Zurich Financial Services and the UK/Irish commercial development sector : sh*t happenz.

NAMA

Property valuation and identifying property trends are not precise activities and relating indices, which amalgamate subsets of transactions into a single %, to a specific property carries all sorts of risks. On the header of this blog you’ll find indices which try to be representative of NAMA’s key markets – the selection of indices is not plucked from the air – they are sources given relevance and credibility in NAMA’s Long Term Economic Value Regulation.

Broad property indices amalgamate subsets of data, for example, the Permanent TSB/ESRI House Price Index represents different geographical areas and different types of property, the JLL Commercial Index represents retail, office and industrial sectors. NAMA, it would appear, has not identified any index in respect of development land which Savills say has now dropped by up to 90% since the peak depending on sub-sector.

Today, Zurich Financial Services has announced significant writedowns in loan values in the UK and Ireland. In respect of the UK, it has written USD 250m from its loan book  “reflecting the continued weakness in the commercial property development market”. One of NAMA’s most expensive assets in the UK is the Battersea Power Station site which is presently awaiting planning permission to be developed for both commercial and residential use. What is particularly concerning is that the writedown has been taken in Q2, 2010 a period in which the UK commercial property market had been making modest gains.

In respect of Ireland, although the company has written down the value of its loans to 50% in the second quarter which led to a provision of USD 80m, that is apparently just a reflection of NAMA’s discounts. For Ireland, the most significant fact is that Zurich has now stopped all development property lending through its subsidiaries Dunbar Bank and Zurich Bank, having previously stopped commercial property lending in 2009.

In overall terms, Zurich’s outstanding property loans in the UK and Ireland at the end of 2009 were USD 2,264m and at that point USD 611m were regarded as impaired and a further USD 213m were past due but not impaired  (page 123 PDF from the 2009 Annual Accounts). It is not clear from the accounts the level of provision against losses on these specific loans.

So as with all indices, it will be a challenge to relate them to specific property, but it must surely be a cause of worry for NAMA that Zurich believe commercial development property in the UK is performing so badly in the most recent quarter.

And let’s not forget what Brian Lenihan said in the Oireachtas two weeks ago in reply to a question about the change in the value of NAMA’s portfolio from 30^th November, 2009 to the present day : “Commercial property price indices suggest that prices in Ireland may have experienced a small decline since November 2009 but prices in the UK, which has about one-third of the assets underlying the NAMA loan portfolio, rose by a greater percentage. The overall impact, on a weighted average basis, is estimated to be broadly neutral.”

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What is the State-aid tipping point to force NAMA back to the EU? Are we there yet?

As we enter a period of intense operational activity in NAMA (more tranches, debtor business plans, providing working capital and development funds to debtors and of course Paddy McKillen’s judicial review of the whole project) you could be forgiven for losing sight of the over-all context for NAMA. To help counter a serious disturbance in our economy, NAMA was part of a range of measures to rescue banks that were seen as being systemic to our economy. It was understood from the outset that NAMA would involve State-aid being given to private-sector banks and this was mainly expressed in the mechanism whereby NAMA was not paying the present market value of the loans but was paying a premium – the Long Term Economic Value (LEV) premium. This premium was State-aid and is recognised as such by the EU.

Of course when approval was sought for NAMA – remember the old numbers, €77bn of loans, €54bn of consideration, €47bn present asset values, €7bn LEV premium –  that State-aid had a value of €7bn which was subject to a reduction of €2.7bn if NAMA didn’t make a profit (5% of the €54bn original planned consideration was going to be via subordinated debt which would not be honoured if NAMA didn’t turn a profit). When granting approval to NAMA in February, 2010, the EU made some changes to the way in which NAMA calculated consideration and attempted to reduce the State-aid through forcing NAMA to apply a higher discount rate to the LEV.

Crucially NAMA was seen to be acquiring the assets in a relatively short window, by the end February 2011. Further, although not acknowledged by the EU, the Irish government asserted that property prices were close to the Bottom and stabilising. However they weren’t anywhere near the Bottom and 7 months after the 30^th November, 2009, the NAMA Valuation Date, commercial prices in the State are off 8% and residential is off by more than 8% (by reference to March 2010 and more likely 10%+ today) and the rate of decline has accelerated for commercial. So with up to 8 months remaining for NAMA to acquire the remaining 80% of the total NAMA loan portfolio, it may be that the actual Current Market Values (a term defined by NAMA and assessed by reference to 30^th November, 2009) of assets may be considerably more than the real values on the date of transfer to NAMA. Meanwhile the metrics by which the Long Term Economic Value (another NAMA term and crucial to the amount of State-aid going to the banks in respect of NAMA loans) are measured may be leading to overvaluations, for example the latest forecast from the ESRI indicates that the population of the State will fall this year and next, something not envisioned by the sources (reports from the ESRI produced before 10^th January, 2010) on which NAMA has been directed to rely in the LEV Regulation. So NAMA is likely to be overpaying for the loans transferred – where’s the problem given the EU signalled their acknowledgement of NAMA being a State-aid vehicle? The problem is that at some point where property values continue to collapse and the LEV outlook deteriorates, the unrecouped State-aid paid by NAMA to the banks will reach an unacceptable point.

Now of course not every aspect of the environment in which NAMA operates has deteriorated since last November 30^th, 2009 – the UK commercial market is up nearly 9% (with a jump of 3% in December 2009 alone), the UK residential market is up nearly 5%, the euro has weakened against some currencies which may improve unhedged NAMA loan values, the UK’s proportion of NAMA loans went from 27% last October 2009 to 20% in April when the NAMA CEO was questioned by an Oireachtas Committee to one third when Brian Lenihan replied to a question in the Oireachtas two weeks ago, short term forecasts for economic recovery (measured by GDP and GNP) have improved in the State. Although this is a subjective assessment, these improvements are minor compared with the continued property value collapse in NAMA’s primary market – Ireland, and the realisation that our population is not likely to grow in the short term and that net migration may be outward for some time to come (population being a key driver in demand for property).

Another issue that might concern the Competition Directorate is that NAMA was intended to realise the LEV of the loans acquired, but recent noises coming from Treasury Buildings give the impression that NAMA will be offloading assets sooner rather than later. The concern would be that NAMA will dispose of assets before they had the chance to recover to their LEV level, or to express it another way, the actual LEV realised by NAMA is possibly going to be far less than the LEV used to pay the banks. Would this shortfall be another element of State-aid?

At what point does it stop being in NAMA’s discretion to go back to the EU to seek a change to its Valuation Date and the final date for any analysis it can use to calculate LEV, and when does it start being the EU’s obligation to call NAMA back to force NAMA to change these dates because the result of using the present dates is that the quantum of State-aid to the banks is unacceptable? Sadly because of the jiggery-pokery used by NAMA to calculate the consideration paid, it’s not exactly possible to understand what was envisioned by the EU and what is presently the case. The decline in Current Market Values is relatively easy to assess, though NAMA have not given any formal update on the split of NAMA loan assets between countries and indeed by property sectors. And of course no individual calculations of loans have been released by NAMA so all we know is that on average the LEV is 11% above the CMV. So all we can reasonably conclude is that State-aid has increased substantially in NAMA’s main market. Perhaps it’s time for the EU to step in and run more accurate numbers to determine if we are yet at the tipping point which makes the quantum of State-aid unacceptable.

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