Archive for November 29th, 2010

EU approves NAMA Tranche 2 valuations

Whilst the folk down at Treasury Building steady themselves after yesterday’s announcements which will see their remit expanded by nearly 25% with Allied Irish Banks and Bank of Ireland €0-20m loans, there is at least some welcome good news from the European Commission which has today approved the valuations of NAMA’s second tranche of loans which was finally absorbed by the agency in August 2010. The EU said:

“The European Commission has authorised, under EU state aid rules, the transfer of the second tranche of assets to the Irish National Asset Management Agency (NAMA). The Commission found this transfer to be in line with the approved scheme (see IP/10/198) and with its guidance on the treatment of impaired assets (see IP/09/322). In particular, the transfer satisfies predefined transparency and disclosure requirements, the assets fulfil the criteria for participation in the scheme and their valuation complies with the requirements of the Commission’s guidance and results in adequate burden sharing. The Commission also continues to rely on the commitments of the Irish authorities related to the exercise of certain specific rights conferred to NAMA so as to avoid undue distortions of competition. The Commission therefore concluded that the transfer of the second tranche of assets to NAMA represents an appropriate means of remedying a serious disturbance in the Irish economy and as such is compatible with Article 107(3)(b) of the EU Treaty.”

No news on the remaining tranches which were to be subjected to estimated valuations pending detailed valuations to be completed by March 2011.

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NAMA and the bailout

At the end of September 2010, there was a significant change to NAMA’s operation when our Minister for Finance, Brian Lenihan, decided to (a) accelerate the transfer of the remaining tranches to NAMA at the short term expense of not undertaking due diligence and granular valuation and (b) in respect of Allied Irish Banks and Bank of Ireland only, to increase the threshold of NAMA loan eligibility from €5m to €20m (bizarrely Anglo which was the priority was to remain at €5m and INBS and EBS were to remain without any minimum threshold).

The announcements didn’t make much sense because even with an accelerated transfer, there would not have been certainty or finality because the EU had to approve the valuations and also NAMA intended carrying out post-acquisition valuations which would see a reckoning with any under/over payment. Anglo by the way was to have completed its transfers by 31st October, 2010. Although NAMA has not made any public statement on the transfers my information is that most of Anglo’s loans have been acquired though there remains outstanding the post-acquisition valuation.

With respect to the increase in the thresholds for AIB and BoI, this didn’t make any sense either. The priority was to give certainty to Anglo’s finances yet Anglo’s threshold remained at €5m. The Minister justified the decision by claiming that the personnel in AIB and BoI were better able to manage these €5-20m exposures than NAMA – “this change will ensure that NAMA can operate to the highest level of efficiency and effectiveness in the management of its loan portfolio and allow for the completion of all NAMA transfers by end-year.” Again that didn’t make much sense because NAMA was supposed to have had the necessary expertise and impartiality to maximise the value of the loans.

But 60 days later, there is a volteface as it has been decided that NAMA should not only absorb AIB and BoI’s €5-20m exposures but should absorb the €0-5m exposures as well! The Minister didn’t make the announcement yesterday, the Financial Regulator did, though no justification is offered. I would guess that the IMF saw that the only reason for making the decision on 30th September 2010 was to avoid BoI and AIB crystallising major losses on these €5-20m NAMA loans which might trigger a need for further capital and in all likelihood push both AIB and BoI into State ownership. Capita, the controversial outsourcing company that is NAMA’s “master loan service provider” saw its workload (payload) drop from 1,400 borrowers to 700 borrowers in one fell swoop on 30th September – yesterday’s announcement restores its workload and presumably adds to it with the sub-€5m exposures at AIB/BoI. NAMA on the other hand will have an extra 650 business plans to review and manage for the €5-20m exposures and God knows how many for the sub-€5m exposures. Laura Noonan at the Independent claims that NAMA will now be absorbing an additional €17bn of loans at par value (that is €91bn instead of €74bn – €6.6bn of €5-20m exposures and €10bn of sub-€5m exposures, no mention is made of the quantum of sub-€5m borrowers). And will these new loans mean that NAMA misses its February 2011 deadline for all transfers. And of course NAMA will need an extra estimated €7-9bn to acquire those €16.6bn of AIB/BoI €0-20m exposures. At least that shouldn’t be a problem because the EU has signed off on the NAMA project needing upto €54bn to acquire these loans and even with these extra loans NAMA is likely to spend less than €40bn.

