“The perception of Irelandexternally is very positive. We have taken the right decisions and are moving in the right direction. We would not be in the position we are in right now if we had not gone down the NAMA road” NAMA chairman Frank Daly speaking to the Financial Times about the application of a NAMA-type solution toSpain’s banking woes
When Ray Kroc was opening his first franchised McDonald’s fast food store in 1955, how could he have imagined that it would grow to over 30,000 stores today. The simple format of basic tasty food worked worldwide and backed up by sound management, the company is one of the most successful in the world. Last night as I read NAMA chairman Frank Daly’s comments provided to the Financial Times about the prospect of Spain adopting a NAMA-type model to sort out its banks, there was a momentary flash of Ireland starting a new service industry which could be franchised and exported across the globe. And there might be something in that, but first of all Spain will need to decide if the NAMA model is suitable for its intensifying problems.
The recent background to Spain’s problems is that its general economic difficulties with deficit, economic growth and unemployment are being exacerbated by problems in its banking system, seemingly caused by losses on loans to the property sector. There is a blogpost on here which examines Spain’s property and banking sectors and concluded that the country appears to have a similar profile to Ireland, but unlike Ireland its property market hasn’t been resolving itself with price declines of just over 20% compared with 50% here, despite similar levels of over-construction and the conclusion was that its banks may be sitting on losses akin to those uncovered in Irish banks, losses which if shouldered by the Spanish people would lead to the Spanish debt:GDP equalling that of Italy, Portugal, Ireland – around 120%.
This blogpost sets out 10 questions that Spain might ask itself before adopting a NAMA-type solution to its banking problems.
(1) What banks need to be NAMAed? Spain has a highly developed banking system with international, national and regional banks. If the Spanish government is to take control of certain banks, it makes sense to have the relevant assets of all of those banks transferred to NAMA. In Ireland we have NAMA with a current portfolio value of just over €25bn competing with IBRC, a 100% state-owned bank with €17bn of loan assets which is also running down its loan book in the same time frame as NAMA. So, in addition to duplication of effort, we have competition for sales and resources between state-owned agencies, which in turn compete with banks outside the State’s control eg Ulster Bank, Bank of Scotland (Ireland)
(2) How big are the losses in the banks? In Ireland there was an initial assumption that the losses on property lending were only 30% whereas in fact, it turns out that they were more than 60% – NAMA paid 43c in the euro for loans, but a recent report by the Comptroller and Auditor General claims NAMA overpaid by 20%. If the losses are too great in any individual bank, then NAMA may not be suitable for that bank.
(3) What is the limit of losses that can be shouldered by the nation?Ireland has so far shouldered €63bn to bailout our banks which represents 40% of our GDP. In addition we found out last week that NAMA had provided €5bn of state-aid to the banks, so the true cumulative current cost of our bank bailout is €68bn and if the mortgage crisis explodes or deleveraging proves more difficult than expected, then that may well grow. So Ireland’s debt:GDP of 120% in 2012 is one third due to bank debt. Many economists believe this debt is unsustainable and will need be restructured or defaulted on. Spain has debt:GDP of over 70% but that is forecast to rise to over 80% this year. If it takes on the same proportional amount of debt as Ireland did to rescue its banks, its debt could balloon to 120%. If Ireland had known that its 25% debt:GDP in 2007 would balloon to 120% in 2013, then it is likely that as a society, other solutions would have been pursued.
(4) What activity are the losses associated with? In the UK they had losses with banks investing in US subprime mortgages. In Ireland we had banks over-lending to various domestic property sectors. NAMA is suitable where is there is uncertainty or doubt over the value of problem assets. For example if the problem was exposure to sovereign debt, then that should be quite easy to calculate, but with property lending, the value of the loan may be a direct function of the present value of the property and that can be difficult to ascertain and unless there is a NAMA process, potential investors and lenders may be deterred from working with banks whose assets have doubtful value. Also it will be no good to deploy a NAMA scheme to a small subset of assets which are of doubtful value. NAMA needs to be part of a campaign which ensures banks are substantially relieved of doubtful assets and are recapitalised to an extent that they act to support the economy.
(5) How competitive is your legal, accounting, insolvency and property professional services? NAMA is spending a fortune on Irish professional services which are amongst the most expensive in Europe. NAMA’s costs are expected to be €1.4bn over its lifetime which represents less than 5% of the assets it initially acquired.
(6) Are prices still falling, when will the bottom be reached and what will the declines have been at that stage? In Ireland’s case it was hoped that late 2009 would have been the bottom of the property cycles and that NAMA could easily nurse distressed lending and the underlying property for a short period before disposing of these assets at prices above what had been paid. Yield analysis was notoriously deployed to demonstrate that the Irish property markets were at, or were close to, the bottom. As it happened, yield analysis was inappropriate to an economy in extreme distress, and since late 2009, both residential and commercial property has declined by 20%-plus. The consensus is that we are a year off the bottom for residential property and possibly less for commercial property. But this means that 2.5 years into NAMA’s life, the Agency is nursing huge losses and the Comptroller and Auditor General said last week that it would be a challenge for NAMA to break-even by 2020. NAMA’s ultimate loss will be shouldered by the nation, so that has to be taken into account when deciding how much is too much debt.
(7) Will the valuation process be credible? Here’s where there might be a franchising opportunity for NAMA. Its valuation process was approved by the European Commission which has also approved the detail of one third of NAMA’s acquisitions. Without intending any disrespect to the Greek people generally, I don’t think there would be a lot of trust in a Greek NAMA because of the perception of political corruption. What about a Spanish NAMA?
(8) Will the political structures allow NAMA to operate independently? If NAMA can’t place trustworthy values on the assets it acquires or is prevented from acting naturally to manage its assets, then you risk exacerbating distortions which can have unhealthy economic effects eg undermining property transactions. Of politicians get to own or control substantial amounts of assets, then experience tells us that we don’t always get corruption-free outcomes.
(9) Will the assets acquired by NAMA lead to unhealthy distortion in the marketplace? In Ireland, NAMA has acquired €6-7bn of commercial property lending in a market which was only worth €0.5bn in 2011. So NAMA has a dominant position in that market. The Agency has seemingly decided to generally hold its Irish commercial assets, which means the market is awaiting an artificially-removed-from-the-market loanbook to come back onto the market, and that anticipation encourages a stagnation of the market with expectations of price drops when supply increases.
(10) How robust is your legal system? In Irelandthere have been three challenges to the NAMA legislation, the first taken by developer Paddy McKillen was partly successful in Ireland’s Supreme Court and practically meant that NAMA did not acquire Paddy’s loans. The second was taken by David Daly but that seems to have been settled when David refinanced his loans out of NAMA and the legal matters at issue never got an airing or judgment. The third was taken by Treasury Holdings which has been given permission to pursue a judicial review of NAMA’s dealings with its loans and that hearing has yet to take place. If your legal system has holes in it, then wealthy developers and others will line up to take pot-shots at NAMA.
There are alternatives to NAMA. If the losses are too great, then all NAMA will do is crystallise colossal losses and unless there is a plan to provide adequate funding to replenish the capital lost through the NAMA process, then other options such as winding up insolvent banks need to be considered. The British solution was to throw extra cash at the banks to tide them over what was considered a temporary crisis, but if the crisis persists then the banks are still left with assets of doubtful quality which will act to deter investment and lending to banks, which in turn will lead to credit restrictions and the spancelling of economic growth. The perspective on here is that a NAMA-type solution has its place in the Spanish example, but it should sit alongside winding-up banks and temporary extraordinary assistance.