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?
NAMA Wine Lake 
Good post.
First the moral question:
You wrote “Some might think that because we are all paying for Anglo, that John should have to privately contribute to his original loss.”
John will be contributing like every other taxpayer to all the losses that were created by the government, the banks and the developers. However, John was the only party here that did NOT ask for his losses to be apportioned and carried by the taxpayers. That was requested by the banks and agreed to by the government. It would have made little difference to John whether his bank folded or not. That only mattered to the government and the banks. And it obviously was not in the interests of the taxpayer that the government volunteered that the taxpayer should guarantee the banks’ bondholders against their losses.
“Others will say. We live in a capitalist society”
If we lived in a truly capitalist society, we would have let the banks go.
Personal guarantees: “…and like John he set up separate companies for each development and didn’t give personal guarantees.”
That would have been very rare. In the case of Anglo, it was impossible to obtain a loan without giving a personal guarantee even if limited and excluding assets such as family homes. (Their validity is another matter). However, guarantees are finite and as the banks knew when asking for them, would never have covered the losses on the size of loans provided if things went wrong.
Nama for the ordinary person: “…shouldn’t Mary and Jim be able to reduce the €400k mortgage on their home that is now worth €250k?”
The answer is “yes” and it will have to happen in one form or another. The banks, Nama and the government will have to embrace debt forgiveness before this is over.
With a pick up in economic activity underway in Europe (but not in Ireland), Euro interest rates will increase and mortgage repayments for already underwater homes will increase in tandem or worse. The looming mortgage default issue will become critical. Banks and building societies with the assistance of the government will have to introduce debt forgiveness, probably in the form of debt for equity swaps.
I edited the post to remove Anglo and substitute INBS throughout but you’re right, personal guarantees are a feature of Irish business lending. However I didn’t want to muddy the dilemma which was detailed enough already. I think NAMA has no choice in the matter – it needs pursue the developers for outstanding debts (including personal guarantees) all the time having regard for cost and benefit. However NAMA should not cut off its nose to spite its face and should sell assets and loans so as to maximise its returns. On the other hand I think the politicians have some communication to do because A LOT of people will be incandescent at the thought of pezzonovante builders buying back their developments at a discount.
Thanks for the challenge. Just some initial reactions. I certainly don’t have the solutions!!!!
To be successful, Nama must get a reputation for cutting very tough deals and adapting “high principles” when dealing with wheeler dealers and defaulters. This should bring people who might view it as a soft touch to heel and to be realistic. Nama should become known as the Nasty And Mean Agency rather than the Nice And Meek Agency. To do this, its staff will need to hide behind huge Chinese Walls and sever all links with former colleagues and peers.
Provided that there is a real market for the remaining 8 houses, Nama should consider accepting John’s offer of €500k but demand a substantial equity stake. If John does not accept this then Nama should call his bluff and either consider the lower €400k offer or put the land into “inventory”. If there is no real market, then it should accept John’s offer – he will probably go bust and his PGs to the new lender will be called.
In the case of the big developer, we are probably talking about multiple projects (some good some poor). Nama should negotiate on the sale of the loans/assets with the developer (who may be bust) from a position of strength and offer a moderate salary and (small) equity stake to run the portfolio of projects. In parallel, it should pursue alternative solutions that do not involve the developer. If the developer is not bust then Nama should demand that he repay as many of his debts as feasible before dealing with him either as a newly busted developer or a solvent one. One way or another, Nama should always separate developers from projects and play the market to get the best deal.
As regards householders in negative equity, I believe that there will have to be some sort of forgiveness linked to equity for loan swaps.
I agree with most of that, but acting like a bully, or even paying someone less than they can earn elsewhere, doesn’t encourage them to co-operate. You just turn from being a gamekeeper into becoming a poacher, or to use another analogy if you want to tax someone at 90%, it’s just self defeating – you push them into the black economy.
