Sunday, April 26, 2015

AIB at the Oireachtas Finance Committee: Discussion on Mortgage Arrears

Last Thursday AIB appeared before the Joint Oireachtas Committee on Finance, Public Expenditure and Reform to discuss an “Overview of the Banking Sector in Ireland”.  The submissions by AIB prior to the meeting were:

A transcript of the meeting is available here.  The meeting was roughly divided between discussions of AIB’s funding costs and interest rates, and in particular its SVR mortgages, and discussions of AIB’s responses to mortgage arrears.  Here are a couple of extracts from statements made by Brendan O’Connor, AIB’s head of the financial solutions group, on the latter.

Mr Brendan O'Connor:  Those with mortgages over 720 days in arrears represent a large cohort. In AIB, 60% of those have made no payment at all, which represents 7,000 accounts. If that is their maximum affordability, it will not be possible for us to restructure the mortgage. Our responsibility is to help the customer exit the property and we will not go after the residual debt if it is not there. We actually can do nothing unless we have that level of engagement.

AIB has around 11,500 mortgage accounts that are more than two years in years. Because of top-up loans, equity releases and the like this corresponds to around 9,000 properties/borrowers. Of these 9,000 around 5,400 made zero repayments in 2014.  It would have useful if the split of these 5,400 non-payers between PDH and BTL properties was provided.  The AIB representatives stated that they had 7,000 accounts on which no payments were being made but there were no questions put to them by the members of the Committee on this issue.

There were numerous questions about the process AIB engages in with borrowers who do engage.  On this Brendan O’Connor said:

Mr Brendan O'Connor: We make our decisions based on affordability. The only criterion we use is how much somebody can pay. Is there enough there to structure a sustainable mortgage solution? We do not go into matters of policy but affordability for the individual in question. There is always an individual set of circumstances in such cases.

If somebody has some level of affordability that allows for a mortgage restructure, we have a product to allow that to happen. Where someone does not have it, we have a process which allows a voluntary sale for loss and will not pursue the residual debt. The only way we can sustain a restructure is if we have the customer’s information, that they are willing to talk to us and willing to make a payment in line with affordability.

The issue of what happens to the residual debt after a voluntary sale is important. A number times AIB seemed to state that if a borrower engages by  providing financial information but that it is not possible to restructure the mortgage to make it sustainable and affordable any shortfall or residual that might remain after a voluntary sale will be written off.

Mr Brendan O'Connor: To the extent that somebody is involved in a voluntary surrender, where he or she has no affordability and no cash-flow such that we cannot construct a sustainable solution that will allow him or her to keep his or her home, we will look at the residual figure. To the extent that there is no affordability we will write an agreement that states the residual amount will be written off.

Mr Brendan O'Connor: The bank has said that where someone cannot afford their mortgage we will not go after them for the residual debt if they sell the property. In effect, that is the outcome we get if a house goes to possession. It makes more sense for the individual, the borrower and the bank to do that consensually and achieve that outcome rather than go through a possession process. However, I would like to find out how many are in this queue that we can restructure, and that is why we try to get the re-engagement.

This seems pretty clear.  When someone cannot afford their mortgage and undertakes a voluntary sale AIB will not pursue a residual that may remain.  Mr O’Connor also said that this is the outcome if “a house goes for possession”.  However, he was not so clear of what happens the residual after a voluntary sale in this statement:

Mr Brendan O'Connor: Regarding voluntary assisted sales, where someone has no affordability post the sale of the property, we do not go after people for the residual debt. There is not much point. However, we do look at residual debt on the basis of affordability, so to the extent that someone can afford to make some payment to the residual, within those reasonable living expense guidelines etc., we will seek it, and typically a payment for a period that is less than the insolvency period.

Although this is unclear AIB did write off a significant amount of mortgage debt in 2014 – €461 million – the bulk of which it can be assumed came at the end of voluntary sale processes.  Although a conclusion that results in loss of ownership is bad, in circumstances where the borrower cannot afford the mortgage, it should be accompanied with a write off of any residual that may remain.

AIB’s representatives were questioned on their motives for issuing legal proceedings against a significant number of borrowers.  The reason why a bank issues legal proceedings is that it wants to take possession of the house, however, taking this action does lead to significant re-engagement.

Mr Brendan O'Connor: There are some interesting re-engagement levels. We are actively seeking an adjournment in 50% of cases where there is a court date because we have had re-engagement. At certain stages in the process, we tend to get re-engagement and, certainly after we give the regulatory letters, we get re-engagement of about 50% at every stage.

