It is now widely known that NAMA is valuing loans that it is acquiring by reference to a valuation date of 30th November, 2009. Since that date property in NAMA’s main market, Ireland, has continued to decline whilst property in some other markets has improved in value. Starting today there will be a new index which attempts to track the value of NAMA’s loans (essentially the property securing the loans) by creating a single index which makes use of the mix of NAMA assets (residential and commercial) and by country (Ireland and the UK). An index value of more than 1000 means that NAMA’s loans are worth more than was paid, and an index value of less than 1000 means that NAMA’s loans are worth less than was paid. The index today following the release of Q2, 2010 commercial capital values in Ireland by Jones Lang Lasalle is 917, meaning that property had to rise by 9% to equal the sum paid by NAMA for the loans.
Background – split of loans by country
According to the draft NAMA Business Plan in October 2009, 67% of assets backing NAMA loans were located in Ireland and 27% were located in the UK. The remaining 6% were located elsewhere – although the US and Canada were given prominence by some, it seems that 0.5% is located in Eastern Europe. Frankly rest of world could cover any number of countries – Irish developers were active in any number of countries outside Ireland/UK/US/Canada/Eastern Europe including Cape Verde, South Africa, United Arab Emirates, Turkey, Spain, France, Germany, India, China, Vietnam, Brazil (and that’s by no mean a comprehensive list). There has been no definitive update on the location of the property securing the NAMA loans since last October 2009 so the index assigns a weighting by territory of 71% to Ireland (67% plus 2/3 of the 6% that was designated Rest of World) and 29% to the UK (27% plus 1/3 of the 6% that was designated Rest of World). Slides used by the NAMA CEO and Chairman in Kerry and Galway respectively in September 2010 are still showing the same geographical split as in the draft Business Plan.
Background – type of assets
NAMA was intended to take over land and development loans, which simplistically were loans secured on land or buildings where development was expected. However even from the outset NAMA was to take over associated borrowings by the same developer and that brought “associated assets” into the picture. Those associated assets seem to be, by and large, other property (commercial property, residential property) but also include everything from wine collections to helicopters to share portfolios. Now development land in Ireland has fallen by 75-90% according to a recent report by Savills. But there is no index produced on development land so for the purposes of this index, it is assumed that development land has, since November 30th 2009, followed and will continue to follow rises and falls in commercial and residential indices. The mix of commercial and residential then needs to be estimated and NAMA are not very helpful in this regard because although they have indicated for Tranche 1 and 2 the breakdown of loan by type of property, they have not extended that analysis to type of property by location . The breakdown of Tranches 1 and 2 shows that 13% of the loans relate to completed residences. In addition 26% relates to development and presumably some will be residential. Let us assume that residential makes up 20% of all loans acquired in all territories. Therefore 80% will be commercial.
How the index is calculated
Firstly we set the CMV (current market value) of the loans at November 30th, 2009 at 100 – that’s just for ease of calculation. Next we split the 100 between Ireland (71) and the UK (29). Then we need figure out how much NAMA has paid for the loans because NAMA are paying a premium on top of the CMV – the Long Term Economic Value (LEV) premium. According to the results of Tranche 1 and 2, NAMA has valued the CMV of the assets behind the loans at €12.97bn and the Long Term Economic Value at €14.33bn (ie LEV is 10.4% higher than CMV). So we know that if the CMV was 100 then the LEV will be 110.4. NAMA pays for loans in two ways – 95% is via NAMA bonds and 5% is via subordinated debt. The subordinated debt will not be honoured if NAMA makes a loss, so from the LEV of 110.4 is deducted 5% (remember this index is about NAMA breaking even). Although NAMA is entitled deduct from the LEV a contribution for its due diligence and enforcement costs as well as a NAMA premium to cover its overall operating costs, these deductions are ignored in the calculation of the index because the assumption is that the deductions will be in fact be used to finance NAMA’s costs of due diligence, enforcement and general operation and that NAMA will break even on this contributions. Therefore the LEV minus 5% for subordinated debt is what NAMA needs recover before it breaks even.