Who will take up and work all these troubled assets under coercive circumstances – at any reasonable price? They will just go elsewhere. And the foreign companies don’t want to know about property in Ireland. If the Nama approach is too hard line they get left with the assets and the taxpayer suffers more.
What is needed is a positive approach, that will ensure Nama makes a profit over the next three years so that the run-off rump can be sold on, thereby taking the taxpayers’ risk out of the equation. The developers are an essential element in making that happen – and it is achieved by co-operation not confrontation.
You can be tough without being a bully. It should not be a case of simply encouraging people who are heaviily indebted to co-operate. Such co-operatrion should be demanded and if if not forthcoming then …. The Golden Rule applies: He who has the gold makes all the rules.
Nama has no hope of making a profit over the next three years, or ever. Remember, it is taking on loans of €80 billion.
If developers who are indebted to Nama don’t co-operate to help Nama maximises its return the then they become part of the problenm and should be replaced – there are thousands of senior people who would jump at the prospect of leading projects. Developers are not essential – were they not called “project facilitators” – but their senior managers are.
Short sales and non recourse loans for an average homeowner in Ireland sounds like fantasy, or drug induced hallucination or something. Is it a possibility ? Ever.
Is there a sinlgle realistic pointer that this might happen? Could someone shed some light.
The recent addition to the Cardinal bid for EBS, Wilbur Ross, yesterday told CNBC that should Cardinal be successful there might be some prospect of reducing mortgages for EBS mortgage holders. EBS accounts for less than 15% of extant mortgage balances (13.6bn at the end of 2009) but this could herald some new model for mortgages. On the other hand Mr Ross’s interview yesterday gave rise to the rumour that Cardinal had actually succeeded in buying EBS ahead of other bidders, notably ILP, so perhaps what was said in the interview wasn’t totally reliable!
To “drunk from Tullamore”:
Th Irsh Times today carries an article on how it may begin to happen:
http://www.irishtimes.com/newspaper/finance/2010/0916/1224278993704.html
When the EBS loan book is purchased, it will be at a discount. The ultimate purchaser will want to turn the “bad” loans into good ones and will write off some of the mortgage balances to levels that reflect the current value of the assets (houses). The amount of the write-down will depend on the discount received on the purchase of the book. By doing this they will have created a well performing bank with proper loan to asset value cover, ready to make new loans at rebased levels.
It is unlikely that the AIB or BofI will be so generous, but they will have to follow suit in some fashion. That is likely to take the form of a debt for equity swap with the homeowner – it’s just that the penny hasn’t dropped with them yet – they are not very bright….. and there’s plenty of proof of that!
When you refer to a”debt for equity” swap in the context of a private residential mortgage, could you explain what you mean by that?
Bank takes equity stake in return for writing down the mortgage outstanding e.g. an apartment bought for €400k with a €300k mortgage is likley to be worth €200k at bottom of cycle. Bank agrees to write down mortgage by €100k in return for a stake in the property. This stake could be 33% or whatever. Takes some pressure off owner and painful for bank but better than a default.
So the borrower sees the value of his mortgage drop from say €300k to €200k, and he only has to pay interest on the €200k. On the other hand he only owns 2/3rds of his home which if sold tomorrow for €200k would mean he got to keep €133k of the proceeds.
So the effect on the borrower is that they would have reduced monthly payments, but they would still take a hit on the property if it was sold tomorrow. For the bank, they write off a loan but in return take a share of the property.
If property prices decline further then the bank loses money (as does the borrower). If prices increase then the bank shares in the benefit of the increase.
Is that how it would work? I ask because I have never seen debt for equity swaps in anything other than commercial arrangements. Are you aware of any similar schemes being adopted by residential mortgage lenders elsewhere?
NWL
Yes, exactly as you describe it. Not aware of it eleswhere but IMHO far superior and fairer than outright defaulting etc.
Brian – You want to turn the State into a property development corporation?
Why not? My main concern is that the life of Nama would need to be 10-15 years rather then 7-10 as being discussed.
