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Archive for March 14th, 2010

It is this author’s view that the key assumption in NAMA’s draft business plan is the 20% default rate (or the 80% non-default rate). The plan describes the rationale 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.”

The term default is not explained in the draft Business Plan. The common interpretation would be that borrowers would repay their loans in line with their loan agreements. Plainly this is not a correct interpretation judging by the AIB’s recent filing of a 20-F which showed that 80% (co-incidentally the same percentage as the NAMA Business Plan non-default rate) of €18.99bn of NAMA loans are repayable in 12 months which would indicate a cash inflow to NAMA of €13bn in 2010 and early 2011 – plainly the NAMA Business Plan hasn’t reflected this as the cash inflow in 2010/11 is €2bn principal and €2.9bn interest.

A broader definition of non-default is that the borrowers would repay the loans at some time over the lifetime of NAMA but not in accordance with the original loan terms, in other words there would be a successful rescheduling of repayments which would see the loan eventually paid off .

However let us examine what we already know from the September 2009 estimates which are still the only official estimates of NAMA’s overall performance despite Simon Carswell’s snippets in the Irish Times. Assets which were worth €88bn at the origination of loans of €68bn were worth €47bn in September 2009 (and are likely to have fallen 5-15% since then so now worth €38bn – €45bn). The borrowers have built up rolled-up interest (which may be contractual or may be the result of arrears) of €9bn last September 2009. So in effect they are being chased for €77bn of debt on assets now worth an estimated average of €42bn

A couple of questions, what was nothing, nil, nada repaid on the €68bn of loans at origination? We are told that not all NAMA loans were taken out in the property boom peak but we are told the Loan To Value at origination was 77%. But if €68bn is STILL outstanding that indicates that every single one of the contracts provided for principals (or any part of the principals) to be repaid when the developer finally realized the property. Strange.

But the over-riding question is why would a talented and smart businessman or company pay €77bn for assets that are worth an average estimate of €42bn and would require a 90% increase in value TODAY to balance the sum owed to the banks?

“All’s fair in love, war and business” goes the saying and the nature of capitalism and limited liability companies is that sometimes companies become insolvent. It doesn’t make the company the devil incarnate and what is wrong with a company acting within the law to mitigate their losses? We allow limited liability companies because they facilitate commerce and economic growth (by the way there might be something in that for our legislators who seem very reluctant to change personal insolvency laws) and their nature is that some will fail, and that some creditors will face losses. Here are some of the problems I fear NAMA will encounter recovering loans from developers.

1. Limited Liability corporations. NAMA, it appears, is just beginning to establish that many large developers use the tried and tested methods of buying and managing assets in ways which limit liability and indeed limit tax exposure. A very common method was (and is) to set up a separate limited company for each transaction. The acronym SPV has certainly entered the general Irish lexicon in the context of the NAMA SPV which is a Special Purpose Vehicle set up by the State to avoid Eurostat classifying the loans NAMA must obtain to pay the banks as National Debt. Well the SPVs set up by developers have similar aims in that they ringfence a liability to a particular company. A developer may have 100 projects on the go at the same time and he may incorporate 100 SPVs to individually acquire, develop and realize each property. The difficulty for the banks (and now NAMA) is because there is ringfenced liability (and when they get to grips with Luxembourg corporation law they will see just how ringfenced) the banks may not be able to seek to recover losses in other SPVs which might still be solvent. It is this author’s view that since the 1990s when apparently Barclays had a default rate of 10% in the UK, the use of SPVs for both risk/liability and tax planning purposes has exploded to the extent that major property advisers may be incorporating 100s per day – it’s the way business is done. So if SPV A owes €77m on an asset now worth €42m, I would suggest NAMA need write the difference of €35m off because they will not be able to chase SPVs B,C,D etc for the debt.

2. Personal guarantees. Of course banks may have sought personal guarantees from key directors of a property development company, and some of these developers became very wealthy in a private sense in the last 10 years. A couple of problems arise though, firstly the guarantees may have been limited and frankly €100k on a €100m loan is little more than a token and may well be paid by individuals but it will do practically nothing to mitigate the loss. The other problem is that many of our richest developers operate on an international stage, they may be passport holders or citizens of other countries. They may hold wealth in countries where there is limited reporting of wealth (Switzerland is still to an extent in that group of countries but Switzerland is an angel compared to the 40-50 other well-known secretive financial centres around the world). So even if there was an unlimited guarantee, there are possibly insurmountable obstacles in recovering debts. This may suggest an element of lawbreaking but NAMA officials may well find that the methods used to protect private wealth are perfectly legal.

3. Moral scruples. I have been at creditors’ meetings in the past where the owners have been in tears and would go out of their way to meet debts owed to creditors even if they disposed of personal assets. I have been at creditors’ meetings where the creditors were in tears because they understand the business owner had done everything they could to keep the business alive and because they commanded personal respect. However I’ve been at other meetings where the creditors have taken the waste paper bins and chairs and water-jug as part payment of outstanding debts. How should our developers behave? I’m not in the moralizing game so others can answer but I come back to the saying that “All’s fair in love, war and business”.

I would challenge NAMA to explain its rationale in adopting a 20% default rate.

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