Does NAMA destroy value when it takes control of performing loans?

It would seem so far that Nobel economics laureate Professor Joseph Stiglitz’s is the flagship expert witness statement at the Paddy McKillen case and there is certainly much in his statement that is convincing and significant.

One of the themes that he deals with is NAMA’s role in adding (or destrying) value through its operation, and in particular he contrasts the fate of a loan and lender at NAMA  compared with at the banks. I have not seen NAMA’s witness statements yet but from recent speeches, NAMA has argued that unlike management in the banks, “NAMA will be in a position to assess each borrower’s viability more rigorously and impartially than banks have done to date” – indeed there have been suggestions that banks may be compromised by feelings of loyalty from long term relationships and a reluctance to recognize losses. “Moreover”, according to NAMA “this assessment will be based on the borrower’s aggregate exposure to all institutions, not the limited view that each institution has had to date”.

 

Now Professor Stiglitz accepts that NAMA may add value to impaired loans (and remember it is claimed that Paddy’s aren’t impaired). He claims that banks which, under normal circumstances, would be concerned with moral hazard when evaluating their treatment of loans may be tempted to abandon such care when operating with a State-guarantee. So he argues that impaired loans should be removed from the banks whose devil-may-care attitude (protected by the State guarantee safety net) means they may be reckless with poor quality loans with disastrous consequences for the State. But if the loans are performing then he argues that banks will be better at extracting value from the borrower relationship than NAMA.

 

I have not seen the detail of NAMA’s arguments but I see that there are claims that the “banks in 2007” are not the same as the banks today and they certainly don’t have the same access to credit. However it might be a challenge to argue that NAMA’s limited human resources with HSBC providing back-up advice could equal the experience and acumen of the banks themselves – before you laugh, of course it is true that banks have gotten us into a fine mess but under normal regulated conditions you would expect they would make a relationship more profitable than those without banking experience or supporting structure.

 

So I personally found Professor Stiglitz’s argument convincing – that banks would enhance the value of performing loans more than NAMA. However, I then wondered why Paddy hadn’t put out a figure on the value that would be destroyed or how much value the banks would add. Of course such an estimate mightn’t have any legal value but wouldn’t it have helped the general bouquet of his case and boosted the case in the public’s mind? And then I got to thinking about what NAMA would see as maximising the value of the relationship. Let’s say NAMA is taking over a €100m loan which is performing, it will pay just over €90m for it (deducting the 5.25% enforcement and due diligence contributions and the NAMA risk premium). No matter how perfect the relationship between NAMA and the borrower, NAMA is not going to get more than €100m on that loan, over 10 years the maximum they’ll get is €100m plus interest received minus interest paid. NAMA is not going to be offering new loans to Paddy for new projects which could conceivably generate new profit. And if the loans are substantially unimpaired then won’t NAMA maximise its profit regardless of the relationship with Paddy – better to have a co-operating debtor for sure, but if the loan is unimpaired and underlying assets sound, who ultimately cares if the relationship has gone to pot? Anglo will not be engaging in new lending under its proposed new structure so they too would surely be interested in recovering just the debt (I wonder would Anglo have objected to Paddy’s loan transfer to NAMA if they had known the EC would reject their v2.0 restructuring plan and that Anglo would end up being run down unable to generate new business?). AIB is to a certain degree more robust than Anglo but Bank of Ireland would be best able to generate new profits from additional lending – perhaps that is why Paddy chose to base this test case on Bank of Ireland’s loans and not his loans with the zombie Anglo or the walking-wounded AIB.

 

So whilst I think Professor Stiglitz makes a convincing argument, I don’t think it relevant to Anglo nor to an extent to AIB which I expect will be effectively State-owned by the end of this year. And BoI would seem to account for just €297m of the €2.1bn debt that NAMA claim is eligible. And whilst BoI might lose €297m of loans to NAMA there is nothing to prevent BoI maintaining what appears to have been a happy and successful relationship with Paddy over a considerable period,  with new lending for example. So although the Stiglitz argument is well made in general terms I don’t see how it significantly benefits the banks in this case, nor if the loans are unimpaired with the underlying property worth more than the exposure how the argument affects NAMA (and by wider implication, the taxpayer).