Nama can, and will, show a profit over the next two to three years – it is thereafter that it becomes a problem. The low hanging fruit and easy sales based in the UK (particularly London) will take place during the early years. Based on the acquired values, Nama is already showing an unrealised profit on these.
The trouble comes with the Irish based assets and the rump of the overseas loans. Nama will make substantial losses on these. That’s why it needs to get out and sell to some gullible foreign bank or fund at the end of the profitable period – it’s known as going out on a high!
WSTT
Nama may generate a cash surplus on trading over the next three years thanks to its creative accounting but it will never, ever make a profit. It is acquiring loans of €80 billion and with the best will in the world might retrieve €50 billion – loss of €30 billion.
Sure you are right about the low hanging fruit but I don’t think that there are many gullible foriegn banks around.
Why not? Because they would need to borrow another €40 to €50 billion (top of the head), to bring the portfolio to completion. It would in effect represent the nationalisation of the property industry. I appreciated that we already have that to a large extent, but not completely just yet. I wouldn’t want to try to sell that to the taxpayer.
It keeps coming back to the question of whether you want the developers to act as gamekeepers or poachers. They can either be an asset – co-operating and used by Nama, or they can become poachers, vying for the the properties that will fall to absurdly low valuations – and which Nama will inevitably be pressurised to sell.
Two points:
If €40 billion is needed, this could be raised over 10 years or so. Maybe Nama could be floated on the stock market when things start turing up (in 5-10 years) or it could sell off blocks to raise funds.
In the scenario outlined (Property Development Corp), I would seek to replace the developers by professional managers ASAP.
Brian,
I agree that over the course of its life, Nama will never make a profit.
Nama is acquiring loans with a face value of €81 billion. It is paying approximately €35 billion for these loans – if the discount of about 60% continues to apply. Therefore it only has to recoup in excess of €35 billion plus expenses in order to declare a profit.
I’ll reserve my opinion on the gullibility of banks!
I read this very scenario some two years ago, but cannot remember where, when NAMA was only just a glint int the eyes of Fianna Fail and the developers and banks.
Back then, the proposed scenario was pretty much ignored, though Brian Lenihan did publically claim that such buy-backs wouldn’t be allowed.
I do think however that this is definitely going to happen, and like the whole NAMA project, no matter the outrage and discussion, it’s going to be permitted.
One could almost see that such a scenario was planned, or at least desirable, for the banks.
The upturn in the economy that’s expected, sometime, whenever, is really only going to occur when NAMA starts selling property.
It’s then that the recapitalized and unencumbered banks will again release the purse stings to the very same developers to rebuy their same properties at massive discounts. And the cycle starts again.
I have long thought that the proposed (ongoing?) reorganisation of the Land Registry will be a most timely event to muddy the waters here for everyone to ensure that the public don’t easily find out the “new” owners of NAMA’ed
property.
What would be very interesting to see will be if others apart from the original owners will purchase from NAMA. My guess is that gentlemens agreements have already been drawn up amongst developers to ensure this doesn’t happen – effectively ensuring that NAMA only ever has one offer for any property.
In theory, with such bargains on offer, you’d expect the losing bidders on many of the massive deals over the past few years to be testing the waters now to finally capture their prey, but I for one won’t be expecting to see any properties change hands – leaving aside the charade of multiple different companies, the ultimate beneficial owners will remain the same (or at least within family units at least).
Hi Declan,
I think there are two points there
(1) Should NAMA sell properties back to the same developers who originally had a loan on the properties which wasn’t paid off? What do you think?
(2) How transparent is NAMA when disposing of property?
Now NAMA have published their code of practice for selling loans which frankly gives NAMA wide powers to sell loans as it sees fit and NAMA doesn’t have to disclose the buyer. The code of practice can be found here:
https://namawinelake.wordpress.com/2010/07/12/if-you-thought-the-nama-business-plan-was-bereft-of-information-the-nama-codes-of-practice-%E2%80%93-disposal-of-bank-assets-and-the-disposal-of-property/
On the other hand NAMA has said that in relation to property it will abide by the Code of Practice for the Governance of State Agencies 2009 which demands transparency on large €150k+ sales though it gives a lot of leeway with transparency on sub €150k sales.
