Hylton offers inside view of how financial sector was saved

Patrick Hylton testified before the FINSAC Commission of Enquiry this week, laying out his involvement in the bailout operation mounted by the Jamaican Government. Hylton, as a consultant to the Government, influenced the decisions made about the institutions that were sold, merged or otherwise disposed of. He later became the head of one of those institutions, National Commercial Bank Jamaica Limited. His formal written statement to the enquiry covered 54 pages and is being serialised in The Gleaner, starting this week.

My initial exposure to distressed financial institutions came as a consequence of my very brief involvement with the Blaise financial institutions in late 1994.

I had been headhunted and courted to assume the position of managing director of Blaise Trust and Merchant Bank Limited for several months by David Parchment, a representative of its new majority shareholder.

This majority shareholder was a company controlled by James Eroncig.

Within days of starting at Blaise, I discovered that it was insolvent - in spite of numerous efforts to conceal that fact from me - and immediately reported my findings to the governor of the Bank of Jamaica (BOJ) and the minister of finance and indicated my intention to immediately resign.

They both asked me to stay on for a few weeks while auditors worked to confirm my assertions.

I did hold on for a few days, but felt compromised with the knowledge I had while persons were entrusting their resources to the company, and resigned without further consultation with either the minister or governor.

Within days of my resignation, Blaise was placed under temporary management and I was asked to return and assist the temporary manager, Philmore Ogle, in unravelling its affairs and developing a scheme for its resolution.

During the period of temporary management, I was employed as operational assistant to the temporary manager and ran the day-to-day affairs of the company, as well as worked with Mr Ogle in finding a resolution to the problem.

The strategy for resolution of the failed Blaise entities was the creation of a special-purpose vehicle known as Financial Institution Services Limited (FIS), in which were vested the assets and prescribed liabilities of these entities, pursuant to a scheme of arrangement sanctioned by the Supreme Court.

Some time after the Century financial entities were placed under temporary management, I was informed by the minister of finance that I should liaise closely with Richard Downer as a precursor to FIS taking over the operations of Century in its post-temporary management transition.

This I did and at the conclusion of temporary management the assets and prescribed liabilities of the Century financial entities were vested in FIS.

The shares in FIS were held by the accountant general of Jamaica and the financial secretary.

mandate of fis

The mandate of FIS was to implement the terms of the schemes of arrangement for the Blaise financial institutions and Century financial entities.

Our role was focused on paying out depositors in accordance with the timetables agreed under both schemes, as well as realising on the assets held by both sets of entities — the Blaise financial institutions and the Century financial entities — while defending ourselves against litigation brought against us by the former owners of these institutions, as well as pursuing litigation against them where we found this to be justified as part of recovering taxpayers' money used to fund the intervention and, in particular, the payment to depositors who, despite the entities being insolvent, were repaid 90 per cent of their deposits, in the case of Blaise, and 100 per cent of their deposits in the case of other intervened entities.

My personal involvement in the resolution of the general financial sector crisis began in 1996 when the minister of finance appointed me as a member of the task force examining the problems in the sector with a view to finding a comprehensive solution.

I had developed an interest arising from my role in respect of the failed Blaise financial institutions, as well as my, at that time, limited involvement in the failed Century financial entities.

Ever since the failure of Blaise, I had taken an interest in understanding how financial institutions failed and the options open to the authorities to resolve failures.

The task force comprised members from the public sector with advisers being Ernst & Young and KPMG Peat Marwick, both out of the United Kingdom.

Their approach to assessment was on the basis of analysing data and other information received from distressed companies, along with macroeconomic data, to try to determine the extent of the problem facing those institutions.

On this basis, reports outlining the extent of the problem and a proposed approach to resolution were prepared for each financial institution in consultation with the principals of those institutions that had approached the minister indicating they needed assistance.

The institutions were the Eagle financial entities, Jamaica Mutual Life, Life of Jamaica, along with a couple others.

These reports were based primarily on the data provided by the institutions themselves.

I understood that this approach was used because the principals of these companies had approached the Government for assistance and, therefore, were expected to be very forthcoming about the extent of the problems they faced.