We actually have 800 people in the court process at the moment who are on a test period, so while they will appear in the legal numbers, they have re-engaged. They are on a test payment period and when that test payment period is over, we would expect them to come out of the legal process.

We have brought 2,000 people back from more than two years in arrears who are no longer in arrears when, previously, they would have been in the legal process. It does drive an intensity of engagement and our observation is that it leads strongly to people coming back to the table.

Brendan O’Connor outlined four stages the banks go through when dealing with non-engaging borrowers in arrears who fail to complete and SFS and indicated that at all stages around 50 per cent of borrowers re-engage.

Mr Brendan O'Connor: The week a borrower goes into arrears, he or she receives a letter informing him or her of being in arrears with a standard financial statement, SFS, which we ask him or her to fill out. That is the process by which we judge affordability. If we get an SFS, we will make an offer to the borrower based on the financial detail that come out of that.

Throughout the entire process, to the extent that the borrower does not follow that up, we send out another letter, known as a Provision 28 letter, which states that we need to keep this moving to the extent that if the borrower does not engage with us, we will have to deem him or her non-co-operating. That is followed by what is called a P29 letter. Approximately 50% of those who get a Provision 28 letter engage then.

A P29 letter states one is non-co-operating. At that stage, approximately 50% of those who are still left in that bucket engage. If a person has not engaged by then, at which point he or she has had a quite significant amount of time, he or she will go into the legal process. Approximately 50% of the borrowers engage before it gets to civil bill stage, and after civil bill stage, as I stated earlier, in approximately 50% of the cases that go to court, we are actively seeking adjournments.
It is all about engagement. We ourselves have various channels in the Irish Mortgage Holders Organisation. To the extent that one engages, one will get an offer.

Thus the stages at which 50 per cent re-engage at each point are:

  1. Letter stating that non-engagement may lead to the borrower being deem as “non-cooperating”
  2. Letter stating that the borrower is now classified as “non-cooperating”
  3. Decision made that the bank will enter the legal process to seek possession of the property
  4. Issuing of civil bill to begin legal proceedings and listing of case for court date.

It is also possible that there may be re-engagement if the legal proceedings conclude with the granted of a possession order by the courts but the extent of that, if any, was not stated. 

AIB have indicated that if they make a decision to go down the legal route with 5,000 borrowers around 2,500 will re-engage and a civil bill will not be issued.  Of the 2,500 borrowers who have a civil bill issued to them and have their case listed in court around 1,250 will reengage at that stage and AIB will seek to adjourn the legal proceedings.  Thus of the 5,000 borrowers where the bank decides to go down the legal route the bank will go to court to pursue the order for possession in around 1,250 instances.  It will be a decision of the court whether the orders for possession will be granted.

Finally, Brendan O’Connor stated the circumstances that lead to the bank’s decision to pursue the legal route:

Mr Brendan O'Connor: The other issue that was raised was the tsunami of repossessions. That was misrepresented in the media today. For anybody to be in the position where we are in a court repossession discussion or in the court process would require them to not have engaged or repaid us anything in a number of years. In those cases, significant numbers will not end up in repossession territory at all because I think we have about 50% who re-engage.

Tuesday, April 14, 2015

What happens when 69 repossession cases come before the courts? Some notes from a Cork sitting.

Yesterday the Cork County Register held a session for civil possessions cases.  There were 69 cases heard (there were 68 on the legal diary with one additional case).  Of these, one was for a commercial premises, one was for farmland and one was a civil dispute over ownership of an asset that did not involve a loan contract. 

Thus there were 66 cases involving residential properties and lenders (mainly but not exclusively banks).  It cannot be determined how many of the properties are PPRs, BTLs or are vacant though this detail is given in some instances.  The 69 cases were completed in just over two hours so the session moves quite quickly and it can be bewildering for the borrowers who are present. 

When a case is called the applicant (i.e. the legal representative acting on behalf of the lender) states which action they wish to take.  There are three possibilities (where the number in brackets is the frequency among the 66 cases involving residential properties):

  • Seek an adjournment to a later date (33)
  • Proceed to seek the possession order  (32)
  • Strike out the proceedings (1)

There were four reasons given by the applicants (the lenders) when seeking an adjournment:

  • Have agreed or are negotiating an Alternative Repayment Arrangement (ARA) with the borrower (21)
  • This is the first listing of the case so a Practice Direction Adjournment (PDA) is mandatory (5)
  • The sale of the property is beginning or on-going (4)
  • Notice of the proceedings has not been served on the respondent (3)

In all cases where the applicant requested an adjournment these were granted.  Most were to sittings in July or October later this year though in one case a ‘general adjournment’ was granted to no specified date unless the applicant wishes the case to be relisted.

