Archive for August 24th, 2010

Yes – if the toxicity level of the residual loans left in the banks after extracting the NAMA loans is uncertain to a significant extent. This entry examines the residual loan books and uncertainty over residual loan values.

As NAMA makes its way through the transfers of the tranches of land and development and associated loans from the five NAMA financial institutions, it is clear that the residual loans left in the five banks are significant and impaired. First, let’s look at the lending profile of the five banks – the information is collated from the latest accounts (period ending December 2009 for Anglo, INBS and EBS and from the recent half year reports from AIB and BoI). AIB have produced a half year statement without full supporting accounts so there are some assumptions about gross loans and the distribution of impairments.

First a summary of the total loans split between NAMA and non-NAMA

Next a summary of the non-NAMA loans showing the gross loans and provisions for impairment

1. AIB Half Year presentation (page 21 shows an analysis of non-NAMA loans). The more complete accounts are here.

2. Anglo accounts for the 15 month period ending 31st December 2009 (page 8 for total lending, page 90 – note 27 to the accounts – for the breakdown of non-NAMA lending). Anglo are due to issue an update on the first half 2010 performance by the end of August 2010.

3. Bank of Ireland Half Year accounts 2010 (pages 101 and 102 show the breakdown of the gross loans and pages 51 and 104 show the breakdown  of the provisions)

4. EBS accounts for the year ending 31 December 2009 (pages 41-42 of the accounts, notes 13 and 14 provide an analysis of lending and provisions)

5. INBS accounts for the year ending 31 December 2009 (pages 63-65 of the accounts provide an analysis of lending and provisions, assumptions have been made as to the allocation of total lending to the spreadsheet headings)

NAMA is supposedly dealing with “Land and Development” and “Associated” loans only. The residual loans in the banks cover everything from residential mortgages, personal loans and credit card balances to commercial loans (including commercial loans for property that falls outside the ambit of NAMA – mostly investment property you would expect). So let’s examine each of these categories of residual loan to see how clear their value is:

(1) Residential mortgages – part 1 (arrears and default). The latest statistics from the Financial Regulator for the first quarter of 2010 (Q2 is expected later this week) revealed that 32,000 of the 791,000 mortgages in the State were in arrears of more than 90 days and indeed of those 21,000 were more than 180 days in arrears. It is understood that in addition to these mortgages in arrears more than 50,000 mortgages have been restructured following difficulties so that they are now paying interest only, having payment holidays, longer periods to repay or some other reductions. The Financial Regulator has recently published a consultation paper which is set to make repossessions more difficult when borrowers are seen to engage in good faith with their banks.

(2) Residential mortgages – part 2 (losses on tracker mortgages). Ireland has a large number of tracker mortgages – of the 791,000 extant mortgages, 407,000 are trackers and a further 113,000 are fixed rate mortgages leaving 271,000 that are standard variable rate mortgages. Banks are widely suspected of losing money on tracker mortgages that will typically be priced at ECB + 0.75% – that is understood to be less than the cost of finance from depositors and money markets. Now these tracker mortgages might not be impaired but whilst ECB rates are set at a low level (which is certainly the immediate outlook over the next couple of years) banks are exposed to continuing losses which they will book as they occur.

(3) Personal loans – unsecured. Ireland presently has an unemployment rate of 13.7% (end July 2010) equivalent to approx 292,000 out of a workforce of 2,132,700 (end June 2010). Ireland maintains a Live Register in respect of people in receipt of employment benefits (this includes the unemployed but also those on low wages) and that total is now 466,824 (end July 2010). Over 20% of homes are understood to be in negative equity and headline wages have dropped 0.7% in 2009 and are forecast to drop by a further 2.7% in 2010 according to the Central Bank (Q2, 2010 Bulletin). Take home pay has been reduced by an income levy (2% for income up to €75k, 4% from €75-175k and 6% on income over €175k). There is a new tax on second homes of €200 per annum which worryingly has a far lower rate of collection in 2010 compared with 2009. Approximately 900 homes per month are having their electricity cut off by energy supplier ESB with a further 11,000 homes per month entering into arrangements to restructure their payment of electricity bills all from a total ESB customer base of 1.5m homes. So I think it is safe to say that there will be pressure on the recoverability of personal loans, particularly in the next couple of years until GNP recovery cascades down into people’s pockets.

