Archive for November 3rd, 2010

The reason in summary is that NAMA did not re-value the loans at 30th June, 2010 by reference to underlying security. If it had, then the near-10% falls in Irish property from 30th November 2009 (the date by reference to which NAMA is valuing current market values of property) plus the fact that NAMA is paying a premium above the current market value (the long term economic value) would mean that the loans were worth far less than NAMA had paid. This entry examines this one issue which is, I would suggest, the most financially significant in the NAMA accounts.  It should be said that it is not usual for companies to re-value their assets every quarter so it is not claimed here that NAMA is being deceptive in the accounts – though it would certainly have been an honest act to have alluded to the underlying value of the loans and changes in value since 30th November, 2009 in the report. There is another entry on here which examines what is effectively the small change of the second quarter’s accounts (it contains a summary at present but will be updated with detail later on, some of which is intriguing but ultimately not as financially significant as the valuation of NAMA’s loans).

NAMA of course has been set up to acquire a class of lending from five Irish Participating Institutions (PIs – AIB, Anglo, BoI, EBS and INBS). The type of lending is supposed to be primarily land and development loans, where the underlying assets as a whole have suffered particularly badly in our property crash. Secondarily, lending associated with the same borrower is captured in the NAMA net which is why NAMA actually now controls lending secured on everything from completed hotels to wine collections to helicopters to historical family homes.

NAMA has a defined methodology for valuing loans (set out in the NAMA Act, the Long Term Economic Valuation (LEV) regulation, the LEV Statutory Instrument, the EU Decision approving the NAMA scheme – the best description though I have seen so far is contained in the Comptroller and Auditor General’s report on NAMA’s acquisition process published yesterday). In short NAMA has set 30th November, 2009 as the date by reference to which the  banks’ loans are to be valued. The loans are primarily valued according to the underlying security, the property against which the loan was advanced. NAMA then calculates a premium to pay to the banks to recognise that we are supposedly valuing at the bottom of the cycle, this LEV premium has on average been 10.5% of the current market value in Tranches 1 and 2. The property which secures the lending is across a wide range of property and is located in Ireland and across the globe. Some property markets have performed better than others : the UK’s commercial property market is up by about 10% from November 2009 levels for example.

So why should NAMA be showing a €600m+ loss for the quarter ending 30th June, 2010? The accounts tell us that NAMA acquired €16.393bn of loans at par value (note 6 on page 8 of the quarterly report is probably the best source for these numbers). NAMA paid €8.427bn for these loans which included an estimated €0.766bn of LEV (being 10.5% of current market values). According to the report on Tranches 1 and 2, 67% of NAMA’s loans are in Ireland and 27%% are in the UK with remainder scattered across the globe – apportion the rest of world to Ireland and the UK and you get a 71:29 split between those two territories. According to the report on Tranche 1 and 2, 13% of lending is residential and 55% is commercial and 32% is undefined, but if we allocate the undefined I think it reasonable to suggest 80% is commercial and 20% is residential. To the end of June 2010, NAMA’s main markets had performed as follows by reference to November 2009.

Ireland commercial – JLL index to Q2 of 2010 – minus 8%

Ireland residential – PTSB/ESRI index to Q2 of 2010 – minus 9.8%

UK commercial – IPD index to end June 2010 – plus 9.3%

UK residential – Nationwide Building Society to end June 2010 – plus 4.5%

One last point, NAMA pays for loans using two instruments – 95% in NAMA bonds which are immediately redeemable by the PIs at the ECB and 5% in subordinated debt which will not be honoured unless NAMA breaks even over its lifespan. So where property prices have fallen overall, we need to deduct from the loan purchase price the 5% subordinated debt as that will not be payable.

In summary, upto June 2010 loans were bought for €8.427bn and paid for with €8.005bn of NAMA bonds and the remainder in subordinated debt that will not be honoured if NAMA makes a loss.  The underlying security was worth €7.626bn in November 2009 and based on the estimated splits by type of loan and geographical spread these loans were worth €7.356bn at the end of June 2010. That means that NAMA has made an estimated loss on these loans of €0.649m (€8.005bn paid in NAMA bonds less the current market value at 30th June 2010).

Of course property prices may increase in future and you would naturally expect prices to increase over a long period like the 10-year lifespan envisaged for NAMA. However the short term outlook for property in Ireland is not good – either for residential or commercial. And NAMA must pay interest on NAMA bonds (Euribor, so not significant) and on subordinated debt (10-year bond rate 7.4% + 0.75% = 8.15% as I write this). NAMA would need see an average 8.8% increase in property prices across its portfolio at June 2010 to break even at a gross level. Along with financing and operating costs, it is far from certain that NAMA will make up the ground lost so far.

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Before presenting the information below, it’s worth explaining what the figures below do and don’t represent. They are supposed to represent the gross cost of bailing out the banks. Some of the cost may be recouped over time which may mean the final net cost is less than is shown. The cost for Anglo at €29.28bn is the government’s estimate (that is, not the worst case or indeed the best case) of the cost of bailing out that bank but it has said that in what they claim is a worst case scenario, the gross cost may be €5bn more. There have been recent suggestions that if subordinated debt is redeemed at a discount, this may reduce these gross costs, so €29.28bn mightn’t be the best case – it could be less. Bearing all of that in mind, here is the estimate from the Department of Finance at the end of September 2010.

Those who follow these matters closely will note that these numbers exclude a possible €5bn extra for Anglo’s cost in what DoF claims would be a worst case scenario and there is no provision for any further costs for EBS though it is understood that the government may face an additional bill of c€0.5bn for that building society which is presently being prepped for sale to either Irish Life and Permanent or a consortium that includes Cardinal Capital, the Carlyle Group and the WL Ross group.  It has been pointed out by the commenter below that AIB’s shortfall of €7bn in that bank’s capital requirements after the sale of the Polish and US interests (capital requirement of €10.4bn by December 2010 less €2.5bn from the sale of Bank Zachodni and €0.9bn from the sale of M&T less €3.7bn shown by DoF) may be made up in part by the full conversion of the €3.5bn of preference shares. Add these together and the upper limit is €52.76bn – remember again that some of these costs may be recouped and that the costs may come in less than €45bn. My tuppence worth is that true loss levels at Bank of Ireland and AIB may push up this cost even further. But taking the present estimates, at an exchange rate of €1= USD $1.40, the upper limit cost would be USD $74bn. By comparison, the most recent US Treasury Department estimate on 5th October, 2010 of the cost of rescuing the US financial system was USD $30bn. Welcome to the Irish freak show indeed.

The above costs exclude any loss at NAMA which is planning to make a profit but NAMA’s profitability is doubted in some quarters. NAMA will spend €30bn approximately on buying a class of lending from banks that has been particularly badly affected by the bursting of our property bubble (land and development plus associated lending). In addition NAMA is allowed borrow up to €5bn to help complete developments. So if S&P is re-visiting its estimate of costs of the Irish financial crisis on the same basis as in August 2010, I would expect to see a range of €80-87bn excluding any interest charges on the borrowing needed to provide these funds.

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