Lorcan O'Connor on sustainability of split mortgages

Lorcan O'Connor, Director of the Insolvency Service, addressed an IBF conference on Thursday and made some interesting comments on whether split mortgages were sustainable.

The starting point is that the PIP must certify that the borrower will be solvent at the end of the PIA.

This can only be achieved if there is clarity in the treatment of the warehoused part. Such clarity would be achieved by specifying

• that, in the event of an increase of x% in salary, y will be moved to the active part
• that inheritances or lump-sums will be used to pay it down
• that it will be paid from the proceeds of the disposal of the house on death.

The borrower would not be regarded as solvent if the treatment of the warehoused part is left vague i.e. at the discretion of the lender.

Danske have changed their tune on split mortgage. Changed from simple interest on warehoused portion to no interest.

If part of your home loan is “warehoused”, interest will not accrue on this Warehoused Balance and the principal only of the Warehoused Balance will become payable at the end of the loan period.

Your home loan, including any "warehoused" part thereof will remain secured by the mortgage provided by you to us.

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What is more interesting is the bit about "the Warehoused Balance will become payable at the end of your loan period".

Does this mean that they won't seek to move money from the warehouse, if your financial circumstances improve?

Brendan

The definition of "solvent" in the Personal Insolvency Act is the ability to pay your debts as they fall due. A debtor could be "cash flow" solvent at the conclusion of a Personal Insolvency Arrangement, but could still be massively "balance sheet" insolvent, particularly if loans are "warehoused".

Jim Stafford

Hi Jim

His point was that if there is €100,000 in the warehouse and the lender can switch it to the active part at any time, you are effectively cash flow insolvent.

If the process by which the money is moved from the warehouse is specified in such a way that you do not become cash flow insolvent, then it is acceptable.

I think the strong hint coming from the ISI now is that "cash flow" solvency on its own is not an adequate outcome of an insolvency arrangement where there are split mortgages involved

If split mortgages are to become part of an approved debt arrangement then there needs to be very clear and tangible plan for paying off the warehoused debt in the future eg a relatively certain Inheritance, Redundancy payment or perhaps even a retirement lump sum.

Lorcan O Connor has made special reference to this on one or two of his luncheon speeches so far and interesting to note that none of the ISI case studies advocates a split mortgage as part of a debt arrangement solution.

Hi Dr Debt

I don't think that there has to be a relatively certain inheritance as such.

I think that the lender must agree that they will not be taking the mortgage out of the warehouse, except in the event of a salary increase or an inheritance.

Brendan

I would suggest that when banks understand the full implications of the Personal Insolvency Act that they will realise that the "clawback" provisions (See Section 103 of the Act) are very valuable to them. For example, if a bank agrees to treat €100,000 of its secured debt as unsecured, and if the property is sold within 20 years for €100,000 more than its value at the time of the PIA, the bank will get back the €100,000 (in full!)

Jim Stafford

Hi Jim

I don't think that the banks think much of that. What is €100,000 in 20 years worth today?

And after say 12 or 13 years, the home owner will just sit it out until the 20 years to sell.

With a split mortgage, they can move some of the mortgage from the warehouse and start charging interest again.

And there is no 20 year cliff either.

In terms of poker hands and from the eyes of the bankers , I think that split mortgage must be seen as a far better proposition to them. The bank still has the security in place and is in a good position to benefit from any property price rises in the future or any favorable change in circumstances of the Debtor. Unfortunately there is no guarantee that either Debtor circumstances or property prices will improve any time soon and for this reason, I don't believe that the banks will be allowed to play this card too often. If the banks are allowed to use split mortgages as a means of avoiding the unsustainable mortgage "work-out" then there's a chance that we'll be no further along in five years time. I dont believe any of our Troika partners will tolerate that.

I still sense that split mortgages are being frowned upon by the ISI too. How can you really say that a debt arrangement has succeeded if you have only managed to park the problem into the future. I know that there is a belief out there (and I dont think that I'm imagining this) that the debt problem needs to be solved now and over the next five or six years and no longer. The ISI's definition of insolvency (cash flow basis) is ok for now as a basis for working through the problem and as a basis for deciding who qualifies for a debt arrangement, however I think most people realise that the only meaningful definition of insolvency is the "balance sheet" basis and that can't be ignored for ever.

S.103 provides for a clawback which allows a secured creditor to convert part of the secured debt into an unsecured debt, allows him to pick up the same dividends as other unsecured Creditors and also allows him a claw back later on if that opportunity arises. This is a better approach to the problem. There's something in there for everyone and there are no skeletons hiding in the warehouse at the end of six / seven years

I note that the Seanad passed the Courts & Civil Law (Miscellaneous Provisions) Bill 2013 on 2 July 2013. Once it is enacted, it will make 15 amendments to the Personal Insolvency Act 1988 and 42 amendments to the Personal Insolvency Act 2012. Many of the amendments are technical in nature and do not change the thrust of the legislation.

Jim Stafford

Dr.Debt said:

I think most people realise that the only meaningful definition of insolvency is the "balance sheet" basis

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Well I am not included in that "most people" category.

80% of people are paying their mortgage repayments in full and should be encouraged to do so.

Maybe around 50% (?) are in negative equity. If they have no other assets, which most of them don't, they are insolvent on a balance sheet basis.

If someone can pay the debts that they freely entered as they fall due, they should not be getting any form of debt relief.

Brendan , I think you might be missing Dr.Debt's point here.

I totally agree with you that any body who is able to meet their mortgage repayments in a negative equity situation should continue to do so and be encouraged to do so.These people will be fine as long as they keep paying.
I am happy to consider this type of person as solvent.

A completely different situation arises where an individual, who continues to hold a split mortgage at the end of a six year debt arrangement and who has a sizable chunk of debt warehoused at that point and has no visible way of paying it back, cannot be considered solvent whatever way you measure it and for that reason I agree that the use of split mortgages in the new debt arrangements cannot be considered a serious or viable mechanism IF the end goal is to restore the Debtor to solvency after 6/7 years.

Hi Importer

I don't think I am missing his point at all. He is quite clear that the only definition of solvency is the balance sheet basis. I don't agree with this.

In the context of split mortgages, if I owe the lender €300k on a property worth €200k, but the lender requires payments based on €200k, and I can afford them, then I am solvent.

If the lender can pitch me into insolvency by shifting the €100k out of the warehouse at their discretion, then I think it could well be argued that I am not solvent.

Brendan