In almost two-thirds of cases where an adjournment was sought by the lender it was because an alternative repayment arrangement had been entered into and time is being given to see if the borrower can adhere to that or because negotiations to put in place an alternative repayment arrangement are on-going.  Almost no details of these cases were discussed and they were concluded in less than a minute in most instances.

In fact, in most cases the respondent (the borrower) did not attend the session.

  • Borrower present and/or represented (22)
  • Borrower not present or represented: (44)

In two-thirds of the cases listed the borrower was neither present nor represented at the session.

The most common outcome among the 66 cases was for borrower to be absent and for the applicant to seek an adjournment on the grounds of an ARA being put in place.  This happened in 17 cases.  In 3 cases the adjournment on the grounds of an ARA was granted with the borrower being present or represented in court. And in one case the applicant wasn’t represented in court.

There were 32 cases in which the applicant wished to proceed to obtain the granting of the possession order.  In 15 of the cases the borrower was neither present nor represented.  Of the 32 cases that proceeded, an order for repossession was granted in 16 instances.  These are summarised in the following table. Click to enlarge.

Orders Granted

In 14 of the cases where an order for possession was granted the borrower was absent.  In the two cases where the borrowers were represented (though absent) the orders were consented to.  In all cases where an order was granted a stay on their execution was granted for between two and six months with longer stays on those which were believed to be occupied.  This is nominally to give people time to find alternative accommodation but the time can also be used to reach agreement on an alternative repayment arrangement if one is possible.  Not all orders granted for possession result in the property being repossessed.  It is also the case that there was no discussion of what would happen with a shortfall, if any remained, after the value of the property was offset against the mortgage.

In all cases with orders granted the representative from the applicant made a request for costs and a €300 contribution was granted.  In the 14 cases where details were discussed the average amount of arrears was €51,500 and on most no repayment had been received for over three years with two instances of no repayment having been received in six years.

No borrower who was present or represented had an order for possession granted against them.  Their cases were adjourned by the County Registrar for one reason or another.  In these cases the County Registrar was excellent.  She listened patiently to the respondents, never interrupted and was helpful and understanding.  The pace of the proceedings can be bewildering but when a borrower was present the pace slowed right down.  The County Registrar allowed the borrowers the space to say what they wanted to but, in the main, kept the exchanges to the salient points.

All cases where the applicant sought to proceed with the order for possession and the borrower was present were adjourned.  In one such case no payments had been made since April 2009 with €76,400 of arrears accrued and the County Registrar emphasised the importance of making some repayments.  There were two other cases adjourned where the borrower was present and had not made any repayment since 2011 and these had €54,000 and €140,000 of arrears respectively.  In most cases where the borrower was present and the applicant wished to proceed with the case few details of the mortgage were confirmed.  There is a table here.

Some quotes from the County Registrar from various cases included:

  • "Everyone needs to show goodwill; some repayments need to be made."
  • "Nothing is possible without engagement; engagement involves making some repayments."
  • "There needs to be a level of engagement; make interim payments."
  • "It is helpful if one makes interim payments;  it doesn't have to be all or nothing."
  • "I have little interest in making orders for possession but there has to be engagement."
  • "Some money must be paid; take it one step at a time."
  • "I am concerned to see few repayments; some repayments have to be made on a regular basis."

The County Registrar was clear and a number of times said "I don't want to be making orders for possession" and that these could be avoided by the borrower if regular payments were made.  It didn’t necessarily have to be the full payment but regular payments were taken as a clear signal of engagement by the borrower. 

In a small number of instances there were separate Family Law proceedings on-going involving joint respondents. In these cases the possession proceedings were adjourned by the County Registrar.  There was one case which was transferred to the “Judge’s List” for hearing in the Circuit Court.

So the summary of the 66 cases involving residential properties is:

  • 33 adjourned by request of applicant
  • 16 cases adjourned where applicant wished to proceed (15 to return to the County Registrar with one placed on the “Judge’s List”)
  • 16 orders for possession granted (14 against absent borrowers, two consented to)
  • One proceedings struck out

One implication of this is that there is a big difference between the stock and flow of cases.  The same cases are listed, and adjourned, repeatedly.

UPDATE: Another session was held on Wednesday 15th April at 10am.  The legal diary listing the 81 cases is here.  One of the cases did not involve bank lending.  There were 80 cases with various lenders listed as the applicant and it is assumed that all of these involved residential property.  It was hard to tell as most of the cases were immediately adjourned when called and all 81 cases were completed in less than three-quarters of an hour.