However NAMA’s challenge with securing the €5bn of development funding sanctioned by the NAMA Act remains. There was no announcement yesterday as to how this might be funded. Emmet Oliver penned a piece for the Independent last week which left it unclear if NAMA had successfully tapped the market for €2.5bn of short term funding but confirmed that NAMA at the very least faced a challenge in securing the additional €2.5bn of longer term funding. As I understand it, although NAMA designed the architecture for a short term commercial paper programme at the start of September, NAMA did not in fact see it funded. And as I understand it NAMA is still in a pickle as how to fund major projects eg Treasury’s Battersea Power Station project, Liam Carroll’s unfinished Anglo HQ, the DDDA’s development of the Glass Bottle site. Was this issue addressed in the undisclosed agreement with the ECB yesterday?

Also left hanging yesterday was what will happen with Anglo’s sub-€5m land and development exposures. Why does it make sense to transfer AIB and BoI’s €0-5m exposures but leave Anglo’s? There is some reference in the Ministerial announcement yesterday to yet another restructuring plan for Anglo and INBS “the restructuring of Anglo Irish Bank and Irish Nationwide Building Society will be swiftly completed and submitted for EU State aid approval”.

The IMF are known to have been keen for NAMA to start disposals sooner rather than later and with €10bn of €0-5m loans being acquired, it is hard to see how there will not be a glut of property on offer in 2011.

My view is that the changes above were rushed and not considered which doesn’t augur well for NAMA. What major change will be imposed on the organization next week? How will NAMA manage with a vastly increased (and varied) portfolio? Will NAMA secure development funding which is key to its raison d’etre? It seems that for the time being NAMA is a sideshow.

UPDATE: 2nd December, 2010.Following the publication of the Memorandum of Understanding and associated documents by the Department of Finance, we can now see the formal framework for the expansion of NAMA’s scope as reported last weekend. Although there is some ambiguity, it appears that the expansion in scope only relates to Allied Irish Banks (AIB) and Bank of Ireland (BoI) loans. In the original scope of NAMA, all land and development loans at EBS and Irish Nationwide Building Society (INBS) were to be absorbed regardless of value. The original scope however had a minimum threshold of €5m for AIB, Anglo and BoI. On 30th September, 2010, the Minister for Finance bizarrely altered the scope by increasing the threshold for AIB and BoI only from €5m to €20m. And now the scope has been altered again so that all land and development loans at AIB and BoI are to be transferred to NAMA, and that includes the €0-5m exposures that weren’t even in the scope a year ago when NAMA was conceived. Although article 10 of the Memorandum of Understanding says all land and development loans are to be transferred it seems that elsewhere in the agreement, this is clarified to mean AIB and BoI loans only. Bizarrely it seems Anglo is to keep its €0-5m land and development loans. Go figure!

Here are the relevant extracts from the documents:

It seems that NAMA’s scope will therefore expand to include some €90bn of land and development and associated lending at par value for which it will pay some €35-40bn (my estimates). The number of loans will increase from 11,000 from 1,500 borrowers to 21,000 from an unknown number of borrowers. NAMA has 100-odd employees though NAMA will receive some support from the banks and from its Master Loan Service Provider, Capita. Concerns have been raised in many quarters that NAMA is underresourced to deal with the loans it is acquiring.

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When the blanket bank guarantee was implemented (planned, legislation drafted, debated and voted upon in the Dail) in 2008, it might have taken a couple of years to collectively realise that we’d been kicked up the arse but yesterday’s announcements won’t need that long. The banking collapse in 2008 is set to cost us an officially derived maximum of €87bn, our neighbours in Europe are charging us 6.75% (possibly plus) for financial assistance, we must cede our freedom to manoeuvre by offering up our pension/cash reserves, we need extra funding beyond that announced to help us roll over/redeem existing debt, senior bank debt will not burden-share AND WHERE IS THE TEXT OF THE AGREEMENT WITH THE ECB?

The announcements came thick and fast yesterday, there was the news conference in Dublin with Taoiseach Brian Cowen and Secretary General at the Department of Finance Kevin Cardiff, there was another news conference in Dublin with the IMF, and yet another one in Brussels with the EU/ECB, the IMF published a statement on its website, the ECB published a briefer statement on its website, there was a press release from Bank of Ireland regarding its new €2.2bn of additional capital requirement, the Financial Regulator in Ireland published a joint statement welcoming the agreement and setting out new capital and liquidity requirements (the most informative statement of the evening). Minister for Finance Brian Lenihan took to the airwaves. A flurry of activity and announcements that made the snow blizzards here on Saturday night seem sedate. But despite the media onslaught from so many different organisations and even if Brian Cowen had disrobed and performed Von Rothbart’s finale in Swan Lake in the nip atop the desk of his news conference it wouldn’t have misdirected us from the following:

