Archive for March 5th, 2010

This is part one of a seven part series (click here for part 2 of 7)

There have been three recent studies into vacant residential property in the State, the latest being from UCD today. The two others are a NIRSA study from January 2010 (which has several sources from irelandafterNAMA blog) and a report by DKM Consultants in September 2009. Although the three reports adopt slightly different methodologies, all begin with the results of the 2006 Census which showed 1,769,613 total homes in the State, of which 1,503,291 were occupied and 266,322 were unoccupied. Of the 266,322 unoccupied homes, the Census revealed that 49,789 were holiday homes leaving 216,533 other unoccupied. So said the Census of 2006 and the next Census will not be undertaken until 2011. The three organisations DKM, NIRSA and UCD then adopted different approaches in updating the figures for the present day and their results can be summarised as follows:

To this author, each of the reports appears to have made very broad assumptions, for example (and each report contains several examples) with respect to holiday homes (DKM), mortgages as an indicator of occupancy (NIRSA) and how vacancies have changed since 2006 (UCD who say “The numbers vacant and unoccupied have been estimated by use of data on population and population to stock ratios over this period allied with discussions with financial and market sources indicating that over one third of additional stock in the period [2006-2009] remains vacant”, page 16 – how the 37.52% figure is arrived at in any defensible way is unclear).

Today, CIF and Housing Minister Michael Finneran have expressed there to be a lack of clarity in the precise numbers of vacant property and indeed in the definitions of terms such as “overhang”.

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This is going to be an on-going series focussing on the 20% default rate used in the NAMA business plan and which many think is the most controversial assumption and the key assumption for determining the success or failure of NAMA. Today I am examining the residential property markets and comparing the UK in the early 1990s with the State today.

To recap, the draft NAMA Business Plan published on 14th October, 2009 is at present the best overall plan we have of the financial impact of NAMA on the State’s finances. The plan was based on preliminary work undertaken by NAMA with the banks and the following were the “big” numbers in terms of its operation.

  1. Value of assets secured against NAMA loans were €88bn.
  2. The loans themselves were at an average of 77% of the asset values (referred to in the business as a LoantoValue rate or LTV rate). Consequently the original loans were €68bn.
  3. A feature of some commercial loans is that interest is not paid as it accrues but is instead “rolled-up” with the original principal until the loan is being repaid. “Rolled-up” interest could also apply to interest due on loans but not yet paid, arrears. It is not clear how much, if any, of the NAMA plan rolled-up interest is arrears. The rolled-up interest came to €9bn in September 2009. It may have increased since.
  4. The property market had dropped by 47% since the loans were granted. Note this is not the same as saying that 47% was the fall from peak because not all NAMA loans were issued at the market peak. Consequently the €88bn was worth only €47bn (47% of €88bn is €41bn and if you subtract that from €88bn you get €47bn)
  5. The Long Term Economic Value (LTEV) – this is a funny little term but in essence it is a presumption that assets have dropped so much in value that they are not representative of their value once we are out of the r(d)ec(pr)ession. The LTEV was €7bn.

The key assumption with making NAMA work was the assumption that 80% of the loans would be fully recoverable – there are other assumptions like % of cash-flow generating loans (40%), the interest rate environment both for NAMA borrowing and also for developers paying back loans, the annual operating costs for NAMA, the price at which defaulted assets can be realised. Funnily enough one of the key assumptions bandied about was that property would increase by 10% over 10 years, yet it is not immediately apparent where that assumption is relevant or applied in the NAMA business plan – the plan on page 8 top states, “Taking subordinated debt into account (5% or €2.7bn of the total consideration) it is estimated that underlying asset prices would have to recover by 10% over the expected 10 year lifespan of NAMA to avoid any loss to the taxpayer” – Hang on a minute! If the assumption is that 80% of the €77bn loans are 100% recoverable then what difference does it make if property increases by 100% over the 10 year period or drop by 50%?,  as far as the NAMA plan is concerned changes in property value are disconnected from the 80% recoverability, no? If there is a secret assumption that property having fallen 47% in September 2009 would have to recover by 10% in order that borrowers could realise assets to pay back loans, then that assumption must be truly shot to shreds with the revelation that commercial property has now dropped by 55% to February 2010.

It is this author’s view that the key assumption in NAMA’s business plan is the 20% default rate (or the 80% non-default rate). In the NAMA Business plan it states as the source for this assumption :  (page 10 bottom) “Over a five year period in the early 1990s one UK bank experienced a default rate of less than 10% on its whole book.Given the concentrated nature of the NAMA portfolio and the possibility of a prolonged recession, a 20% default rate assumption has been made. It is also assumed that €4bn will be realised from the sale of underlying assets secured by the defaulting loans of €15bn. These are conservative and prudent assumptions.” That’s it, nothing more is said about the source of the 20% default rate, its stress testing, its appropriateness to Ireland in 2010.

The Irish Times reported on the 15th October, 2009 that the “UK bank was Barclays” and that “Barclays was the hardest hit of the British banks during the collapse of the UK property market.”

Britain in the early 1990s (not defined but I take this to mean the years 1990-1993 inclusive) The residential property picture.

In Britain, the Halifax (now Lloyds) and Nationwide building societies were the traditional commercial source of house price indices. The government through the Land Registry produced less detailed (no breakdown by type and size of property) though more comprehensive (all property transactions regardless of whether mortgage based or cash) figures. My observation as a valuer in the UK for 5 years is that the Nationwide and Halifax indices tend to correlate highly and the Land Registry correlates if you use a time lag (arguably because it can take several months for a transaction to be registered with the Land Registry). The Halifax has the most detailed analyses so I am using their statistics which are available here.  They show

1988 1989 1990 1991 1992 1993
House price Nat £k (Dec) 66.5 68.4 68.7 66.3 61.2 61.9 Halifax
Annual Change 2.9% 0.4% -3.5% -7.7% 1.1% calculated
House price index (Dec) 215.1 221.2 222.4 214.7 198 200.4 Halifax
Annual Change 2.8% 0.5% -3.5% -7.8% 1.2% calculated

For Ireland, I have sourced the statistics from the ESRI and they show actual prices and indices for years 2006-2009. I have used the median forecast by a group of pundits in the Irish Times in January 2010 to determine the prices at the end of 2010 (a 9% drop from the start of the year).

2006 2007 2008 2009 2010 (f)
House price Nat €k (Dec) 310.6 287.9 261.6 213.2 191.9 ESRI/Irish Times
Annual Change -7.3% -9.1% -18.5% -10.0% calculated
House price Nat (Dec) 139.3 129.1 117.3 95.6 86.0 ESRI/Irish Times
Annual Change -7.3% -9.1% -18.5% -10.0% calculated

What the figures show is that in the UK in the early 1990s there was an annual peak to trough drop of 9%. In Ireland the peak to trough has been 31% to the end of 2009 and is forecast to be 39% at the end of 2010. I do not have statistics with respect to loan to values when properties were purchased but I am aware of 100% mortgages and more during the Irish boom, the higher the loan to values advanced the greater prospect of negative equity when property prices drop.

In summary, the collapse in Irish property prices in the present crash is approximately 4 times as great as the decrease in prices in the UK in the early 1990s. Why therefore would one not take the default rate in the UKs in the 1990s and multiply it by 4 instead of 2?

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