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Archive for September 16th, 2010

In their recent presentations to the Cantillon School of Economics and the Fianna Fail gathering (the one that suffered from such poor optics, though that had nothing to do with NAMA), a common theme addressed was what NAMA called misconceptions about its operation. Four areas were explored (pages 29 & 30 of Frank Daly’s presentation in Galway set them out as NAMA intended). This entry examines these four misconceptions.

1. NAMA is going to be a borrower bailout. NAMA says “No”! and that borrowers will continue to owe 100% of their debt. Furthermore NAMA may be better than banks because NAMA is more rigorous and impartial than the banks. And that some borrowers are “unlikely to survive” (don’t think NAMA is going to have them whacked!).

My response: Of course it is early days for NAMA relative to the 7-10 year NAMA lifespan. So far NAMA has taken legal action against Paddy Shovlin, though it seemed to give notice last weekend that it was contemplating legal action against 12 more developers who owe a total of  €300m. High profile developers from the boom still maintain what for most people would be rich lifestyles (by reference to their residences and personal/leisure transport). Beyond telling developers that excesses will be not be looked on kindly, it is not clear what else NAMA can do at this stage – their role is to maximise the return from the assets they’re buying, not to moralise or persecute (unless they can make money out of it). Banks certainly built up what many would characterise as cozy relationships with certain developers and it may come as a severe shock to developers not have your word taken on trust by NAMA’s management. NAMA should not have any relationship with developers which might compromise the impartiality of their actions and that will remain a concern because NAMA needs employ people from an industry that will have some degree of familiarity with some developers. That needs to be policed vigorously by NAMA. It would have helped if NAMA’s accounting methods made it clear that the gross value of the loan remains outstanding with accrued interest and also the level of write-down that take place. So overall, too early to say.

2. NAMA is going to be a bank bailout. NAMA says “No”! and adds that valuations are stringently assessed, that the 5% subordinated debt element of the consideration to banks will not be honoured if NAMA makes a loss and that a surcharge can be levied on banks for any residual losses when NAMA is wound up.

My response: This is a weaker area for NAMA. NAMA has not apparently sought to change its valuation date from 30th November, 2009 despite the fact that in NAMA’s main market, Ireland, property prices have continued to decline. NAMA is letting performing loans slip through its fingers (at AIB through the sale of its UK operations and possibly through the sale of Bank Zachodni, at BoI where €4bn-odd of loans are no longer going to NAMA and Anglo where €1bn-odd of NAMA-eligible loans are seemingly being sold by Anglo with NAMA’s agreement). As regards the 5% subordinated debt, it is certainly the case that banks are expecting to see some value  looking at the latest bank balance sheets but it is basically a clever aspect of the NAMA model that 5% of consideration may in fact not be paid. It should however be noted that the interest rate payable on the NAMA subordinated debt is nasty – it’s the 10-year Irish bond rate plus 0.75%, that’s over 6.75% this morning. With 10 years of payments at that level, banks mightn’t be so concerned with not having the value of the subordinated debt honoured. The levy is laughable though it was included in the NAMA Act. Anglo and INBS are terminal basket cases and will not (in all likelihood) be around to absorb any levy. Serious professionals like Frank Daly and Brendan McDonagh belittle themselves when they still continue to refer to the levy.

3. Scale of property market recovery: NAMA says “Not impossible” and that only a modest recovery is required to break even.

My response: This is dealt with in some detail in an earlier entry. In short NAMA needs a recovery of about 10% in prices from today to break even at a gross level (ie acquisition value of loan less sale value). There is risk of further price declines hampering NAMA’s operations and NAMA needs to be careful to ensure its operating costs and interest payable are fundable from interest receivable and cost allowances that are deducted from NAMA loans.

4. NAMA is a goldmine for advisers: NAMA says “No”!, that costs on advisory services have been low to date (no quantification given), that there was competitive and public procurement for valuation and due diligence services to drive prices down, that 100% of due diligence costs are recouped from the banks and that the taxpayer needs to ensure that loans are correctly valued.

