Paddy McKillen v NAMA – Michael Cragg’s expert witness statement

There is a break in the McKillen case today at the High Court but it is set to resume tomorrow and continue until Friday. So, continuing with the examination of the expert witness statements submitted by the applicant (Paddy McKillen and 15 of his companies), this entry looks at the statement of Dr Michael I Cragg. Again, he may not be a household name here but in the introduction to the witness statement he alludes to his experience. Like fellow applicant expert witness Joseph Belanger, Dr Cragg is currently employed by the Brattle Group. His CV is apparently attached to the statement but I have not seen that but the statement says that he has a PhD from Stanford University and was an economics professor at Columbia University and UCLA. He has “conducted research, published, testified, taught and made presentations on the subjects addressed in this affidavit including the current financial crisis, commercial and investment banking failures, financings of property and real estate development, structured financial products, securitizations and other financings”

He deals with what he claims are three fundamental errors in the affidavits filed by the NAMA side (Brendan McDonagh, Anne Nolan, Aideen O’Reilly, John Mulcahy, Philip Lane, Dermot McAleese, Ian Goldsworthy and Matthew Webster):

(1) That any consultation between NAMA and borrowers would be costly and wasteful. On the contrary argues Dr Cragg, it would enhance NAMA’s efficiency and raise its profile in a positive way “internationally”.

In probably one of the most tantalising sections of these expert witness statements, Dr Cragg claims that “numerous references can be found in NAMA e-mails in which the authors admit to scheduling meaningless meetings and setting arbitrary deadlines. These meetings and deadlines are set to give an outward appearance of being accommodating and thereby lessen the chance of EU intervention. This can be seen for example in a March 11, 2010 email from Brendan McDonagh to NAMA board members discussing a deferment in the acquisition of the Maybourne loans:

The Chairman and myself know that the timeline we propose is too short but we are building a defence against [being] accused of being unreasonable and to try to stop an EU complaint before the first tranche occurs” and Frank Daly comments on the thread of emails “The key issue here revolves around the EU. I have no doubt at all that if we go back tomorrow and say no that there will be the strongest of representations on this to the EU and I have a real concern that they at least feel that they have to investigate”

The exchange above is claimed by Dr Cragg to evidence NAMA being more concerned with EU intervention that engaging with borrowers. If NAMA allowed a consultation process it would only be accessed by performing borrowers as impaired borrowers have nothing to lose as they have lost their equity.

(2) Whether Paddy’s loans constitute a systemic risk to the Irish banking system. It is claimed that the NAMA side has not defined “systemic risk” but to the extent it means risk to the entire financial system, Dr Cragg says that the system is already knackered (and the risks now are to do with recapitalisation, the guarantee and the deficit) and Paddy’s loans are but a small part of the overall total. He then lists out six areas that he would expect to be considered as part of any overall consideration of the risk posed by Paddy’s loans (the six areas are identical to those in Jim Power’s expert witness statement):

(i) The solvency of Paddy and his related companies

(ii) Whether there has been or is likely to be any impairment or non-payment in respect of any given loan

(iii) Whether there has been or is likely to be any impairment or non-payment across the portfolio

(iv) The quality and diversification of the portfolio

(v) The historical performance of the debtors

(vi) The extent to which cash flow exceeds financing costs

If NAMA has not considered these headings in relation to Paddy’s loans, then how can NAMA have judged Paddy’s loans to be systemic, argues Dr Cragg. What expertise have Brendan McDonagh, John Mulcahy, Aideen O’Reilly and Sean O’Faolain to judge systemic risk, what analysis did they carry out and they appear not to have engaged an expert to advise on the matter.

There is a very lengthy and interesting retelling of the rise and fall of the Irish economy through the 90s and 2000s, the Celtic Tiger years (divided into pre- and post-2000), the expansion of debt, the construction and housing bubble, the bust, the collapse in share prices, the scale of bad debt. This part of the statement draws heavily from the Patrick Honohan’s Summer 2010 banking report. There mightn’t be much that you haven’t see before but the point is that the losses already exist, and the risks now are to do with the magnitude of our bailout costs and the guarantee. Dr Cragg sees NAMA as destroying value through its professional fees and considers a €80-90bn recapitalisation of the banks might have achieved similar results. Paddy’s loans relate to borrowing before the post-2000 mania, his property is diversified in location and funding source and represents less than 0.2% of AIB and BoI’s lending and less than 1.5% of Anglo’s. And in terms of risks associated with bank recapitalisation, Paddy’s loans are performing so shouldn’t affect that State exposure.

(3) The “flawed, inadequate and economically unsupportable process” that NAMA used in judging the treatment of Paddy’s loans

Dr Cragg cites the Official Journal of the European Union in March 2009 “Information from European Union Institutions and Bodies Commission on the treatment of Impaired Assets in the Community banking sector” which says “However, assets that cannot presently be considered impaired should not be covered by a relief programme” If NAMA was supposed to deal with performing assets then it would have credit capability over a long period. He goes to claim that NAMA are interested in Paddy’s loans because they may represent an opportunity to make a profit. He describes an email from NAMA board member Eilish Finan which makes reference to “the very real possibility that in a few months if the loan were to be refinanced and/or the asset were to be flipped at a profit, NAMA has forfeited the profit”