NWL wrote “So the borrower sees the value of his mortgage drop from say €300k to €200k, and he only has to pay interest on the €200k. On the other hand he only owns 2/3rds of his home which if sold tomorrow for €200k would mean he got to keep €133k of the proceeds.”
That’s the basic structure, except for the last sentence.
There are many different formulae. Underneath is just one:
He (the borrower) retains 100% ownership of the property up to a value of €200,000 (he is paying interest on that amount) and he gets to keep the full sales amount up to that figure.
Any income above €200,000 generated in a sale is split 2/3rds to 1/3 between the borrower and the bank after the bank receives value for the written-down amount (in this case €100,000).
Any loss in a sale below €200,000 is the responsibility of the borrower.
There are many ways of cooking the goose (or whatever the expression is). It just requires a little ingenuity – something that is sadly lacking in our current crop of politicians. I include all persuasions in that statement, not just the present incumbents.
Hi WSTT,
Have you seen debt for equity swaps for private residential mortgages operating elsewhere? Any examples?
What you describe above seems to disadvantage the bank more than the borrower. Banks aren’t known for their public spiritedness, and after all they are there to make money. So why would a bank want a debt for equity swap when it could just restructure the loan so that it was paid off over a long period or went to interest only for a period or there was a payment holiday. I think the scale of the problem demands more than restructuring but what bank would agree to it is my question.
The crisis that we face at this moment calls for a number of different approaches. All those that you cite are valid responses.
The problem has the capability of swamping the banks. We need to move towards a solution that may begin to relieve the looming mortgage problem that could eventually break them. And that’s the only reason that they will give it consideration.
So we need innovative approaches to this critical issue. An alternative to debt financed home ownership underpinned by the principles of shared appreciation in equity is a creative approach that should be examined.
The benefit to the homeowner is clear, as he receives fractional ownership and the benefits of continued homeownership, while at the same time the institution receives equity ownership in exchange for mortgage abatement.
Obama has a plan to tackle home foreclosures. The details are yet to come, but in essence he will be proposing that the banks would commit not to evict certain homeowners and in return would receive a share of equity in the house once the market recovered and prices rose.
The idea is in its infancy and would be stillborn but for the fact that the banks are desperate to find some way out other than foreclosure.
The following website may be helpful:
http://www.homeequitysales.com/index.html
@Declan Higgins – I vaguely recall writing some warning about developers dumping stuff into NAMA through one door, suffering very little pain in the process, then running round to the other side and picking them back up cheaply. I can’t remember where – probably blog or more likely irisheconomy. Regardless of Lenihan’s protestations, I always thought that this is what NAMA was designed to achieve – protection/damage limitation for the wealthy and powerful. I liked what I read about debt for equity swap above. Interesting thinking.
The purchase of debt by borrowers, equity funds, banks and assorted entities is a tool used in the rebasing and restructuring of companies all over the world. It is an integral part of the capitalist system and economic recovery.
An example of this is given in todays Irish Times where €100 million of Calyx debt was purchased from Anglo Irish for €10 million.
http://www.irishtimes.com/newspaper/finance/2010/0917/1224279095418.html
In practical terms it is impossible to exclude the original borrowers from raising funds and being a participant in any restructuring. And it is naive to think that such an exclusion can be imposed.
Hi NWL,
I had to rush off to the day job and was unable to answer you queries regarding residential “debt for equity swaps” fully.
You asked had I any examples of where this had happened before?
Mortgage interventions in the USA and elsewhere have traditionally been for moratoria. Debt for Equity Swaps are just a new tool – not commercially but in the residential context. My cousin is Professor of computer Science in Stanford and he told me of such a program at Stanford University, which was subsequently duplicated in style by other institutions. The program had the university become part-investor in the home purchases of faculty members. Upon sale, Stanford recaptured its principal and a share of the return.