(4) Commercial lending – property. Development land may have suffered most in the Irish property crash – indeed Savills have recently said that prices are up to 90% off peak – “Spend on development land in Ireland was down an estimated 90% in 2009 from the peak in 2006, while values have fallen by up to 75% to 90% from their peak particularly in provincial towns. Many sites purchased between 2005 and 2007 are now largely uneconomic to develop given the price paid” But we also know that what might be classed commercial investment property (finished offices, shops and industrial space) has dropped considerably in value. According to the IPD commercial capital values are now 58% off peak  and the recent trend has been an acceleration in declines despite attempts by property companies to reassure and stabilise the market. Of course these assets are not acquired for development but the severe decline in their values must place non-NAMA property loans at some considerable risk.

(5) Commercial lending – non-property. Besides a property crash, Ireland is suffering a good ol’ fashioned recession with GNP declining by 17% from 2007 to late 2009 and expected to decline by in excess of 1% in 2010 before recovering in 2011. It has been ““the deepest and swiftest contraction suffered by a western economy since the Great Depression” according to economist Morgan Kelly. There were 917 corporate insolvencies in the first seven months of 2010 (compared with 1,406 for the full year 2009 and 773 for the full year 2008.

The analysis of the accounts and half year statements above show in relation to the non-NAMA loans that there is an overall estimated provision of €11.5bn against total loans of €261.7bn (a “haircut” of 4.4%) – is this adequate in light of the severe pressures on Irish businesses and households? Will external providers of funding to banks still consider there to be potentially nasty shocks in store after the NAMA loans have transferred?
So how much financial certainty will there be in the non-NAMA residue of loans  in the five NAMA financial institutions come 2011 when NAMA is due to finish its transfers? There will plainly be some degree of uncertainty, the important question is whether the uncertainty will significantly impede the banks from attracting external non-government funding so that they can indeed return to normal lending to “viable homes and businesses”. And I think the answer to that question is far from clear.


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Now that the tranche 2 transfer of loans from the five NAMA financial institutions to NAMA is complete, NAMA must seek EU approval for the valuations. If the experience of tranche 1 is anything to go by (completion of transfers to NAMA on 10th May, 2010, EU approval granted on 3rd August, 2010) then EU approval may take several months. The entry examines potential problems with tranche 2  that may lead to the EU rejecting valuations.

The first loan valuations were undertaken in December 2009 and delivered by the banks to NAMA just before Christmas 2009. NAMA had selected a Valuation Date of 30th November, 2009 by reference to which the loans were to be valued. As we now know, the first tranche did not transfer until 10th May, 2010. The delay has never been fully explained but the EU only approving the NAMA scheme on 26th February, 2010 (and making some changes to the way loans were valued) and the worse-than-expected condition of the loan documentation must have played a part. Regardless over five months elapsed between the Valuation Date and the completion of the first transfer. During this time, it became apparent that property prices (residential and commercial) in Ireland were continuing to fall though the UK fared better with a robust recovery in commercial prices and a more modest recovery in residential prices. November 30th, 2009 clearly though was not the bottom of the market. And that is one of the principles underpinning NAMA – NAMA buys distressed loans at the bottom, nurses them until there is a recovery and sells them at a profit (or at least enough to cover the long term economic value premium it has gifted the banks). The latest property indices for Ireland are for the quarter ending 30th June, 2010 (the next Irish indices will not be released until the start of October, 2010 in respect of Q3) – the latest indices show that commercial and residential property in Ireland has dropped 8-10% compared with 30th November, 2009. Whereas the EU might have accepted a Valuation Date of 30th November, 2009 for the first tranche will it reject the second tranche and demand that NAMA re-base its valuations by reference to a more recent valuation date. Otherwise NAMA banks are getting far more State-aid than was envisaged – they were supposed to get a Long  Term Economic Value premium of 10-15% over the Current Market Values – in fact they are getting 25%-plus premia – is this just too much State-aid? UPDATE: 24th August, 2010. Professor of  finance at Trinity College Dublin, Brian Lucey, discussed the issue with NAMA’s Valuation date of 30th November, 2009 on RTE’s Morning Ireland – his contribution is about 15 minutes into the podcast. In particular he draws attention to the fact that Irish property prices have declined since last November.

The minutiae of NAMA’s valuation methodology has never been fully understood by the public or indeed academia. However both the Long Term Economic Value Regulation and the EU Decision indicate that NAMA will deduct from the Long Term Economic Value calculation a sum to compensate NAMA for the fact that on a proportion of loans NAMA will need foreclose and enforce the security. The deduction for enforcement authorised by the EU is 5% and in the EU Decision in February, 2010 this is what the EU had to say on the derivation of this 5%.

“The seizure of the underlying property by NAMA could be achieved in a number of ways, including by legal enforcement. The costs associated with a full legal enforcement process are approximately 15.00%. It is however very difficult to predict ex-ante the proportion of assets for which NAMA will have to go through a full legal enforcement process. The Irish authorities propose to apply enforcement costs of 5% to all the assets. This corresponds to over 50% of the non-cash flow producing loans incurring a 15% enforcement costs. The Commission considers, on the basis of the information available, that this is a reasonable and prudent assumption.”