Next we need to know the split of the loans between residential and commercial. That split at present is 20:80 and the reasons for that are set out above. Next we need know the performance of the residential and commercial markets in Ireland and the UK since last November 2009. The performance is measured by reference to indices that NAMA itself judges reliable enough to include them as acceptable references for loan valuations in the LEV Regulation. So for Ireland we use the Permanent TSB/ESRI Index for residential, the Jones Lang Lasalle index for commercial (unfortunately both are quarterly – there are no monthly indices in Ireland) and for the UK we use the Nationwide Building Society index for residential and the IPD index for commercial (both are monthly). By applying the split between residential and commercial and the performance of both in the two markets since November 2009 we can calculate what the CMV should be today.
By calculating the CMV today we can calculate what % increase is needed to the CMV today to get to the LEV (minus 5% for subordinated debt) that was paid for the loans. We can convert that % into an index (with the base at 1000) by working out what index would correspond to the % increase needed to break even. And so today the index in October 2010 after the publication yesterday of the JLL quarterly Ireland commercial property index is 917 indicating that a 9% increase is needed to current market values to break even. Below is the calculation.
When the index is updated?
When the four indices are updated (the Ireland residential and commercial indices are published once per quarter, the UK indices are updated monthly)
What are the drawbacks of the index?
(1) The price indices used to measure performance from November 2009 to date are overall indices and may not be representative of the mix of assets that NAMA has acquired eg commercial indices include performance for industrial, office and retail buildings which might not correspond to the NAMA mix of commercial properties.
(2) The index assumes the 6% of NAMA assets that are located outside Ireland and the UK perform exactly in line with the mix of properties in Ireland and the UK.
(3) The index uses the split between residential and commercial property implied by the results of the Tranche 1 and 2 NAMA loans. Also it is assumed that both the UK and Ireland have the same mix of residential and commercial loans.
(4) NAMA land and development assets may not perform in accordance with residential and commercial indices. Development land in Ireland is reportedly down 75-90% from peak whereas commercial prices are down 59% and residential is down 36%.
(5) NAMA may gain control of associated loans that have nothing to do with property eg business lending, fine wines, cars, helicopters, yachts. No account is taken for these loans.
(6) Future tranches may not have the same characteristics as Tranche 1 and 2 in terms of split between residential and commercial.
(7) Exchange rate movements between sterling and the euro may affect the mix of loans between the UK and Ireland.
(8) Future LEVs as a proportion of CMVs may be different to those in Tranches 1 and 2.
And finally, a new header!
The reason this blog is called NAMA wine lake is grounded in the concern that NAMA might have an effect on property prices similar to the effect brought about by the policy which gives us wine lakes. Wine lakes after all are artificial economic stores of the produce of (mostly) French vineyards, and the policy objective behind wine lakes is to avoid flooding the market and driving down prices which might deter producers and lead to uneven production with shortages and oversupply in subsequent years. Its sibling, butter mountains, is the other visual product of the EU’s Common Agricultural Policy which was set up to ensure some stability in the production and pricing of a vital product – food. Wine on the other hand is not essential but nonetheless French wine growers in particular lobbied for, and secured, protection for their product. Unlike food, property is not an essential (when oversupply is an issue) and my great concern for NAMA at the outset was that it would distort the natural course of the market in dealing with oversupply and would lead to artificial support for prices to the extent that it would stagnate activity in the property market (transactions, construction) and act as a drag on wider economic recovery. We have been conditioned in recent times to regard surplus or vacant property in the State as a bad thing. But think about it from an economic viewpoint – we have constructed a vast national asset which should drive down housing and accommodation costs which should be a massive boost to competitiveness and the cost of doing business in Ireland, not to mention benefits to society where we can eliminate homelessness totally and increase the security and responsibility of citizenruy and there should be huge boosts to sectors as diverse as retirement/nursing homes to tourism. The new header graphically expresses the concern with NAMA, that it will prevent price discovery through propping up prices for a time but as time goes on NAMA itself may stifle the property market and the economy generally so that true recovery takes far longer. Also if you squint at the graph it looks like the topography of a lake!
UPDATE: 13th May, 2011. Following the abandonment in the PTSB/ESRI publication of its index, the new CSO index will be substituted for the old index.