The authorities and principals of these companies also wanted to avoid the potential panic that could occur if the Government's advisers went into each institution to seek to do an independent in-depth analysis of the problems.

special-purpose vehicle

The task force eventually submitted its reports, which detailed its findings and recommended the formation of a special-purpose vehicle to spearhead the Government's intervention in the financial sector.

In January 1997, arising from these recommendations, as well as further deliberations with the task force, Dr Gladstone Bonnick, the Ministry of Finance and Cabinet, FINSAC Limited was incorporated.

FINSAC's shareholders were also the accountant general and the financial secretary.

The purpose of FINSAC and FIS incorporation was to facilitate the orderly intervention in troubled financial institutions, to preserve the deposits and life insurance policies and pensions of the public, and some confidence in the financial sector.

FINSAC was also to assist in restoring financial institutions that were considered capable of resuscitation and preparing them to be sold.

FINSAC and FIS reported to the Ministry of Finance, primarily through the financial secretary. Regular updates were provided in writing and in meetings, in which we indicated progress made and difficulties encountered in each of the major work streams.

Dr Bonnick was initially selected as chairman, and Dennis Boothe as consultant/CEO.

I was named as a director of FINSAC and was asked to continue to lend as much of my time as possible to assist FINSAC with its work given its limited human resources and my knowledge of the issues gleaned through my work with the task force, as well as at FIS, of which I was the CEO.

FINSAC held discussions with the troubled entities and, in March 1997, had its first major public intervention when the Eagle Financial Group was acquired for $1. That was the price paid because the group was massively insolvent.

I say 'first major public intervention' deliberately because there were some legacy agreements for assistance that had been provided, arranged by the ministry, prior to FINSAC's incorporation.

These included a loan to Jamaica Mutual Life, through the Ministry of Finance, which FINSAC was asked to assume.

The intervention in the Eagle Group was precipitated by a run on that institution which was unprecedented in Jamaica. It was an ugly and frightening experience which shook confidence in the entire financial system. I recall spending hours on numerous phone calls trying to assure several persons that there were safe banks still operating in Jamaica. By the time the run abated a few days after FINSAC's acquisition of the Eagle Group, Eagle Commercial Bank's overdraft at the BOJ exceeded $10 billion.

FINSAC's mandate to protect depositors, policyholders and pensioners was communicated to FINSAC and the world at large through a ministry paper.

Many questioned the wisdom of the Government's undertaking at the time to rescue depositors, policyholders and pensioners.

There are, and were at the time, powerful economic, social and political incentives to rescue depositors, pensioners and policyholders, as is the case in all countries around the world that have experienced financial sector distress.

The recent rescues in the United States and Europe underscore this point.

It is important to note that FINSAC was formed as a response to an existing crisis.

At the time of its formation, all the institutions that would be subsequently intervened were already insolvent and the loans bought by FINSAC were already non-performing and/or substandard.

FINSAC's role, therefore, was to find a way to resolve this conundrum with its limited resources, consistent with its mandate while seeking to maximise value through its activities.

There were a series of subsequent interventions in Life of Jamaica Limited — now called Sagicor Life — Citizens Bank, Island Life, Dyoll Group and Dyoll Life, Jamaica Mutual Life, NCB, Victoria Mutual Building Society, among several other financial institutions.

It is to be noted that several of the institutions intervened were effectively rehabilitated and are important players in the financial sector today.

The rehabilitated financial institutions, as I recall, were Citizens Bank, Island Victoria Bank, Eagle Commercial and Merchant Bank, Horizon Merchant Bank and Workers Savings and Loans Bank — these were amalgamated into Union Bank, now called RBTT Jamaica Limited; Crown Eagle Life, Dyoll Life, Horizon Life and Jamaica Mutual Life —amalgamated into Guardian Life; Life of Jamaica — including also what was then Island Life; Victoria Mutual Building Society; and NCB.

The rehabilitations were accomplished by injection of capital, appointment of new boards and sometimes new management, development of rehabilitation business plans in conjunction with our consultants and the rationalisation of costs and infrastructure, as well as the consolidation and/or merger of institutions and their business. FINSAC took shares in all the intervened financial institutions that survived, except for Victoria Mutual Building Society.