In the context of Ireland, what I am suggesting is that where property values have fallen by 20 percent or more (pretty much everywhere), borrowers would have the right to require lenders to swap a write-down of this deprecation off the loan in exchange for, say, a 50 percent equity stake in any appreciation.
I’m not a constitutional lawyer, but to maintain constitutional integrity, it may be critical that reforms aimed at promoting loan restructuring do not mandate that lenders’ collateral be impaired below its present value (not the face value of the loan – the value of the asset).
It is important to note that the surrender of a portion of equity is a serious disincentive for those who do not need restructuring but would be tempted to join any program that requires givebacks only from lenders.
In a “debt-for-equity” swap, both parties to the contract offer consideration for the benefits they receive from restructuring.
Because it is a par-value swap against the principal private residence, the technique would avoid the Revenue treating write-downs as income to homeowners and creating a potential tax liability
While we are on the subject, there is also the possibility of a “rent-with-option” plan.
The plan would require lenders to offer (say) a five-year, market-rate lease to homeowners who surrender their deed in lieu of foreclosure. After five years, the homeowner would have first option to repurchase the house from the bank at market price.
This particular mortgage rescue plan could be denigrated as equity-stripping, but the mandate for market rent would likely result in a much lower monthly payment than a mortgage repayment at a much higher effective rate.
I can see lenders resisting this particular plan, but if they do some analysis and assume some rise in the market over the next five years; they (the lenders) would be properly compensated for receiving market rents, by the increased capital value of the property.
But …. My ulimate plan would be to create a Pool of distressed mortgages and refinance them by Unitisation:
Stage One: transfer the properties to the Custodian (say Nama Residential or Anglo Distressbank ).
Stage Two: agree affordable rentals and index link them to an agreed measure of inflation;
Stage Three: divide the resulting Pool of rentals into proportional Units (or n’ths);
Stage Four: allocate a proportion of rentals for maintenance/ management and sell the balance of Units to Investors.
For the Occupier, this is a new form of Rent to Buy – since any amount paid in excess of rental will buy Units.
For the Investor, Units provide a reasonable, index-linked, secure revenue stream, ideal for risk averse long term investors such as pension funds.
For Banks holding portfolios of distressed mortgage loans such Unitisation will enable what may be described as a NEW form of Debt/Equity swap.
Moreover, it will be seen that the proceeds from selling such Units will far exceed the proceeds of a conventional debt restructuring into new debt, which simply leaves intact the unsustainable obligation to repay capital.
Outcome: the outcome could be a debt/equity swap on a massive scale into a simple but radical new form of REIT Unit (which we don’t have yet) or a Limited Liability Parnership.
The mountains of un-payable debt would be exchanged for Units carrying a reasonable and index-linked rental, and the risk of non-repayment of debt would become simply the risk that no buyer for equity could be found. This is a low risk since even if no investor wishes to buy, the fact that Units are redeemable for the right to occupy property would mean that demand from property occupiers would underpin the market price.
These Units would be attractive to pension funds, and to sovereign wealth funds, and one of the attractions to Middle Eastern pools of Petro Dollars would be the fact that these Units are Sharia’h compliant at a deep level, rather than the current Islamic veneer on a distinctly un-Islamic reality.
What is more we could slice and dice them in tranches, have them rated by Moody’s and……. Uh,oh…. Uhmm…. got to learn to restrain my worst entrepreneurial excesses!
Hi WSTT,
These two concepts deserve an entry on their own, and thank you for setting out your thoughts and sharing the experience, particularly of an employer taking a stake in a home-loan.
