Legal fees

The flurry of Irish banks selling off portfolios of bad loans and mortgages has thrown up quirks in some cases.

O'Brien points to the case of one client, a Co Waterford businesswoman who had €1.5 million of debt written off. A fund, Promontoria Aran – in a highly unusual situation – ended up with two of the woman's debts that had been used to vote both for and against her PIA. Promontoria held more than €1 million of her debt that it used to vote against her proposed PIA and later found itself the owner of the woman's €550,000 mortgage, through its purchase of a portfolio of Ulster Bank loans, that had been used to vote for the PIA.

The vulture was essentially cannibalising its own interest in that case. The court sided with the debtor and her plan.

PIPs bemoan the tactics of the funds, particularly when they waste money on legal fees on procedural challenges that could be better used to reduce debt.

O’Brien questions the merits of banks selling off loans in the first place, as they reduce non-performing loans quickly to meet targets set by EU regulators when there were other, more constructive solutions.

“The sale of a loan to a fund is a bank accepting a write-down; there is no other interpretation,” he says. “In a personal insolvency arrangement, if the bank had accepted that write-down or less of a write-down, they would have had a better return because they would have a performing loan at the end of it.”

Duffy says some funds are slowly recognising this, seeing an asset not just in a surrendered property but in a restructured mortgage they can sell on.

“Some of them have twigged that and are prepared to work with you. Not all of them,” he says.

He believes that the slow crawl of cases inching through the courts will ultimately lead to a personal insolvency regime that avoids lengthy spells in the courts.

“I do think it is getting there but it is just really painfully slow,” he said.

Meanwhile, the McNamaras’ case is back in court on Monday, to resolve another technical issue, around what class of creditor the Revenue Commissioners is dealing with when its debts are being repaid in full.

In numbers: Personal insolvency arrangements
126 in 2014
619 in 2015
697 in 2016
733 in 2017
959 in 2018