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Archive for September 15th, 2010

Reuters are now saying that unnamed sources familiar with the sale of EBS are saying that no decision has been made, apparently contradicting the CNBC report below. It was previously expected that a sale would take place before December 2010.

There is breaking news that one of the five NAMA institutions, the Educational Building Society (EBS) has been acquired by a consortium including the Dublin based Cardinal Asset Management,  venture capitalist the Carlyle Group and Wilbur Ross. It would appear that the other bidder, Ireland’s Irish Life and Permanent – a financial institution covered by the State guarantee but not taking part in NAMA,  has been unsuccessful in its bid. Wilbur Ross earlier this year took a stake in New Jersey lender Sun Bancorp and invested millions in British entrepreneur Richard Branson’s Virgin Money.

EBS is very much a minor participant in NAMA with approximately €1bn of NAMA qualifying loans. Its NAMA loans are 2nd best performing with an average cumulative haircut over tranches 1 and 2 of 38% (just behind BoI on 36%). It does however have a large deposit book (of almost €9bn and non-NAMA loans of €16.6bn, of which €13.6bn are mortgages mostly in Ireland).

The Cardinal Consortium is reported by RTE to have “They have pledged to put €550m into EBS in return for a 70% stake. This would leave the Government with the remaining 30%.” and also to “have raised the possibility” of reducing the amount people owe on their mortgages with Wilbur Ross comparing Ireland with *some* US states which have non-recourse loans.

Updates and the analysis of any impact on NAMA’s operation will appear here.

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Consider the following completely fictitious scenario (and to be clear any resemblance to any real person or circumstance is accidental): John is a farmer who a few years ago got into the property development game after he sold a few sites. His first major development -building 10 houses on a piece of land he bought outside a small rural town – started just before the peak of the property market in 2005. He set up a company, let’s call it A Limited, to financially manage the development. John wanted a limited company for a few reasons – he saw it as being more professional, he thought it would help minimise his tax and lastly if the development went pear-shaped, he didn’t want the debts coming back on the farm which was in his family for decades. Now John put €250k into the company, and bought a company van and a few bits of equipment. But he had €200k left and he went to a bank, let’s say it was INBS, and sought a loan to finance the development. The development was to cost €2.5m and John was going to finance that with pre-sale deposits, his remaining €200k in the company and a loan from Anglo of €2m, €1m to be drawn down for the purchase of the land and the remainder to be drawn down as the buildings were erected. The development finally obtained planning permission in late 2006 and John started building as quickly as he could because he had a feeling things were slowing down. Although he put the foundations and built to wall plate level at the same time on the 10 houses, he then started completing the houses one by one so that he could finalise sales – he was worried that if he waited for all the houses to be completed the market might have dried up. John, or more properly his company A Limited, had no sooner completed the third house when the purchaser pulled out losing a €25k deposit. Prices were obviously declining and the bank claimed that John had breached the Loan to Value covenant on the loan and was calling the loan in. John put in another €100k of his own money into the company to desperately try to finish the houses because a part complete and occupied estate was deterring potential buyers. After a few weeks of sleepless nights, John decided to call it a day. The bank had lent €1.5m at this stage and the unsold development was probably worth €1.2m. The bank decided not to foreclose as it didn’t want to realise the loss and also John was otherwise a decent customer with a long-standing and decent reputation and if there was any pick-up John was probably the best man to help the bank get its money back. Two years later the development is worth less than €500k and the loan with interest is now €1.7m. In two months time, the loan will be transferred to NAMA (there is no lower limit on INBS and EBS loans). John didn’t give any personal guarantee for the loan though it is also secured on the other assets of the company A Limited (a 4-year old van and a few bits of equipment, in all maybe worth €10k today). John still wants to undertake the development, for pride, because he liked the development game when it was profitable, because he thinks it’s a bit of an eyesore and he feels ashamed of bumping into the two families that bought houses from him and are now living in an incomplete estate. John has €250k of savings and his farm is worth €2m.

Can NAMA sell John the loan, and if they can should they?

Let’s say NAMA take over the loan. They pay €490k for it (they figure the development was worth €500k in November 2009, applied a 10% uplift to give a long term economic value of €550k and then deducted the 5% enforcement and 0.25% due diligence and 5% NAMA premium from that). John has offered them €500k for the loan. No-one else is interested in the development at that sort of price level and the best that NAMA could achieve aside from John is €400k.

