Despite criticising the Comptroller and Auditor General’s (CAG) report on NAMA last week as incoherent and aimless, it does contain some interesting information. And aside from the payments (bizarrely including VAT) made to some third party companies, the detailed worked example of a NAMA valuation of a loan is possibly the most interesting nugget in the entire report. This entry examines the worked example.

Firstly it should be said that despite a NAMA Act, a Long-term economic value (LEV) Regulation, an EU Decision, Tranche 1 and Tranche 2 reports, extensive debate on Irisheconomy.ie (here and here would be the best examples) and indeed an email response from NAMA shown on here, it has never been entirely clear how NAMA value loans and we should be thankful to CAG for at least including the worked example in what is overall a dreadful report.

The worked example looks horrendously complicated when you consider what the objective of the valuation is: to figure out (1) what the property was worth at 30^{th} November, 2009 (2) what it is worth long term and (3) deduct a sum for due diligence and enforcement as these are costs NAMA is incurring. I would have expected the 5.25% due diligence and enforcement to be calculated on the par value of the loan but the worked example shows that it is calculated on another (much lower) figure. I am also confused by the calculation of the current value of the loan and why it makes use of a different discount rate (for which I can find no support in the various legislation and EU Decision). So for the time being I present what the CAG has presented with some better explanation but this is a post to which I expect to return.

The worked example appears at Annex A to CAG’s report from page 49 on and consists of three pages – the worked example, explanatory notes and a graphic illustrating the calculation of the “state aid” element within the NAMA payment for the loan. The “Asset Acquisition Process” in Chapter 2 of the report (pages 29 onwards) provides further explanation as to how some of the rates have been derived. The worked example relates to an investment property loan.

Here’s the worked example.

Here’s the explanatory notes.

Here’s the graphic showing the State aid element of the payment.

The explanatory notes are not very explanatory in my view and I have set out below the components to the valuation.

(1) The **loan balance** is the sum outstanding on the loan – straightforward enough. NAMA of course needed to do a reconciliation between when the valuation was undertaken and when the loan was transferred (additional interest, repayments, additional advances). In this case we assume the loan valued doesn’t change.

**Derivatives** can be confusing creatures. In this case let’s assume the “derivative” of €2,955,704 is an interest rate swap. What’s that I hear you say? Okay, let’s assume the developer took the loan out a couple of years beforehand. At the time the bank was insisting on an interest rate equal to the ECB main rate plus 2%, in other words a variable interest rate as is usual. At the time the main ECB rate was 3%, so the developer would have been paying 5%. The developer though was concerned that interest rates were going to rise and if they did then he might lose his profit on the development. So he wanted to lock in his interest rate, pretty much like a fixed rate mortgage. So he bought a “derivative” from the bank fixing the rate at 6% and that’s what he is supposed to pay. Now of course the ECB rate came down to 1% so it wasn’t a good deal for the developer and now in addition to the outstanding loan, he owes a further €2,955,704 on the derivative. Now if interest rates had shot up to 7% then the bank would owe the developer.

(2) The **Current Market Value** (CMV) of the property on 30^{th} November, 2009. What would the property fetch on the open market at that date.

The **Long term Economic Value** (LEV) of the property is the CMV increased by a subjective % by the valuer to reflect the long term value of the property based on a number of considerations (which are set out in sections 5 and 6 of the LEV Regulation) which are subjectively interpreted by the valuers.

The **Standard Discount Rate** in the example is **5.57%** comes from section 2(2) of the LEV Regulation “the NAMA 5-year discount rate, for bank assets denominated in euro or any other currency, is 5.57 per cent (which includes a risk margin of 1.7 per cent)” **Why 5 years**? That comes from 7(b) of the LEV Regulation “where the bank asset is a bank asset for which the security is land for which the adjustment factor is more than 10 per cent of the land’s value but less than or equal to 15 percent of that value, NAMA shall take into account the projected cash flows of the bank asset over a period of 5 years using the NAMA 5-year discount rate,” **Why is the adjustment factor 15%**? Well that’s going to be a subjective assessment by the valuer based upon the factors set out in sections 5 and 6 of the LEV Regulation but I think it is worth noting that NAMA engaged a British consultancy, London Economics, to report on likely property trends in key NAMA markets and “the report concluded that the range of implied property price changes (in nominal values) for the period 2010 to 2016 for a combination of commercial and residential property was Ireland – 17.7% to 28.8%, UK – 14.7% to 20.3%, US – 10.5% to 23.7% (page 38 of the CAG Report). In addition to a valuer working out the CMV at 30^{th} November, 2009 (what would the property sell for at that date on the open market on the basis of a willing buyer and willing seller, both in possession of perfect market knowledge), the valuer is required to look at cash flows on the property in the **relevant period** (5 years here because of the above)

(3) The **loan collateral valuation **is what NAMA actually pays the bank for the loan and is calculated using three components (it seems derivatives are valued at zero)

(i) the **LEV of the property expressed in current terms** by applying the **Standard Discount Rate** in (2) above of 5.57% and

(ii) then deducting **5.25% representing the costs that NAMA will incur in undertaking due diligence of the loan (0.25%) on acquisition and the predicted average costs that NAMA will incur in enforcing loans (5%** – the standard enforcement fee is supposed to be 15% but NAMA convinced the EU that less than a third of loans would require enforcement) plus the cashflow from the property discounted using the discount rate in (2) above, that is 5.57% in this case.

(iii) and adding the present value of the future cash flows discounted by the **Standard Discount Rate**

(4) The **haircut** (or **discount**) is the difference between the value of the loan (including derivatives) on the bank’s books and what NAMA actually pays. So the difference between (1) and (3) above. The haircut % is the haircut divided by the value of the loan (including derivatives) on the bank’s books. The haircut shown in the example is 30.02%. In reality the haircut on Tranche 1 total was 50% and Tranche 2 total was 56% and the weighted average in Tranches 1 and 2 was 52%. So the example shows a relatively high valued loan.

(5) **State-aid** has not really cropped up in discussions up to now in the context of the detailed valuations but CAG put a number (quantum and %) on it – basically it’s the difference between the Collateral Current Market Value (from (3) above) the **Loan Current Market Value**. And this would be where the CAG lost me. It refers to the CMV of the collateral (€62m), the future rental income (€3.7m in 2010 and 2011 and €5.7m in 2012, 2013 and 2014). And then there is a discount rate applied. This discount rate of 11% is different to the Standard Discount Rate and seems to be a NAMA invention and is shown on page 44 of the CAG report and I reproduce the table here.

I am still lost as to how the CAG arrives at a value of €50,391,460 based on a CMV of the loan collateral of €62,000,000 and future rental income of €3.7-5.7m per annum. Plainly the figure arrived at is less than the CMV of the loan collateral which is partly why I’m confused.

So there you have it. I must declare that I have valued property before so what the CAG presents should not be alien to me, but I must also admit that the calculation of State aid (and in particular the CMV of the loan) is puzzling to me. I expect to return to this entry in future with clarifications.