Archive for August 30th, 2010

With Anglo Irish Bank Corporation Limited (“Anglo”) poised to report its results for the first six months of 2010 tomorrow, there is speculation that it is likely it will report losses in excess of the €4.1bn for the equivalent period last year. And these losses will be on top of the €12.7bn losses reported for the 15 months to the end of 2009. This entry examines areas of the Anglo half year report that are likely to be relevant to the NAMA project.

1. Losses on NAMA-bound loans. If Allied Irish Banks’ (AIB’s) first half results for 2010 are anything to go by, this area of reporting may be a damp squib. AIB merely reported the actual loss on the first tranche of NAMA loans which were transferred in April 2010 with a 42% haircut. For the remaining loans they simply put in place a haircut that equalled 18% after tranche 2 which transferred in July 2010 with a haircut of 48% was excluded. This AIB forecast haircut of 18% for tranches 3 onwards was ridiculed as fantasy against an average haircut for tranches 1 and 2 of 45%. Anglo’s haircut in tranche 1 was 55% and tranche 2 was 62% with a weighted average over the two tranches of 58%.

2. Losses on non-NAMA-bound loans. At the end of 2009, Anglo had €36.5bn of non-NAMA loans with a cumulative provision against losses of €4.9bn. It seems that the majority of these loans were related to property which is not eligible for transfer to NAMA (non-land and development loans, land and development loans for less than €5m). The Financial Regulator earlier this year shook a stick at banks to start recognising the reality of the condition of their loan books, though there has been precious little evidence that he carried through with his threats. The Irish Times today reveals that a Department of Finance official suggested in relation to an IMF review of Anglo that “I’m not sure that it would be helpful to have Anglo talk up their capital requirements. Perhaps a word with DOC [Anglo’s then chairman Donal O’Connor] could temper this”. So again, don’t expect a wall of losses to be announced here, particularly against the backdrop of the EU presently considering Anglo’s future and both the management of the bank and the DoF apparently pushing for a viable Newbank for the good loans and a residual asset management company for the bad loans. An entry on here today asked if NAMA should be taking over all commercial property loans which would reduce Anglo’s loanbook to below €10bn.

3. Reclassification of NAMA loans. Anglo CEO, Mike Aynsley, said in an interview with RTE on August 6th, 2010 that €2-4bn of what would have been NAMA-bound loans secured on assets in the UK and US may not now transfer to NAMA and he further indicated that NAMA was agreeable to this. The UK and US have, in the main, performed better than Ireland in this financial crisis and the fear would be that these loans are of good quality and performing. NAMA can ill-afford to lose such loans so the detail of why they might be reclassified will be of interest.

4. Redemption of NAMA loans. Bank of Ireland famously saw its NAMA-bound loan book drop from €16bn in September 2009 to €12bn at the start of this year. This was attributed to loans being redeemed. Of course there is nothing untoward about loans being redeemed at 100% of their face value, that after all is generally the prerogative of any borrower. The concern is that loans were redeemed below their face value but possibly at more than NAMA would pay. You would expect section 71(2) of the NAMA Act to have prevented such shenanigans. However it will be an area to watch out for.

5. Anglo’s protests regarding the classification of Paddy McKillen’s loans. As the dirty laundry surrounding Paddy McKillen’s loans gets set for an airing at the Commercial Court in five weeks time, it will be interesting to see what Anglo has to say about the formal protest it made about Paddy’s loans being transferred. It was revealed in July 2010 that Anglo had invoked the dispute procedure in the NAMA Act to object to Paddy’s loans being transferred, even though NAMA apparently  told Paddy’s representatives that there was no such objection! As Paddy’s loans are reported to be performing and Anglo (like NAMA) needs all the performing loans it can lay its hands on, it will be interesting to hear the status of the dispute as it will be material to Anglo’s (and NAMA’s) future.

Of course the focus tomorrow may be on Anglo’s overall future with the 5-year orderly shut-down option getting increasing prominence. That is of course the more important matter but until Anglo’s future is resolved the above small matters will be relevant to the NAMA project.

