NTMA withdrew money from Anglo in 2007 because it didn’t understand its business model – NAMA CEO, Brendan McDonagh. But how understandable is the NAMA business model?

Broadcaster Vincent Browne is on what seems like a one-man crusade to show that Anglo’s parlous financial state was recognised within government circles in 2007 and that consequently the government could have taken earlier action with that bank which would have mitigated the catastrophe that unfolded in late 2008.

On Monday night last, he used his underrated show on TV3 to examine the issue again. This time he had video footage of the appearance at the Cantillon School of Economics in Tralee of the NAMA CEO, Brendan McDonagh. Before joining NAMA, Brendan was the Director of Finance, Technology and Risk at the National Treasury Management Agency (NTMA), a post he held from 2002 to 2009. The NTMA is responsible for managing Ireland’s debt, and in discharging its responsibilities it routinely deposits short term cash with Irish and foreign banks. In 2007 the then-head of the NTMA, Dr Michael Somers, took the decision to stop placing deposits with Anglo. He was subsequently prevailed upon to reconsider his decision and indeed he recommenced placing relatively small sums on deposit with Anglo. At the Cantillon School, Brendan McDonagh was asked about the NTMA’s actions in 2007 and 2008. Brendan told the audience that the NTMA became concerned at the explosive growth in Anglo’s balance sheet in the early 2000s and said that “they didn’t understand the business model at Anglo” and that was the reason they stopped the practice of placing deposits with that financial institution. When pressed whether these concerns were relayed by the NTMA to the government, Brendan said that the reporting line would have been via Dr Somers. Vincent sees this episode as being critical to the charge that is often levelled at the government (including the present Taoiseach who was the Minister for Finance in 2007 and until May 2008) that the government was negligent in its handling of the banking sector which has now imploded and is costing the State between €28-90bn depending on whose estimate you believe. It is a subject dealt with again by Vincent in the Irish Times during the week. Today in Simon Carswell’s interview in the Irish Times with Dr Somers, Dr Somers makes reference to Vincent’s concerns but seems to dismiss them by saying “No [he should not have raised his concerns elsewhere], because I didn’t know enough to say anything to anybody, and if I had said it they would have said: ‘Would you ever go and mind your own business? This is a very successful institution – what are you on about?’ It would not have mattered if I had said something to Cowen. What could he have done?” Vincent would probably say, “ah, but did you say in fact something to Cowen, or to others in government?” No doubt that the subject will be pursued and whilst Anglo is spilled milk, perhaps the answers might sweeten the bitterness of the pain of dealing with Anglo over the next decade.

Anyway,“not understanding Anglo’s business model” was the reason given by the NAMA CEO in Tralee for stopping placing deposits at Anglo. Brendan McDonagh however gave us the NAMA view of its own business model. And I think quite a few people would not understand it. Here’s the relevant slide.

The business model looks at the role of NAMA from the point of view of the banks and from the point of view of NAMA.

What NAMA says :the banks

NAMA reduces Risk Weighted Assets (RWA) which will have a high weighting for capital ratio purposes

NAMA removes loans from banks’ balance sheets that generally cannot be used for collateral purposes to access liquidity with Central Banks or market counterparties

Banks receive government securities which can be used for collateral with Central Banks and market counterparties for liquidity

My response: NAMA does indeed reduce RWAs but it forces banks to recognise large losses today. It is completely true that NAMA replaces a class of bank asset (land and development and associated loans which are to a large extent toxic) with nice clean exchangeable-to-cash government backed securities. There are two difficulties with what NAMA is doing – firstly banks recognising large losses today is forcing the State to recapitalise the banks and secondly whilst NAMA is taking €80bn of property loans, it is leaving €70bn-odd of commercial property lending which is perhaps not as toxic as land and development but is still pretty poisonous (commercial property has fallen 60% from peak in Ireland and 40% in the UK). So NAMA helps with restoring health to the banks but NAMA by itself is not the solution (as claimed by NAMA elsewhere in the slides), it is but an element of the solution. Whilst the State is painfully recapitalising banks, it is not addressing the poisonous commercial property loans that will remain on the banks’ balance sheets when NAMA has completed its work. So to that extent you’d have to say the NAMA business model is incomplete. You could argue that the NAMA cleansing of €80bn of loans will be sufficient to restore a degree of credit availability in the economy. Will it be enough?

What NAMA says: NAMA

NAMA controls the relationship with the borrower and makes all the decisions

NAMA receives income on the acquired loan portfolio (using floating interest rates plus a margin)

NAMA pays a coupon on government bonds (using floating interest rates)

My response: not a great description of the NAMA business model. NAMA may well control the relationship with the borrower but what about when the borrower can’t repay and NAMA has to deal with the underlying asset? It is also a little underhand to say that NAMA receives income on the acquired loan portfolio which will include a margin but NAMA only has to pay a coupon rate without the margin. NAMA’s performing loans seem to be rapidly decreasing, it was 40% at the draft business plan stage, 33% in April 2010 and 25% in the June 2010 business plan. Now AIB is selling its UK operation with €3.2bn of what are thought to be mostly performing loans, Paddy McKillen is doing his damnedest to keep a reported €2bn of performing loans from NAMA and Anglo is selling €1bn of loans in the UK and US which are assumed also to be mostly performing. So NAMA is receiving a floating interest rate plus a margin *on a small proportion* of its loan portfolio. On the other hand NAMA is paying out a floating rate on 95% of the loan consideration, fair enough. On the 5% subordindated debt, NAMA is paying the 10-year Government bond rate plus 0.75% (over 7% in total today).

A better description of the NAMA business model might be: acquiring assets at roughly 10% over values today in the hope that the market is close to the bottom and will recover to the extent that the price realisable for the property is enough to cover the purchase price (or that the plan worked out with the developers is to profitably deal with the asset and/or secure repayment) and any shortfall in operating income (operating income = interest receivable plus expenses recovered from the banks (enforcement and due diligence) plus the NAMA risk premium (4-6% on purchase) minus NAMA’s operating expenses and interest payable).

Of course, it is not our decision whether to put money into NAMA or not – it is the Department of Finance’s and it is they who should understand the NAMA business model. It would help NAMA’s image though if the business model was a bit more understandable beyond Upper Merrion Street.

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