MARK PRIMEAU
Guidelines clarified
The federal bankruptcy reform bill, signed into law in late April by President Bush, will create stricter guidelines for consumers and businesses looking to file for bankruptcy. Effective in six months, it is receiving praise from local bankers and trade associations, but few in the industry expect to feel much impact.
“It’s long overdue,” said Charles Valade, president and chief executive officer of Commonwealth National Bank in Worcester. “It will make people think twice about piling on debt with the idea of just walking away from it.”
Changes to the bankruptcy code clarify guidelines for parties on both sides of a bankruptcy filing, according to one local banker.
“It clarifies a lot of issues for creditors and debtors,” said Mark Primeau, executive vice president at Boston-based Eastern Bank, adding it creates a more “equitable” system.
Daniel J. Forte, president of the Massachusetts Bankers Association, said the bill makes some positive steps in correcting abuses that have occurred over the last 20 years. However, he admitted that banks in Massachusetts won’t notice a big change because few offer unsecured credit, such as credit cards.
“Is this going to be a revolutionary bill favorable to banking? No,” Forte said.
According to the American Bankers Association, the bankruptcy reform bill creates a more “objective, needs-based” bankruptcy test that will be used to decide if debtors can afford to repay some or all of their debts. That change, ABA noted, will force more bankruptcy filers who are capable of repaying a significant amount of their debts to do so under Chapter 13 of the bankruptcy code. The means tests “creates a presumption” that debtors can repay their debts if they earn more than their state’s median income, which is approximately $54,000 nationally for a family of four, according to ABA. Debtors also would have to have at least $100 per month leftover after living expenses and payments toward taxes, alimony and child support.
The median income in Massachusetts, according to MBA, is approximately $83,000. If a debtor makes more than that amount and can pay the lesser of $10,000 or 25 percent of the debt outstanding, but not less than $6,000 over a five-year period, then that individual would file under Chapter 13 with a debt reconstruction plan instead of filing under Chapter 7, which eliminates most debt, according to information published by MBA.
‘Formulaic’ Process
A means test will allow for special cases to permit debtors to file for bankruptcy. It will allow those who make less than the state’s median income and those who cannot afford to repay their debts to file for bankruptcy.
“The means testing makes the process more formulaic,” said Emmanuel Grillo, partner with Boston law firm Goodwin Procter and chairman of the firm’s bankruptcy and restructuring practice.
Individuals seeking bankruptcy relief will now be required to undergo credit counseling from an approved nonprofit agency.
Forte said the bill isn’t intended to hurt the poor and indigent.
“It does retain an opportunity for a fresh start for those truly in need,” he said.
According to ABA statistics, the total number of bankruptcy cases filed in 2004 totaled more than 1.6 billion. Before the bankruptcy reform bill, higher-income filers were free from repaying $3 billion to $4 billion annually, some of which they can afford to repay.
While it is still too early to tell how the changes to the bankruptcy code will affect banks, Grillo said financial institutions will certainly see a positive impact on business.
“It should have an impact on the recovery rate in respect to consumer loans,” Grillo said.
Within the changes are commercial bankruptcy improvements, which could impact banks with a large commercial customer base, like Commonwealth National. However, Valade said he is not expecting to see much activity. It removes the current $4 million debt cap on single-asset real estate cases in which expedited relief for creditors is available, according to ABA. The court must grant relief from the automatic stay within 30 days after determining the debtor has not filed a realistic reorganization plan or began making monthly payments to creditors.
“These provisions will end abusive Chapter 11 filings that waste assets and allow property deterioration where the debtor has no feasible chance of reorganizing,” the ABA said.
MBA supported the bill, which took nearly a decade to be passed, and recently informed member banks on the provisions of the bill that will eliminate abuse practices. The changes will eliminate the ability of repeat bankruptcy filings to delay foreclosures. In addition, abusers will be prevented from loading up credit cards prior to bankruptcy, and the law also lengthens the time between filings for Chapter 7 from six to 10 years and for Chapter 13 from zero to five years.
“It’s designed to go after the top-tier abusers,” Forte said.
Although banks have waited for years for such reform, Grillo said changes won’t happen overnight.
“[Banks] will adapt over time,” he said, adding it is hard to predict exactly how banks will adapt.
Judges will also have a greater role and overall, Grillo said the “interplay of a number of different constituencies whose roles will be determined” will occur over the next few years.
Banks like Commonwealth National, with approximately $182 million in assets, Eastern Bank and Arlington-based Leader Bank all said they don’t expect a dramatic impact on their institutions.
Sushil Tuli, president and chief executive officer of Leader Bank, said he expects banks will win out with the bankruptcy reform because banks won’t have to write off as many debts. However, he said he doesn’t expect to feel much of an impact at Leader, which has more than $135 million in assets.
Regional institutions such as Eastern Bank – which has $6.4 billion in assets – also don’t expect to feel a major shakeup.
“It is going to be good for banks – some banks more than others,” Primeau said.
Banks with unsecured credit, such as credit cards, will reap the most benefits from the reform, Primeau said. Because most banks are able to realize collateral on residential and auto loans, bankruptcy hasn’t been much of an issue. Also, because real estate prices have been high, Primeau said many borrowers sold their homes before entering into bankruptcy.
Forte said individual banks probably won’t be impacted, but said the changes will make the system more affordable for everyone.
Despite the sweeping changes to the bankruptcy law, Primeau said he doubts banks will change their underwriting standards.
“We never want to make a loan that a customer can’t pay back,” he said.
Commonwealth National’s Valade agreed, saying the way his bank makes loans won’t change. Looking at a customer’s individual profile is how Commonwealth National will continue to determine loan approvals.
Although bankers feel that the benefits exist for both sides, Forte noted that people must be held accountable.
“It gives protections to consumers and lenders in the long run,” he said. “[But] individuals have to be responsible for their actions.”
Jennifer Jope may be reached at jjope@thewarrengroup.com.