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No some will groan, it should be wound down immediately, it shouldn’t even be allowed its current scope, it will only put more of our money at risk. This entry highlights a paradox in NAMA’s operation to date and examines an extension in NAMA’s role.

From the outset NAMA was designed to take a certain class of loan from the books of banks operating in Ireland, on the basis that these loans were as a class, toxic – of either bad or indeterminate quality (some of the loans will be top quality but they’re still part of a class that is in overall terms, toxic). That class of loan was “land and development”. Now from the start it was recognised that some borrowers would have taken out loans for “land and development” but would have additional lending for all sorts of things, some of which had nothing to do with property eg art collections, helicopters but others were property related eg investment property, mortgages on their own property. These loans given to these borrowers “associated” with the “land and development” were also to transfer to NAMA. So when NAMA produced it’s draft Business Plan in October 2009, it was projecting (page eight) that €49.4bn of the then €77.1bn loans would be for “land and development” and €27.7bn would be “associated” loans. An eligible loan regulation was published in 2010 which set out in some detail the loan assets that NAMA was to take over.

But take a look at the loans that NAMA has taken over in tranches 1 and 2, totalling €27bn  – out of what is now projected to be a final total of €81bn. Of the €27bn, only €7.1bn relates to “land and development”. The rest relates to completed property ab initio. The June 2010 NAMA Business Plan says on page 23 that investment property is expected to make up 30% of the final NAMA portfolio total. That would mean that of the remaining €54bn of loans only €4.3bn related to investment property which feels wrong (by the way I am drawing a distinction between land and development and all other commercial property – the remaining commercial property is investment property in my terms).

And why was NAMA designed to only take one class of property loan and not others unless they were associated? Because land and development loans were seen to be most impaired, most toxic and most likely to jeopardise Irish banks. And indeed Savills are now saying that development land in Ireland is now down between 75-90% from peak. However that was the view back in early 2009. Since then the capital value of commercial property has continued to drop like a stone. Between the end of March 2009 and the end of June 2010 Irish commercial capital values have dropped by 24% with no end in sight and we are now off some 58% from peak values – see table below for the SCS/IPD quarterly capital falls and the effect on a base of 100 at the end of March 2009 and also the peak to date drop.

The components of the SCS/IPD index are shown in this report from IPD in June 2009 (page 30). It is Dublin-city and -county focussed but 5% of the property assessed is provincial and this index is one of the two adopted by NAMA in its Long Term Economic Value Regulation (the other is the Jones Lang Lasalle index which shows a similar profile).

So the question now is – based on the fact that commercial values have dropped significantly since NAMA was designed and that more than 70% of NAMA’s tranche 1 and 2 relate to non- “land and development” loans, should NAMA’s scope be expanded to include all commercial property? Or to ask the question another way – if NAMA’s scope is not extended to include all commercial property then won’t banks still have a significant toxic loanbook after NAMA transfers, and won’t banks still be unable to access finance?

As was shown here last week in a rough analysis of the non-NAMA loanbook there would appear to be €71bn of non-NAMA commercial property loans with only €7bn of provisions for losses against them. So if NAMA were to take over these loans, NAMA would need double in size (from €81bn to €152bn) but all other processes would remain. The time taken to value and transfer loans would extend, and NAMA would need be a bigger organisation. If NAMA doesn’t extend its scope then the risk is that its role will be in vain, it may mitigate slightly the toxicity of certain banks but there will still be a black-hole of commercial property loans which will deter the risk averse financial markets.

I leave you with one thought courtesy of Brendan O’Connor in yesterday’s Independent. The Americans have changed totally, and modified elsewhere, their approach to dealing with this financial crisis. They have done so with openness and confidence. By contrast there has been precious little refinement of our own approach to confronting the crisis. Is there a fear that any change will spook the markets and undermine the image of sure-handedness and commitment in our approach? That should not be the case and we should not avoid review and modification of our strategy and tactics if that’s what current experience tells us.

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