Archive for July 24th, 2010

That’s the question posed by NAMA-bound developer, Paddy Kelly in his extensive interview with Fintan O’Toole which appeared in last Saturday’s Irish Times. And yesterday Paddy produced the answer at the MacGill Summer school – a video recording of his presentation and discussion is here, the revelation comes about an hour in. The person who signed off on it was John Mulcahy, then of Jones Lang Lasalle and now NAMA’s Head of Portfolio Management. According to Paddy, the property was worth €80m just two and a half years later, something which Paddy finds stupefying. A few weeks ago, NAMA appeared to go to some lengths to bat away criticism of John Mulcahy’s involvement in the Irish Glass Bottle factory site in Ringsend saying John was not responsible for its valuation at €412m in 2006 (having fallen to €50m-level in 2010).

Other highlights from what was a wide-ranging speech by Paddy included criticism of the State guarantee of the banks (in particular Anglo), the caliber of leaders and politicians (“teachers and solicitors” – he was lumping Brian Lenihan in with the latter profession), the cost of the State (from which Paddy believes there should be €10bn of cuts – teachers in Germany earning half their Irish counterparts, doctors in Malta earning €30,000 a year and the level of dole – “the dole was always our biggest competitior”), Bord Pleanala whose behaviour just doesn’t make sense and the failure to implement the Kenny Report.

However, in what was far from being a negative speech, he praised Brian Cowen’s involvement in Farmleigh and reaching out to the Irish diaspora – Paddy observed in America the role American Jews play in the success of Israel and Paddy would dearly love to see the energies of the Irish diaspora channeled in a similar way. Paddy has praised NAMA saying that they unblocked problems in hours which banks had taken months to confront. Paddy also appealed for NAMA to be transformed into a properly capitalized property bank – €5bn should do it, he thinks.

In what was often a very personal speech, he presented us with the concept of Whelan’s pony – apparently a horse owned locally to where Paddy grew up in Laois that won races locally but was outclassed when competing further afield. Paddy’s father warned him not to be a Whelan’s pony which might go some way to explaining Paddy spending less than half his time in the State and building business these days in Canada, the US, Malta and Africa. It would also be general advice not to get complacent with familiar territory and to push yourself and expand your boundaries, something Paddy would exhort us all to do to deal with the present difficulties.

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The Committee of European Banking Supervisors (CEBS) together with the EC and ECB has published its eagerly awaited results of stress-testing 91 European banks. The two Irish banks included in the exercise, Bank of Ireland and Allied Irish Banks passed the stress-test which set out to examine the capital base of banks in two scenarios – a benchmark scenario and an adverse scenario. Good news for BoI and AIB – seven other European banks didn’t pass the test.

As stated in the report “the benchmark scenario was based on the EU Commission Autumn 2009 forecast and the European Commission Interim Forecast in February 2010, with several adaptations to reflect recent macro-economic developments in a number of countries. The adverse macro-economic scenario was based on ECB estimates”. The assumptions for Ireland are summarized below together with the calculation by the CEBS of the effect on commercial and residential property prices

For information, here is a round up of recent predictions/projections for the Irish residential market:

For information, the ESRI published this week recovery scenarios for the State  – the high growth scenario and the low growth scenario. Both scenarios forecast 2010 GDP to contract by 0.4% and unemployment in 2010 to reach 14%.

What makes the stress test fascinating from the point of view of NAMA is its forecasts for commercial and residential property prices. It’s benchmark scenario is for a 15% compound decline in residential in 2010 and 2011 with drops in both years, a 19% compound decline in commercial in 2010 and 2011 with drops in both years. There is no projection beyond 2011. NAMA has chosen a Valuation Date of 30th November, 2009 pursuant to section 73 of the NAMA Act by reference to which NAMA is valuing the loans being transferred from the financial institutions.

How much does property need recover by 2020 assuming

1. Prices stop falling at the end of 2011

2. All property is sold in December 2020

3. 67% of property is located in Ireland

4. 33% of property is located in the UK

5. Property in the Ireland and the UK is split 50:50 between commercial and residential

The table below what recovery needs happen if NAMA is forced to rely on the recovery of the property market to break even – remember in the draft Business Plan is that the recovery was a flat 10% over 10 years. With the CEBS benchmark scenario, the recovery would be 24.7% and in the adverse scenario 41%. Both of these represent significant changes to NAMA’s draft Business Plan. To emphasise, assuming prices stop falling after 2011, the compound rate of growth needed would be 2.5% per annum for each of the nine years in the benchmark scenario and 4% in the adverse scenario.  These compound percentages might be rendered meaningless if there is significant default and NAMA’s interest receivable falls below its interest payable.

Perhaps a more interesting implication from the benchmark scenario is related to the question of whether NAMA is overpaying for loans now by paying for loans according to the 30th November, 2009. The answer is a resounding yes and if you compare forecast prices at the end of 2010 with the 30th November, 2010, there is an implication that NAMA is overpaying by something in the order of €3-6bn again based on the following assumptions:

1. NAMA acquires the loans by reference to a valuation date of 31st December 2010

2. Price changes in the month of December 2009 have been ignored

3. The LEV remains at a constant 11% above CMV

4. 67% of assets are in Ireland

5. 33% of assets are in the UK

6. The split of assets between commercial and residential is 50:50

Now of course the above is very much a simplification. NAMA’s assets may not correspond to general commercial and residential forecasts – where is development land for example? NAMA will have 7% or so of assets in the Rest of World. NAMA’s LEV as a percentage of CMV may change. So far this year in Ireland residential is off 5% (to the end of Q1) and commercial 8% (to the end of Q2) and the UK is broadly positive, so we have some way to drop before we get to the EU benchmark scenario. There are other assumptions but it is a fair representation, I believe, to say that we are overpaying by billions for NAMA loans by reference to current values – some overpayment was planned via the Long Term Economic Value device but the overpayment being referred to here is on top of that.

Lastly this stress test report comes on the heels of the publication of the EU’s Decision in respect of the first Anglo restructuring plan which was submitted with the DoF’s imprimatur, to the EC in November 2009. The Decision (paragraph 41) revealed that Anglo was planning for property prices were seen to drop in 2009 by 15-19% [actual according to Permanent TSB/ESRI was 18.5%] and continue falling in 2010 and 2011 before starting to rise in 2012. The average decline in property prices in the plan is estimated at 47% peak to trough but in the worst case is 62%. And now with this stress test we have the official EC/ECB estimates that property will continue to drop this year and next. Of course a finance minister has a responsibility to instil confidence but Brian Lenihan’s Bottom statements in September 2009 and April 2010 are now looking distinctly disingenuous and more importantly damaging because the Bottom will come at some point but may overshoot because of a lack of confidence in advice from the government.

UPDATE: 27th July, 2010. There has been some discussion about whether the adverse stress tests are sufficiently realistic, for example in the Telegraph and on irisheconomy.ie. The tone of the discussions has tended towards the view that the adverse stress tests were weak and declines in property prices in particular could well exceed the adverse scenario testing. Should the adverse scenario deteriorate then the effect on NAMA would be that the over-payment for loans would be accentuated and NAMA would need a greater improvement in the property market to break even.


UPDATE: 19th October, 2o10. Labour Euro MEP Alan Kelly is writing to the Competition Commissioner, Joaquin Almunia, to ask why AIB was given the all-clear in the stress test and only three months later needed an additional €3bn of State funding. “Was the Commission’s stress test really a stress test or was it designed to inject some positive sentiment in the European markets?” he asks.

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