The difficulty I see with the principle in a “debt for equity” or “reduction in mortgage in return for giving the bank/your employer a share in the deeds to your home” is that your employer (for bank, see below) needs to come up with the funds to buy a proportion of the mortgage – can you imagine what that would do to attracting enterprise here – “come to Ireland for the 12.5% tax rate and for the educated, flexible workforce but watch out for the state-legislated debt for equity swap which might cost you €100k per employee and may represent a substantial financial risk to your balance sheet for the next decade and beyond”.
As regards a bank initiated debt for equity swap, they too would need recognise a loss immediately. Though I guess you’d say if there are mass defaults then they will have losses anyway and they might be on a larger scale. Maybe but I can’t see a foreign-owned bank with a pure profit motive wanting to expose itself to that sort of loss, and I can’t see the State being able to force them in an EU context (and possibly a constitutional one).
If you’re to reduce the problem to its basic principles – you have borrowers with large mortgages on homes worth substantially less than the value of the property (plus the borrower’s other wealth) and you have banks with very limited capital and an inability to either finance or absorb losses on the loans they’ve advanced.
Will home values ever come back to previous levels? Of course they will in nominal terms but if you factor in, say 4% interest rates on banks paying for the funding so they can advance loans today, will loan values ever come back to that level ie if a bank has advanced a €300k mortgage on a home worth €200k today and the bank has to pay its providers of funding 4%, will the €200k home ever reach the level of the mortgage again? For example if home values increase by 7% per annum, it will take 15 years for the home to reach the value of the mortgage plus 4% annual bank funding cost.
So who’s going to take the cost?
There might be a solution if you get a large enough flexible provider of funds (you would need something in the €10bn range so say the NPRF), some sort of lease-back arrangement (so something like upon death the NPRF gets your house), some repayment by the borrower (even if it’s just interest) and a long enough period of time. You have got me thinking!
On public radio in the US, many callers call to say:
‘I got a debt restructuring deal from the bank, now I have to pay as much or more, over a longer period , for something that won’t recover it’s value. I should have just mailed the keys to the bank. ‘ Something to think about especially as Irish prperty prices might not recover in our lifetimes. What’s lost is lost.
On the other hand,
In california many banks are allowing short sales , writing off 50 to 100 k in the process, and the customer actually walks away happy to be rid of an underwater property.Customers get an average 200 point hit in their credit score and it is on their credit profile for just 2 years. A 200 point deduction will not hurt an average persons credit in the long term .A good score is around 700. I live in a complex of 200 units, the local back approved short sale on 6 so far, to me that is amazing. In a million years I can not envisgae this happening in Ireland. Maybe it’s a question of scale. Maybe it’s because developers have cornered the market on forgivness. Maybe it’s california facing up to reality in a way that Ireland is not.
Very useful sfca writer, for Irish readers who might not be familiar with short sales, there is an entry on here from some time back which explained what they were and how they work in the US.
https://namawinelake.wordpress.com/2010/05/11/short-sales-%e2%80%93-solving-the-problem-of-negative-equity/
You’re very welcome, NWL.
I don’t think that an employer sourced “debt for equity” swap should be anything other than voluntary. The banks are another matter entirely, and I believe that they should be legislated. If the home is in negative equity and the homeowner can’t pay the mortgage, the bank is already in deep manure (being very polite here). The loss is already there.
The questions are:
Is it possible to recover the loss?
What is the best way of achieving that objective and turning a bad non-performing loan into a good performing one?
There are funds that would take an interest in the equity side of the swap for a premium – if the banks wanted to dispose of it. They would of course have to accept market price – which might require them to accept a discounted value.
strangely the short sale process is not well defind. Issues such as late fees assocaited with loans and so on are negogtiaited on a case by case by realtors, often the realtors have no finance bacakground. They look at family situation, history and so on. They talk to a real person in a bank. This approach works in California, but I cannot see it in a country where trust and human interaction have been devalued by the tone set by NAMA. How many underwater home mortgages could be fixed with the price NAMA will spend one poorly planned office block? I guess its a question of the government’s priorities.
The 2008 prices are not coming back, any plan that invilves waiting for them to do so is crazy.