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Archive for November 9th, 2010

You would be forgiven for letting out an almighty groan at someone trying to explain the way in which NAMA values loans. It is convoluted in the extreme with a large number of components. A broad theme examined on here before is one of these components, the Valuation Date, was set to 30th November, 2009 and since then, the value of property in NAMA’s main market (Ireland) has continued to decline in value which suggests that NAMA is overpaying by today’s standards. That remains the case even if the UK has partly offset the falls here, but it seems NAMA and its masters in the Department of Finance are determined to plough on and complete the transfers and not stop to consider valuation niceties.

The release last week of a report by the Comptroller and Auditor General (CAG) into NAMA’s acquisition of loans threw up a very interesting (for the geeks that follow these things at least) piece of information – a sample valuation. There is an entry on here from yesterday which explores the sample valuation which provides a level of detail not seen outside NAMA before. Whilst examining the valuation I was reminded that one of the components in NAMA’s valuations – the Standard Discount Rate – was supposed to be based on the yields on our 3,5 and 8-year bonds. These rates were set in stone in the NAMA Longterm Economic Valuation Regulation but it is worth remembering that they were supposed to be based on State borrowing costs – this is confirmed in Para 118 of the EU Decision – “Concerning the discount rate applied to the cash flows, the Irish authorities will discount the asset cash flows over 3 maturities (3, 5 and 8 years) depending on the recovery prospects (paragraph (64)) at a rate equal to the Irish government bond yield as of 21 December 2009 for the relevant maturity plus 170 basis points”. The Long term Economic Value Regulation itself sets out the various discount rates at in section 2(2) “(a) the NAMA 3-year discount rate, for bank assets denominated in euro or any other currency, is 4.54 per cent (which includes a risk margin of 1.7 per cent),

(b) 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), and

(c) the NAMA 8-year discount rate, for bank assets denominated in euro or any other currency, is 6.16 per cent (which includes a risk margin of 1.7 per cent).”

Plainly our borrowing has rocketed in recent days and I show below the assumptions in NAMA’s LEV Regulation compared with midpoint bond rates today.

What effect have these rates on NAMA’s valuations? They mean that NAMA is substantially overpaying for the loans. By how much will depend on the precise mix of loans and assets being taken over by NAMA but the table below looks at what happens to valuations at 3,5 and 8 years which don’t have any associated cashflows and shows that we are overpaying by 10.3-25%. With another €18bn of consideration to be paid for the final tranches (which together with the €12bn paid for tranches 1 and 2 will mean NAMA pays about €30bn for €73bn-odd of loans) this means that we may be overpaying by €1.7-3.6n by reference to today’s bond yields based on the assumptions above. Regardless of the mix of loans however, it is a fact that we will be overpaying regardless. Ouch!

It would also have been helpful if the CAG drew our attention to this over-valuation in what must be one of the most useless audit reports ever produced.

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The State presently owns 36.5% of the ordinary stock of Bank of Ireland thanks to the payment in lieu of cash of the 8% dividend on the €3.5bn “directed” investment from the National Pension Reserve Fund in March 2009 and the conversion of some preference shares to ordinary shares in May 2010. You might recall that in February 2010, BoI paid out 184m ordinary shares to the NPRF on its €3.5bn preference share investment made in March 2009, in lieu of a cash dividend because the pesky EU had forbidden it to make a cash distribution when in receipt of State-aid. Three months later, the NPRF acquired additional ordinary shares in BoI through the rights issue by the bank and the conversion of some €1.7bn of the preference shares to ordinary shares. As part of the rights issue conversion of preference shares the interest rate payable on the remaining €1.8bn of preference shares was to rise from 8% to 10.25%. So that’s how the State this morning owns 36.5% of BoI and has €1.8bn of preference shares yielding 10.25% per annum with the dividend due next February 2011.

Next February 2011, BoI will be required to pay the NPRF €214m – roughly 10.25% of €1.8bn (I say roughly because remember we had €3.5bn preference shares earning 8% for about two months of this dividend year and then the 10.25% applies for 10 months approx). We are now waiting almost four months (a record as far as I can tell) for the EU to publish the Decision announced on 15th July, 2010 which set out the conditions for BoI’s restructuring. I’m willing to bet that the EU will allow BoI to start making cash payment for dividends again. Because if they don’t, BoI would need pay the €214m in ordinary shares or at current prices (€0.42 per share with the company having an ordinary share capitalisation of €2.24m), nearly 10% of the company which would bring the State shareholding up from 36.5% to 46.5%. Given the volatility of BoI’s share price, we could easily end up with an ordinary share dividend which would give us 50% of BoI – majority control which seems anathema to the State’s strategy for the banking sector.

And so yesterday in the High Court we witnessed the bizarre spectacle of BoI applying (in simple terms) to be allowed reclassify part of its capital base in such a way that a dividend payment can be made in cash so the horror of the State taking majority control of BoI can be avoided. Of course if economist Morgan Kelly, whose latest jeremiad in yesterday’s Irish Times is correct (and there is sufficient support for his position to suggest he’s not being a crackpot), then the scale of non-NAMA losses in BoI will give us majority State control in the near future anyway. Nonetheless it is interesting to see the legal lengths to which BoI will go to avoid majority ownership in the next three months.

UPDATE: 8th November, 2010. Based on Bank of Ireland being valued on the stock market at €2.28bn with an ordinary share price of €0.427 then by my calculation based on a fixed dividend of €214m in Feb 2011 and if that dividend were to represent 13.6% of BoI’s value at that date (which together with the existing 36.5% shareholding would give the State 50%+ control of BoI) then the share price would need drop from €0.427 today to €0.295. That’s a 31% drop which is quite significant but I see that BoI did reach €0.185 in March 2009.

UPDATE: 27th November, 2010. BoI has been successful at the Commercial Court (specialist division of the High Court that fast tracks commercial applications) in getting permission to use part of the share premium account to make a disbursement in cash in respect of the next dividend payable to the NPRF in February 2011. Phew! Because at yesterday’s closing price (€0.26 a share) the NPRF was in line to own 52.03% of BoI (36.5% existing holding plus €214m dividend on 10.25% €1.8bn preference shares for 10 months and 8% dividend on €3.5bn preference shares for 2 months).

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