The Tribune

By NEIL HARTNELL

Tribune Business Editor

A LEADING attorney yesterday proposed a 'debt-for-equity' style-swap as the solution to the Bahamas' existing mortgage woes, telling Tribune Business that to force commercial banks into losses and capital write-offs could endanger the nation's financial system and create even greater problems.

Michael Paton, a partner at Lennox Paton and a former Bahamas Financial Services Board (BFSB) chairman, in a counter-proposal to the Progressive Liberal Party's (PLP) plan, suggested that lending institutions take an equity stake in distressed properties subject to their mortgage loans, rather than writing-off all unpaid interest and fees owed by delinquent borrowers.

Emphasising that his comments were "not political in nature", and that he held "no brief" for any person or political party, Mr Paton said his plan would eliminate the "moral hazard" issues that might arise from simply forgiving the debt owed by delinquent borrowers.

Acknowledging that the fine details of his proposal would have to be worked out, Mr Paton told Tribune Business that under his scheme - variations of which have been employed to varying degrees in the US and UK to deal with their delinquent mortgage crises - delinquent borrowers would be given a 'call option' that allowed them to repurchase the equity stake in their home taken by the lender when they had the financial wherewithal to do so.

To protect the lender, they would have a 'put option' allowing them to sell either their equity interest or the entire property if the borrower subsequently defaulted once again on their new, reduced obligations.

Mr Paton argued that rather than directly intervene in the Bahamian mortgage market by guaranteeing the performance of delinquent borrowers, the Government should "facilitate" a private sector solution through actions such as exempting mortgage restructurings from Stamp Duty.

With the National Debt already at $4.3 billion and growing, the Lennox Paton partner added that the Government could simply not afford to underwrite the Bahamian mortgage market. He also described the PLP's proposed levy on all home borrowers to fund its guarantee as "discriminatory" against mortgagees 'in good standing'.

"It protects the Government and mortgage borrowers in good standing," Mr Paton told Tribune Business of his proposal. "It's [the mortgage crisis] a private sector issue. It shouldn't become a government issue.

"This is a way to hopefully solve the issue. If we have all the banks writing-off their capital, it puts the financial system in problems, which will have a greater impact than these current problems."

Describing his solution to a market where some $450 million worth of mortgages were 90 days past due, or non-performing, and around $690 million in arrears, Mr Paton said: "An alternative plan would be to put in place a mechanism whereby the mortgage debt can be restructured by a debt for equity swap, where the principal of the mortgage debt would be reduced in return for the lender taking an equity position in the property.

"This would eliminate the moral hazard of straight debt forgiveness. The borrower would have a call option on the lender's equity interest, so the borrower could regain 100 per cent of the equity in the property, where he is financially able to do so.

"The lender would have a put option to sell the property or its equity interest in the event the borrower re-defaults on the mortgage. This mechanism would enable the banks to avoid large capital write offs (any required impairment charges could potentially be amortised), and would not transfer any financial risk to either the Government or borrowers in good standing, who have not defaulted on their mortgages. There are numerous details of the plan that would need to be worked out, but the premise of the debt for equity plan is, in my opinion, viable."

Outlining his concerns over the PLP's mortgage relief plan, as stated on its website, Mr Paton said: "The PLP Mortgage Relief Plan is fraught with moral risk; delinquent borrowers will gain an advantage over borrowers in good standing by having both unpaid accrued interest written off, and a reduction in the interest rate on their mortgage loan to Prime + 1 per cent (a rate that the vast majority of borrowers in good standing do not enjoy). There will be an incentive for borrowers to default."

When it came to the proposed 0.5 per cent annual levy on the outstanding balances owed by all mortgage borrowers, Mr Paton said that apart from being "discriminatory against borrowers in good standing", it "may well be unenforceable".

He also pointed to the contradictory statement by Lynden Nairn, the Colina Insurance executive who helped to devise the PLP plan, that the annual levy would only be paid by those borrowers in default who were selected for the relief plan.

This, Mr Paton said, "raises additional questions about the viability of the PLP mortgage relief plan", given that the gap between funds raised via the levy and the guarantee was likely to be wider than the $105 million previously suggested to Tribune Business by Bahamian banking industry executives.

"If the Government of the Bahamas is going to intervene in the private sector mortgage debt market, it should only do so in a way that facilitates a private sector solution, rather than imposes losses and capital write-offs on the finance sector of the Bahamian economy," Mr Paton told Tribune Business.

"One way the Government could assist is to ensure that any restructuring of mortgage debt is exempt from Stamp Duty. The Government of the Bahamas cannot afford to become the guarantor of performance of Bahamian mortgage borrowers; the National Debt is already too high and risks being unsustainable, which if it happens will have a catastrophic impact on the Bahamian economy."

And he added: "A solution to the Bahamian mortgage debt problem should not impose costs on the taxpayer or the thousands of borrowers who are in good standing. Rather, it should be resolved by the parties who are directly affected, namely the lenders and the borrowers who are in default.

"The Government is certainly an interested party, but its interest should be limited to facilitating a solution, not being the solution. The 'debt for equity' plan may need the Government to pass legislation to make it easier to implement, and if so would be a good example of the Government facilitating the private sector to reach a solution to the current problem."