In March 1998, I was appointed managing director of FINSAC, following Dr Bonnick's resignation.

By that time, FINSAC was the owner and/or conservator of a large number of companies and, consequently, a large segment of the indigenous financial-services industry.

In addition, FINSAC, through this process, had also acquired significant real sector holdings across a diverse range of industries.

FINSAC had, by the end of this process, a significant interest, very often control, in more than 200 companies, several of them large and important operating companies in Jamaica.

The scale of this involvement was driven by the fact that the intervened institutions had themselves acquired these businesses as assets.

It was impossible to proceed with an intervention which ignored these assets held by the institutions.

I was also appointed by the minister of finance to the boards of NCB, Crown Eagle and numerous other entities intervened by FINSAC.

This, although representing significant additional work, gave me another perspective and insights into the challenges facing them.

A common characteristic of the intervened financial institutions was the absence of an appropriate framework for the management and monitoring of critical risk areas such as liquidity risk and foreign-exchange risk.

They were, in many instances, not monitoring or actively managing issues such as gapping, duration and concentration.

This framework was particularly important in the post-foreign-exchange-market liberalisation environment, and banking executives would have been expected to realise this.

On the credit risk and operational risk sides of their business, there were also significant inadequacies and quite frequently an inappropriate and insufficient governance framework.

The absence of these factors in many of the locally owned institutions contrasted, at the time, with the foreign-owned banks operating locally, largely where these practices and systems were well entrenched.

This provides some explanation as to why those institutions were able to go through the period of high interest rates unscathed.

A common characteristic of the majority of the intervened financial institutions was that they were run by executive chairmen. While this might not be considered by many to be a significant issue with non-financial companies, it was also highlighted as a common theme among many large financial institutions which failed in the global crisis of 2007-2008.

The point is that good governance often requires a separation between the chief executive officer and the chairman in companies operating on significant leverage and, consequently, managing significant risks.

The dominant characteristic of these holdings was that they were experiencing distressed financial conditions and were badly in need of support, restructuring and rationalisation.

It was a massive undertaking, the scale and scope of which was unprecedented in the Jamaican context.

The initial efforts at supporting the rehabilitation of the distressed financial institutions that had approached the Government would have been largely informed by the estimates of the extent of the problem and the resources required, as indicated by the institutions themselves.

With the exception of the Eagle Group, initially those interventions primarily involved FINSAC taking 26.5 per cent equity - that is, ordinary shares - some preferences shares and a few seats on the boards.

The expectation was that FINSAC would then monitor the performance of the companies, collect payment of the interest on the preference shares and eventually exit when the company was strong enough to redeem the shares.

As it transpired, however, several if not all of the companies came back seeking further assistance, some more than once.

It was clear that the size of the problem was grossly underestimated through the approach that had been used, which was based on the information provided by the intervened institutions themselves.

We also needed to develop a framework for financial-sector restructuring and rehabilitation on a sustainable basis if we were to quickly resolve the problems, minimise the costs and maximise the value of the Government's, and by extension taxpayers, investment in the sector.

It was not unusual for me, personally, to receive over 200 calls per day during that time, many of them requiring urgent attention from the management of companies and their customers, suppliers, etc.

This would be in addition to numerous emails, meetings and other activities.

The challenge facing us was clear.

To quote from our then chairman, the late Dr Kenneth Rattray, OJ, in his chairman's remarks in FINSAC's 1999 annual report: "We realised that the fire-fighting was finally over, and that what we needed to do now was to assess the extent of the damage in the sector, and work out what new superstructures might be needed for rebuilding to proceed."

In my own remarks in the same report, I said: "We considered two key questions: How could FINSAC, as an institution, maximise the value of Government's investment in intervention? How could we ensure that the new financial sector we were planning to build, would be sustainable?"

To assist us in making these and other consequential decisions, we contracted the services of the internationally respected firm McKinsey & Company.

Cross-functional teams of their consultants and our staff worked tirelessly using detailed financial models and other analyses to produce a plan for dealing with the financial institutions under our control, as well as the non-core and non-performing assets we had acquired.

We also established the framework of a plan for regulatory and legislative reform of the sector.