Starting with the initial action of the applicant a summary of the session is:

  • Seek an adjournment to a later date (75)
  • Proceed to seek the possession order  (2)
  • Strike out the proceedings (3)

Across the 80 cases, borrowers were present and/or represented in 13 instances.  Of the 75 adjournments sought by the applicants the reasons were:

  • Have agreed or are negotiating an Alternative Repayment Arrangement (ARA) with the borrower (7)
  • This is the first listing of the case so a Practice Direction Adjournment (PDA) is mandatory (41)
  • Notice of the proceedings has not been served on the respondent (27)

In one of the seven cases with an ARA the property, which is vacant, had actually been abandoned and was taken into possession by the lender.  This case was adjourned generally with no subsequent date fixed but should probably have been struck out.

In the two cases where the applicant wished to proceed the with the case an order for possession was granted.  These are summarised here:

Orders Granted 15-04-2015

This session was very different to the first one described above.  For more than half the cases it was their first time to appear in court since notice had been served on the respondents and a Practice Direction Adjournment is required at the first hearing.  In most instances these adjournments were to the end of July but in a few cases the borrower was present or was represented and a longer adjournment was requested.  In most of these the adjournment was to October.

It was also the case that around one-third of the cases could not proceed because notice had not been served on the respondents.  Various difficulties were outlined by the agents representing the applicants in serving notice on the respondents.  In many of these cases there were joint respondents and notice had been served on one respondent and not the other. 

In most instances the case was adjourned to July to give more time for notice to be served.  For some cases which had been listed on a number of previous occasions an application for “substitute service” to doing so in person was made (such as pinning the notice to the door of the property). As stated the 81 cases were dealt with in less than three-quarters of an hour as very little progress was made in the vast majority of them.

Friday, April 10, 2015

US MNCs and nearly $100 billion of deferred taxes

The tax strategies of MNCs, and US MNCs in particular, continues to attract a lot of attention.  This week Apple, Google and Microsoft appeared before the Economics References Committee of the Australian Senate.  The exchanges followed the well-worn path of the companies explaining (some of) what they do with the politicians aghast that they don’t do something else – even though what the politicians suggest the companies do would actually be illegal.

Apple, Google and Microsoft are hugely successful companies (at the moment at any rate) but they are US companies.  The risks, functions and assets that actually generate most of their profits are in the US.  These companies only owe corporate income taxes to other countries on the basis of the risks, functions and assets they have there not because their customers are located there.

And even still these companies are subject to the 35 per cent US federal corporate income tax on their worldwide profits – so even if they do make profits in other countries they will be liable for US tax (though they will be granted a credit for any foreign corporate income tax paid).  The key aspect of the tax strategies used by MNCs is not to avoid corporate income tax in the countries of their customers, it is to trigger a deferral of the 35 per cent US corporate income tax that they are liable for.

The critical aspects of their tax strategies are:

  1. A licensing agreement with a subsidiary for the rights to sell the US MNCs products or services outside the US, and
  2. A structure to engineer a deferral of the 35 per cent US corporate income tax payment that is due on the profits made from these sales.

The licensing agreement will be with a subsidiary that is based in a low or no corporate tax jurisdiction such as Bermuda and a structure will be set up so that the US corporate income tax is not paid until the profits are transferred to a US-incorporated entity within the company’s structure, if ever.

The licensing agreement is key and this is entirely under the domain of the US tax authorities.  This establishes the payment the offshore subsidiary(i.e. non-US incorporated) must make back to the US parent for the right to sell the company’s products in markets around the world.  It could be that the price would be close to the profit the subsidiary would make from these sales so most of the profit would be transferred back to the US parent and the US corporate income tax that is due would be paid at that point. 

However, if the price is substantially below the profit the offshore subsidiary makes the profit accumulates in the subsidiary and, in certain circumstances, the US corporate income tax is not paid until a decision is made to transfer the profits as a dividend back to the US parent.  The main purpose of tax strategies used by US MNCs is to ensure :

  1. A low price is set in the licensing agreement, and
  2. that the circumstances to trigger a deferral are in place.

The criteria by which these can be set are set out in US tax law.  It is US tax law that determines whether the licensing agreement is appropriate and it is provisions of US tax law such as “check the box”, the “same-country” exemption and the “look-through” rule that allow a deferral of the tax.

Using these provisions in the US tax code Apple, Google and Microsoft are successfully able to defer the payments of huge amounts of US corporate income tax.  Under existing rules unless the locations of these companies’ risks, functions and assets change this tax would not be due to anyone else.  These are US-based companies and they owe US taxes.  Of course, to be able to defer huge amounts of taxes you need huge amounts of profits and these companies are hugely successful. 