My response: In the NAMA draft Business Plan, the projection was for almost €200m of costs in the early years which would presumably be paid to third party for services. The accounting in the first quarterly accounts doesn’t help much with seeing what is being spent because some costs are taken to the Profit and Loss account whilst others are aggregated and capitalised. However it was clear that some €2.45m was spent with Pricewaterhouse Coopers on “secondment fees” which were not subject to public tender. Due diligence costs are relatively minor, there’s a 0.25% deduction that NAMA can make to loans being acquired for due diligence. Of more concern is that NAMA is entitled to deduct 5% for future enforcement costs based on the fact that average enforcement costs for defaulting loans are reported to be 15% and that less than 1/3rd of loans will default. NAMA is also letting performing loans slip through its fingers and the upcoming Paddy McKillen case which apparently involves €2bn of performing loans may further reduce the proportion of performing loans in NAMA’s final portfolio and NAMA may end up spending vast sums on enforcement not covered by this initial 5% allowance. The last point about NAMA’s duty to the taxpayer is valid and NAMA will be reminded of that should any attempt be made to acquire Anglo loans at a block discount. A related point concerns recent revelations on salaries and benefits at NAMA, though presumably NAMA will say it needs the best people.

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There are many aspects of NAMA that suggest the organisation is being run on a shoe-string – the NAMA brand, a limited number of employees and modest accommodation. Revelations on pay and benefits and the perception (unfounded or not) of a professional fees gravy train tend to counter the appearance of austerity. However the duplication of presentation slides in two recent NAMA public appearances at the Cantillon School of Economics in Tralee on Friday last (NAMA CEO, Brendan McDonagh) and the Fianna Fail lock-in in Galway on Tuesday (NAMA Chairman, Frank Daly) suggests that NAMA is at least being economical in how it presents itself to the world.

Both sets of slides, although addressing different themes, included an update on NAMA’s progress and sought to dispel a few perceived myths about the agency. This entry examines one section of one of 30-odd slides in each presentation, and specifically the part which says “Some commentary has suggested [the] property market will need to recover to 2004-2007 levels. The scale of recovery required is, in fact, a more modest 10% over the lifetime of NAMA [elsewhere stated to be 7/10 years] taking into account the 5% subordinated debt (€2bn)”.

The slides elsewhere tell us that 67% of NAMA loans will be in the State, 6% in Northern Ireland, 21% in the “mainland UK” (NAMA might want to modify that territory name before making more presentations up north!) and 6% in the Rest of World.

NAMA is valuing loans by reference to the 30th November, 2009 and the “key market data” in the NAMAwinelake header show the performance of the residential and commercial property market in the two main NAMA territories (Ireland and the UK) since 30th November, 2009. Ireland has so far experienced an 8% fall in commercial from end November 2009 to the end of June 2010 (the last available data – Q3, 2010 will be reported in October) and residential  has fallen by 9.8% over the same period (Q3, 2010 residential will also be reported in October). The pace of falls in commercial accelerated from Q1, 2010 to Q2, 2010 but residential declines eased. The outlook on commercial is mixed with property companies predicting a recovery, whilst the recent EU stress test suggested further declines.

The UK on the other hand has had a solid recovery in commercial prices, 15% over the past year and 9.3% since last November 30th, 2009 to the end of August 2010. The pace of increases has slowed markedly and the recent EU stress test forecast a 2% rise in commercial property in the UK for all of 2010 which would indicate a fall of 4% from prices today. Residential has had a more modest increase of 2.3% since last November and the EU stress test was for no change in 2010.

Although NAMA has valued the current market values of loans by reference to 30th November, 2009 it is apply an uplift – a long term economic value premium – to help out the banks on the assumption that November 2009 was the bottom of the market. The average uplift applied over the two tranches so far has been 10%.

The breakdown of tranches 1 and 2 shows that 13% of the loans relate to completed residences. In addition 26% relates to development and presumably some will be residential. Let us assume that residential makes up 20% of all loans acquired in all territories.

NAMA is paying for loans with NAMA Bonds (making up 95% of the payment) and NAMA subordinated debt (making up the remaining 5%). The subordinated debt will only be honoured if NAMA makes a profit. So if NAMA makes a loss then these subordinated debt instruments won’t be honoured. NAMA is paying very roughly €40bn for the loans so the subordinated debt element will be €2bn approximately.

So Frank and Brendan, how truthful is the statement in your slides that you require a modest 10% increase in property prices (and take the benefit of the sub debt conditions) to break even. Let’s see…

So assuming the Rest of World has been flat since last November, 2009, NAMA needs just an 8.3% increase to break even at a gross level (ie simply looking at the acquisition and sale prices). So a 10% estimate would indeed be truthful. If it weren’t for the subordinated debt then an average increase of 14% would be required. NAMA would still save themselves (and us) some billions if they were to rebase the current market valuation date to September 2010.

Of course NAMA will need ensure its operating costs are contained within its enforcement, due diligence deductions from loans bought and NAMA premium and in that regard it can’t afford to let performing loans slip through its fingers and maintain a measly 5% enforcement deduction. It will also need ensure interest payments on NAMA bonds and subordinated debt are contained within the interest it receives on performing loans.

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