Essentially the diagnostic, which was completed in the summer of 1998, highlighted the need for a massive undertaking of consolidation and rationalisation of our core financial-sector holdings to reduce costs, remove excess capacity and restore viability.

The substance of our findings was that there were too many institutions operating in the sector.

Some dominant features of those intervened was an overinvestment in real estate and other underperforming assets, and severe liquidity problems.

Our findings also underscored the need for the establishment of an institutional framework for the management and eventual sale of the institutions' non-core and non-performing or under-performing assets as key sources of badly needed liquidity in the short term.

These included loan and real-estate assets.

Rationalisation and consolidation of both the banking and insurance holdings of FINSAC was an urgent prerequisite for sustainability. We also developed a series of key considerations and requirements for legislative and regulatory reform.

Key among these were the recommendations in relation to insurance regulation which informed the Insurance Act and Regulations passed in 2001.

FINSAC's organisational structure was reorganised and resourced to efficiently and effectively support the major work streams.

There were also important subunits within each functional area.

The major functional areas in the new structure were banking intervention and rehabilitation, insurance intervention and rehabilitation, asset management and divestment, legal counsel, finance and administration, and monitoring and evaluation. There was also the important function of liquidity management for the intervened entities, as well as FINSAC.

We recognised that the structure of the companies in which FINSAC had acquired control - many of them had entities operating in both banking and insurance, as well as non-financial operations - required close collaboration and cross-functional work within FINSAC.

In addition, activities such as regulatory reform, even when anchored in one area, would require collaboration from multiple areas.

It is against this background that FINSAC executed its plan for mergers, consolidation, rationalisation, workout, restructuring and the sale of assets, as well as its holdings in the financial sector.

The rationale for significant mergers and consolidation was fairly simple.

It was clear that many of the institutions, unable to find sufficient core activities in banking and insurance, had gone off on a frolic to engage in several real-sector activities without the proper funding and management structure in place.

Their continued involvement represented a strain on their financial and management resources.

Having intervened, FINSAC was now funding both their core and, in many instances, non-core loss-making activities.

To resolve this situation, it was decided to save costs by merging the smaller core banking and insurance businesses to create Union Bank, now RBTT Bank Jamaica, and a new insurance company with the right scale to make it sustainable.

In relation to the insurance company, the proposal evolved into the eventual sale of the portfolios of Dyoll Life, Mutual Life and Crown Eagle to Guardian Life.

This would also remove significant duplication and costs.

The separation and sale of the non-core assets would stop losses, provide urgently needed liquidity and transfer these real-sector entities to appropriate owners which would enhance their prospects as going concerns.

These included Boscobel Hotel, Terra Nova Hotel, Hedonism II and Grand Lido - which had been part-owned by Jamaica Mutual Life - Holiday Inn Hotel and Ciboney, which had been owned substantially by the Eagle Group, and the orange farm now operated by Trade Winds Citrus Limited.

In this way, they could meaningfully contribute to economic development.

One of the greatest challenges we faced was meeting the liquidity requirements of the intervened institutions. As the country did not have the cash resources, our primary means of intervention was with FINSAC notes, which primarily paid interest with additional notes.

While this addressed the solvency problem of the institutions, it did not solve the liquidity problem and several institutions continued to experience cash deficits.

We had to establish a liquidity management function within FINSAC to monitor on a daily basis the liquidity needs of these entities.

FINSAC personnel worked closely with persons from the ministry of Finance's Debt Management Unit, Accountant General's Department, and the Bank of Jamaica to successfully manage this challenge.

Hylton's work history

1981                 Teller, Bank of Nova Scotia Jamaica.

1988                 Citizens Bank.

Nov-Dec 1994    Blaise Trust and Merchant Bank.

1995                
Operational assistant to temporary manager of Blaise Trust Company
and Merchant Bank, and its

                         affiliate  Consolidated Holdings Limited.

Nov 1995            General manager/corporate secretary, Financial Institution Services.

July 1996           Managing director, Financial Institutions Services.

Mar
1998           Also engaged as managing director, Financial Sector Adjustment
Company Limited to June 2002 and then as a consultant.

May 2003           Deputy group managing director, National Commercial Bank Jamaica.

Dec 2004            Group managing director, NCB.

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