Now I don’t know how the EU arrived at the conclusion that 5% was an adequate average contribution by the banks to NAMA for enforcement costs but I do recall that in the draft NAMA Business Plan the assumption was that a maximum of 20% of loans would default so perhaps the calculation was as follows

Industry standard enforcement costs x proportion of defaulting loans or

15% x 20% or


And since 5% is greater than 3% and the 20% default rate was supposed to be prudent, perhaps that is how the EU arrived at its conclusion.

The problem is that in Ireland, the 20% default rate was seen by many as being too low. It was apparently based on the experience of Barclays in the UK in the early 1990s when the UK suffered a property crash. However the UK crash was not anywhere near the scale of Ireland’s (in nominal terms) and Barclays seem to have had better lending standards and practices than the likes of Anglo Irish and Irish Nationwide Building Society. The new NAMA Business Plan in July 2010 did not specify an up to date assumption on defaults. However consider the following:

(a) We now understand that the loans of Paddy McKillen will not transfer pending the outcome of an application by Mr McKillen for a judicial review of NAMA’s dealings with his loans. Apparently Mr McKillen’s loans are performing.

(b) We now understand that AIB is selling its UK operations which includes over €3bn of what are assumed to be peforming loans.

(c) We now know that the estimate of Bank of Ireland loans to be transferred has fallen from €16bn in 2009 to €12bn today and the understanding is that the difference, €4bn, related to performing loans that were redeemed.

(d) Anglo has recently stated that NAMA is agreeable towards €2-4bn of loans in the UK and US not transferring to NAMA. Again the assumption is that these are performing loans.

(e) NAMA itself has reduced its estimate of the proportion of performing loans in its portfolio from 40% at the draft NAMA Business Plan stage to 25% today.

In light of the above should the 5% contribution by the banks for enforcement increase?

And lastly what will the EU have to say about NAMA allowing apparently performing loans to be sold (in AIB’s case), retained (in Anglo’s case) or potentially not being taken over (in Paddy McKillen’s case)? NAMA is entitled to deduct a premium from the Long Term Economic Value to reflect the digout it is giving banks. Should that premium increase?

So in conclusion, I do not think that NAMA should be confident in getting EU approval of the second tranche valuations as it would seem the amount of State-aid being provided to the banks is significantly more than was envisaged when the EU granted approval for the NAMA scheme.

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In most property markets, first time buyers (FTBs) are seen as critical for the smooth operation of the market – they are assumed to buy “starter” homes to get their feet on “the property ladder”. And like bottomfeeders in a marine ecological system, FTBs are seen as vital to the market by buying homes which will in turn enable the sellers to trade up. FTBs are also by definition new entrants to the property market and traditionally they are seen to be adding to an existing market which is good for property sellers, builders and property prices.

But has the nature and significance of FTBs changed in the Irish property crash? Mortgage figures published by the Irish Banking Federation yesterday show that FTBs make up 60% of the volume (56% of the value) of new mortgage lending for home purchases in Q2, 2010. That compares with the peak (by reference to volume of mortgage lending in Q4, 2005) when FTBs made up only 36% of the total volume. So FTBs are a very significant cohort of buyers in the present mortgage-bought market, there is no doubt about that. But are they distinguishable from other buyers?

According to the IBF statistics, the average mortgage obtained by a FTB in Q2, 2010 was €193k. Unfortunately we do not know either the location of the purchases or the deposit available to the FTB. The highest LTV currently available with standard Irish mortgages at present is 92%, though there are suggestions that buyers may need 25% deposits in the present credit market. This would mean that a €193k mortgage would enable a home purchase of €210-257k (92% – 75% LTV). The average price of a home in the State according to the latest Permanent TSB/ESRI index for Q2,2010 is €201k nationally (Dublin €242k and Outside Dublin €182k). So unless FTBs are predominantly buying in Dublin and have high LTV mortgages then they are not buying “starter homes”, they are buying average homes.

And what of the role of FTBs in enabling sellers to trade up? This is based on the assumption that sellers stay in the market and that may not be true for a number of reasons. Emigration continues at a very high level and is likely to mean that our population stays flat in 2010 compared to 2009 or indeed suffers a slight fall. A second reason is that in Ireland the rental:purchase price:yield framework has gotten completely out of equilibrium and it would seem (anecdotally at least and certainly at the mid- to upper-end of the market), renting makes more financial sense than buying. So FTBs may not be fulfilling their traditional role of buying “starter homes” at the lower end of the market enabling a chain of trading-up by existing owners.

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