And they do not hide their success in deferring US taxes.  They show how successful these strategies are in their financial statements.  The deferred tax liabilities come in two forms. The first is what the company have actually provided for in their income statements which is recognised on their balance sheets as being owed; the second is unrecognised because they do intend to transfer the money to a US-incorporated entity within their structure.  Here are extracts from the most recent 10k filings made by Apple, Google and Microsoft to the SEC.

APPLE: $43.6 billion of deferred taxes.

As of September 27, 2014, the Company had non-current deferred tax liabilities of $20.3 billion.

As of September 27, 2014, U.S. income taxes have not been provided on a cumulative total of $69.7 billion of such earnings. The amount of unrecognized deferred tax liability related to these temporary differences is estimated to be approximately $23.3 billion.

GOOGLE: up to $18.5 billion of deferred taxes.

Deferred income taxes, net, non-current $1.9 billion

We have not provided U.S. income taxes and foreign withholding taxes on the undistributed earnings of foreign subsidiaries as of December 31, 2014 because we intend to permanently reinvest such earnings outside the U.S. If these foreign earnings were to be repatriated in the future, the related U.S. tax liability may be reduced by any foreign income taxes previously paid on these earnings. As of December 31, 2014, the cumulative amount of earnings upon which U.S. income taxes have not been provided is approximately $47.4 billion. Determination of the amount of unrecognized deferred tax liability related to these earnings is not practicable.

MICROSOFT: $32.3 billion of deferred taxes.

Deferred income taxes $2.7 billion

As of June 30, 2014, we have not provided deferred U.S. income taxes or foreign withholding taxes on temporary differences of approximately $92.9 billion resulting from earnings for certain non-U.S. subsidiaries which are permanently reinvested outside the U.S. The unrecognized deferred tax liability associated with these temporary differences was approximately $29.6 billion at June 30, 2014.

This is a total of $94.4 billion of deferred income taxes for just three companies.  There is nothing hidden or untoward about this.  It is all there in the companies’ accounts.  This was achieved with licensing agreements sanctioned by the US and the deferral provisions of Subpart F of the US tax code.

There is a general deferral of the US corporate income tax due for non-US active income of US companies but most of the income in question here will be passive income (or at least has been converted to passive income) through the use of patent royalties, license fees and dividend payments.  There is a general non-deferral of the US corporate income tax due on the non-US passive income of US companies.  However, the companies can avail of the exceptions to this in Subpart F which were introduced for one reason or another.

All those shouting for a “clampdown” on tax avoidance by US MNCs should be aware that it is corporate income tax payments to the US that will be most affected – unless they can get these US MNCs to move the risks, functions and assets that generate these profits to their countries and the US is unlikely to stand for that.  It is one thing for the US to allow their companies to defer the payment of US tax; it is another thing to let another country to collect it.

Thursday, April 9, 2015

US MNCs at the Australian Senate

The Economics References Committee of the Australian Senate is undertaking an inquiry on “corporate tax avoidance”.  The inquiry was initiated last October with a call for submissions and oral hearings began this week. 

On Wednesday representatives from Google, Apple and Microsoft appeared before the committee.  The transcript of the session is here.  Unsurprisingly, numerous references were made to Ireland (27 times) and Irish (14 times – half of which were to “double irish”) during the course of the hearing.  Some extracts from the hearing are below the fold.

The fiscal impact of the banking crisis: how much did Ireland pay?

A research paper from the ECB has lots of useful information on the scale of the financial assistance provided by governments to their banks from 2008 to 2013.  As can be expected, given the size of our banking collapse, Ireland features quite extensively. 

The summary position for Ireland for the period from 2008 to the end of 2013 is:

  • Ireland is 1.8 per cent of Euro area GDP (2013)
  • The Irish government provided 12.9 per cent of the total financial assistance given to banks by governments in the Euro area (€65.2 billion out of €504.7 billion)
  • The Irish government acquired 6.3 per cent of the net financial assets acquired by governments from banks in the Euro area (€21.1 billion out of €336.5 billion)
  • Ireland incurred 26.2 per cent of the total government deficit impacting measures (capital transfers and net financing costs or revenues) to support banks in the Euro area (€44.0 billion out of €168.2 billion)
  • Ireland incurred 9.4 per cent of the public debt increase to the end of 2013 resulting from measures to support the financial sector (€48.8 billion out of €514.6 billion)
  • The Irish government has incurred 26.2 per cent of the estimated public losses to the end of 2013 from providing support to financial institutions in the Euro area (€44.0 billion out of €168.2 billion)

The full details for all 19 Euro area countries (and the UK) for the six points made above are in the following table which is based on the figures provided in the ECB paper.

Bank Bailout Costs[Conflict]

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