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Financial Regulator “for AIB, its haircut on average had gone up from 42% for the first tranche to 55.5%” Deputy O’Donnell “That is nearly an extra 11%”

Our new-ish Financial Regulator Matthew Elderfield appeared before the Oireachtas Joint Committee of Economic Regulatory Affairs on Wednesday 5^th October, 2010 where he was subjected to questioning of a quality reflected in the arithmetical ability of Deputy Kieran O’Donnell’s comment above.

 

Whilst the slip from the usually-sharper Deputy O’Donnell is a little amusing, what wasn’t funny was the absence of any meaningful questioning by politicians (deputies and senators from all of the parties) of a man close to the heart of the plate-moving crisis being played out right now in our banking system. In particular there was an absence of questioning on the final cost of the banking bailout and the parameters of the Prudential Capital Assessment Review (PCAR) and indeed its seems there will be a PCAR v2.0 next year though we did learn that it will take half a decade to get banks back to normal in the Regulator’s eyes “my guess, however, is that getting the funding position to a steady state will take at least five years. It could take nine years to get to the new Basel standards”

 

In respect of non-NAMA loand portfolios the Regulator said “we stand by the assessment we have done for the non-NAMA portfolio [in March 2010]”. So even though in March 2010 when less than 0.5% of the NAMA portfolio had been acquired and before the full horror of lending practices, loan documentation and security came to light and when the haircuts were still at relatively modest levels, and when some €70bn of commercial property lending by NAMA Participating Institutions (PIs – AIB, Anglo, BoI, EBS and INBS) is not going to NAMA, the Financial Regulator still thinks his estimates in March 2010 for required loss provisions are adequate? On the face of it, this is rubbish but alas our politicians were too busy looking for easy headlines “did the banks lie to NAMA”, “did the government know what the NTMA suspected about Anglo”,

 

The Regulators, colleague, Shane O’Neill (Retail Banks Supervision in the office of the Assistant Director General at the Financial Regulator) said “the non-NAMA loans were viewed and identified at the time of the PCAR process within each of the institutions, along with the processes they had for provisioning. We also set benchmarks for loan losses, such as the expectations for losses over a three-year period. We looked at the various processes each of the institutions had and we benchmarked the institutions against one another. At the end of that process we came up with add-ons to their own estimates which, in some cases, were significantly larger than in others. We have not changed that view, although the current trend is still one of increasing arrears, the rate of increase has slowed down. That is not out of line with our expectations at the time of the review, or out of line with the banks’ own expectations.” Unless those add-ons in March 2010 had magical properties, it is difficult to accept that the non-NAMA portfolio’s, which include substantial commercial property lending, are at all adequately provisioned.

 

With respect to the €6.6bn of €5-20m loans that will be remaining with AIB and BoI, and which, in my opinion, have saved BoI’s from coming under majority State-ownership if the true level of losses on these loans was to be recognized (which would have happened had they continued in their journey to NAMA). “What we have done, as a prudent measure, is to require the capital requirement for that to be the higher level, or the peak higher level which we used in March, and the haircut on all the NAMA transfers that had gone before for that bank. We have a double conservatism test for that group because we know that group could be suspect and we will have a closer look at that next year.” So this “rump” of sub-€20m loans are subject to the highest discounts in previous NAMA tranches even though there is evidence that because they are solely development loans (without much prospect of bringing in better performing associated loans) and more likely to be for rural fields that the haircuts should be substantially higher than has been the case with previous tranches. “Double conservatism test” my backside – they are using the most pessimistic aggregate of what has gone before and kicking the can into next year. So much for certainty by 31^st December, 2010.

 

I will leave you with the Regulator’s comments about the increased capital requirements at AIB which, when announced last week, led to the departure of the chairman and CEO who were apparently “stunned” at the €3bn extra in capital they had to find by the end of the year. According to the Regulator “they should have had an insight into the values that were coming through” and “the senior management should have realized”. Perhaps they had the arithmetical ability as Deputy O’Donnell.

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