Firstly a distinction needs to be made between John and his company A Limited. The “limited” in the company A Limited means that the shareholder’s (just John and the missus) liability is limited to the net assets of the company. So John knows that NAMA could maybe realise €10k from the van and equipment. But that’s it. Although John has a sum in the bank and owns the farm outright, that is owned by John, not A Limited. Limited companies can be perceived as unfair because their limited liability sometimes means that creditors don’t get paid but the reason society allows them is because it encourages business which benefits the entire economy and society more than the downside risk of limited liability. So John and his €250k bank balance and €2m farm can’t be touched for the debts of his development company, A Limited. That’s an important point.

NAMA’s operations are governed by the NAMA Act (section 139 appears particularly germane), two Regulations (eligible assets and long term economic value) and one Order (the NAMA commencement date) and the five NAMA Codes of Practice (the Disposal of Bank Assets is the most relevant to the questions here). The EU Decision granting approval to the NAMA scheme would also have authority though it appears irrelevant to the question here. None of the above would prevent NAMA selling the loan to the highest bidder in the circumstances above. NAMA realises the highest amount it can for the loan. It should be noted that section 172 of the NAMA Act would appear to prevent NAMA from selling the property to John’s company, A Limited, but there is no apparent obstacle to NAMA selling the loan to John. Section 172 says at subsection 3 ” A person who is the debtor in relation to an acquired bank asset, who is a person referred to in any of subparagraphs (i), (ii), (iii), (v) or (vi) of section 70(1)(b) or who is a person on whose behalf the debtor or the person referred to in one of those subparagraphs acts as a nominee or trustee in relation to an acquired bank asset shall not, if any of those persons is in default in relation to any acquired bank asset, acquire from NAMA or a NAMA group entity, any legal or beneficial interest in property comprised in the security forming part of any acquired bank asset in relation to which the default has occurred.”

What about John? John sets up another company B Limited and puts €250k in it and gets a loan from another bank for €400k which is also put in the company and is secured on the purchase of the loan from NAMA. B Limited starts to complete the remaining houses and they are put on the market at 50% of the price of the originals and John makes a profit and pays back the new bank loan of €400k. John doesn’t own a helicopter but he and the missus have nice cars.

So should NAMA have sold the loan back to John?

That becomes more a moral question. And people will have their own views. Some might think that because we are all paying for INBS, that John should have to privately contribute to his original loss. They will see John keeping his farm and his cars and indeed still working on the remainder of the estate he started, whilst they have lost their jobs, their homes and car and have nothing and will face reduced public services in the future as a result of bailing out INBS. They’ll feel angry even though John is probably one of the more decent people you’ll ever meet. They’ll say John is a capitalist and his business went under and he should suffer and not burden the rest of society with his losses.

Others will say. We live in a capitalist society. Furthermore that capitalist society allows companies to limit their liabilities and in the long run that’s of benefit to society generally. NAMA is there to maximise returns from its operations and we don’t want NAMA cutting off its nose to spite its face – in other words we don’t want NAMA selling the loan for €400k when John is offering €500k.

Now lets say that instead of John, the above scenario applied to a bigger developer, a high society celebrity developer whose photographs in the newspapers you couldn’t escape during the boom years as he went on to bigger and bigger projects. And unlike John there’s no great fondness for this developer who is politically affiliated and displays many of the trappings of wealth. Once NAMA has pursued that developer to the maximum extent possible (and like John he set up separate companies for each development and didn’t give personal guarantees), should NAMA deal with that developer if it is in NAMA’s financial interest to do so?

With NAMA rapidly approaching the point (and possibly being beyond that point) this is a question which perhaps needs to be debated, so that the public can own whatever action NAMA takes – there was widespread talk of shenanigans last Friday when the NAMA CEO mentioned the disposal of €500m of property (no evidence whatsoever of shenanigans but NAMA needs to aware of how sensitive this whole area is and more importantly politicians need confront it).  Politicians have strenuously given the impression that developers would not be buying back their loans and assets at a discount and starting up again. And there is also the NAMA for the ordinary person – after all if John can get his commercial loan back at a discount shouldn’t Mary and Jim be able to reduce the €400k mortgage on their home that is now worth €250k? It is a different matter legally, but will the public generally recognise that difference?

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Recognising the significance of resolving Anglo’s future, the NAMA Chairman Frank Daly is reported by Deaglan de Breadun in the Irish Times today to have told gathered reporters at yesterday’s Fianna Fail’s think-in that NAMA would assist in any way possible. The government has indicated that it will try to put a final figure on the cost of Anglo to the State in October 2010. This entry examines NAMA’s scope for assisting and the obstacles that may be faced.

What NAMA can do:

1. Prioritise Anglo’s loans ahead of the four other institutions – AIB, BoI, INBS and EBS. This would seem to be straightforward. NAMA has an obligation to complete the transfer of loans by February 2011, though in reality that date can be changed. Although theoretically AIB and BoI could claim their business was suffering if they’re pushed to the back of the queue, in reality the 2-3 month delay might not be significant. BoI and AIB could claim that if the transfer of their loans is delayed to 2011 then they may have difficulty proving compliance with the Financial Regulator’s minimum capital levels required for 31st December, 2010. Another difficulty is that INBS and EBS are also exposing the State to bailout costs though these are small in comparison with Anglo. Officially INBS is set to cost €3-4bn though others have suggested the final bill will be over €5bn. EBS is tiddly by comparison with an estimated bailout cost below €1bn. However there is a need to get certainty on the cost of these two building societies, so NAMA focussing on Anglo might not be as helpful as expected.

2. Reduce the paperwork required for each loan from 1,000 data items presently. There may be some scope here but there is risk that the EU will reject valuations based on what the EU considers incomplete paperwork.

3. Abandon its attempt to take over Paddy McKillen’s loans. Anglo has apparently lodged a formal protest within the framework of the NAMA Act to oppose the transfer of Paddy McKillen’s loans which have been estimated at €2bn though it is unclear if that is split over several NAMA banks. Anglo wants to keep what are being claimed as performing loans. By doing so, Anglo wouldn’t suffer a haircut (however small) or pay a 5% enforcement fee to NAMA. All of that would help Anglo. NAMA is already letting go eligible loans in AIB (Bank Zachodni possibly and the AIB UK operations certainly). NAMA has apparently allowed €1bn-odd of Anglo loans in the US that would have been NAMA-bound to be put up for sale. BoI’s NAMA-bound loans have shrunk from €16bn to €12.2bn under circumstances that are not totally clear.

4. Allow Anglo to sell even more of its NAMA-bound loans to third parties including the borrowers themselves.

5. Not highlight the nonsense of applying a levy to Anglo in respect of any loss suffered by NAMA. Talk up NAMA’s profitability.

6. Seek to expand the scope of NAMA to include Anglo’s non-NAMA loanbook. There is widespread support for putting a final cost on Anglo’s losses and consequent bailout costs. However until the non-NAMA loanbook is credibly valued then a combination of Anglo’s management, the Financial Regulator and even the Central Bank governor throwing shapes and making serious pronouncements is not going to divert suspicion that Anglo will incur even higher costs. Frankly the only credible estimate of losses at Anglo at the end of September 2010 is to assume the non-NAMA loanbook suffers a 100% writedown – anything short of that carries uncertainty and risk.

7. Expeditiously and carefully examine the derivatives taken over from Anglo. There are suspicions that some of these instruments carry significant exposures. And of course Anglo has plenty of non-NAMA derivatives.

What NAMA can’t do:

1. Apply a block discount to the remainder of Anglo’s NAMA loans. This would be at odds with the valuation framework approved by the EU in February 2010 and would inevitably mean that NAMA’s valuations were rejected which would detract from NAMA’s credibility and also maintain uncertainty in Anglo’s final cost, thereby undermining entirely the objectives with respect to Anglo.

2. Overvalue Anglo’s loans. NAMA has committed to a fairly detailed set of valuation procedures involving the RICS Red Book and compliance with the Long Term Economic Value Regulation. A departure from these procedures would torpedo EU approval of the valuations.

As Mr Daly said, he would do anything that was “possible” to assist. He would appear to have some scope to assist but NAMA will not be a magic bullet to the uncertainty at Anglo in the short timeframe outlined.

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