(1) The announcements were about the banks. The State funding of the banks is now set to increase from the €46-52bn announced on 30th September, 2010  (see below) to €56-62bn “immediately” with another €25bn in “contingency”. The bottom line is that funding the bank collapse is to cost up to €87bn, a sum that independent economists have declared to be the likely zone of costs when we finally get to the bottom of our banks’ loanbooks. Of course it is claimed that some of these funds might be recouped and some are contingency and may not be needed, that we are “overcapitalising” and “showing the firepower” ranged behind Irish banks. With respect to the final losses in the banks, I will frankly admit that I have only a vague notion and instinct as to what they will be. Like everyone else I observe that NAMA has levied discounts far greater than was expected and remembering they are valuing by reference to November 2009, I conclude that the non-NAMA loans are likely to suffer losses far in excess of those presently accounted for by the banks. Like everyone else I observe the way in which the 11% collapse in GDP is affecting businesses and households. In respect of mortgage debt I observed the experience of the State of Nevada which shares many similar characteristics with Ireland (the weather isn’t one of them! housing bubble, negative equity, unemployment, recourse mortgages were though) and I fear that mortgage default will balloon. I also observe that the Financial Regulator has yet to conduct a “granular review” of non-NAMA loans and that banks are still using the fantasy discretionary accounting of IFRS 9. Like many of you, I listened in horror yesterday as Pat Rabitte suggested the prospect of further major losses on bank derivatives in his interview on RTE’s “This Week”. So my gut instinct is that if the IMF is setting aside a further €35bn for the banks with €10bn “needed” immediately and €25bn of contingency, then my gut instinct is that it will all be needed and that the State funding costs of the banks will go from a maximum of €52bn at the end of September 2010 to €87bn. I dearly hope I am wrong.

(2) We are being charged 6.75% (possibly plus) by our friends in the EU for access to funds. There was an homogenous form of wording used in the press conferences, that the interest rate was convoluted and that it would take a considerable amount of time to explain. At the very least why could the Taoiseach not have told the nation “The range of interest rates being charged by our partners in the EU is xx% to yy%, dependant on zzz”. Yes by reference to 9% 10-year money today, 6.75% is cheaper but hardly much cheaper than the 7.1% 3-year money. In terms of deriving 6.75%, this comes from the following statements:

(a) The IMF will provide 1/3rd of any external bailout at a maximum interest rate of 4%.
(b) The EU will provide 2/3rd of any external bailout
(c) The “blended average” rate if all external bailout assistance is drawn down is 5.83% (note the 3 in the second decimal place).
The EU rates must be 6.75% because 1/3rd of 4% plus 2/3rds of 6.75% equal 5.83%. I say 6.75%+ because the IMF bailout costs start from just over 3% – see the IMF press release.

(3) The National Pension Reserve Fund (NPRF) is to be effectively wiped out to fund the banks. By that I mean that the fund had a value of €25bn-odd at the end of September 2010. Of this, c€7bn was already invested in BoI/AIB/ A further €3.7bn was committed for AIB. And yesterday’s announcement says “this action, along with early measures to support deleveraging set out below will result in an immediate injection of €10bn of fresh capital into the banking system, above and beyond that already committed [my emphasis]”. I therefore understand the announcements to mean the NPRF of €25bn will have €1-3bn left when this exercise is carried out and that is to be used for infrastructure/capital spending. In addition we need pony up €5bn from our €20bn-odd cash reserve. The State is throwing its freedom to manoeuvre, its “full funding to the middle of next year” (and beyond) away to secure funding for the banks. That is a very risky gambit involving our main strategic asset.

(4) WHAT AGREEMENT HAS BEEN REACHED WITH THE ECB? The ECB had signalled its withdrawal of emergency liquidity assistance funding in January 2011. What about the €90-100bn of such funding to the six State-guaranteed Irish banks at 29th October 2010? Will the ECB be providing the financing for rolling over some €12bn of maturing sovereign debt (bonds and treasury bills) in 2011? Will our banks be required to buy sovereign bonds?  Will the interest rate on emergency funding to our banks (or whatever replaces that funding programme) be more than 1.5%? What effect will interest rate changes have on our domestic lending market? Will new Irish mortgages (and existing standard variable rate mortgages) cost 8% even when the main ECB rate is 1%?

(5) The bondholders. I must say I am getting a little annoyed by this term. Because having painstakingly examined the balance sheets of the six State-guaranteed institutions (you can see their latest and indeed their historical accounts here), I see that lending to our banks by others takes many forms – you would think from the analysis in the media that it was limited to subordinated and senior bonds but it’s not – it includes medium term notes (MTNs), certificates of deposit, commercial paper. When we’re talking about “bondholders” why are we excluding the other lenders? Senior bondholders account for some €33bn of debt – what about the other €80bn of (non central bank) lending plus the €13bn of subordinated bondholders? Europe says “no!” to applying a haircut to the senior bondholders. The Taoiseach practically guarantees that haircuts for subordinated bondholders at Anglo and INBS will be applied more generally which I take to mean AIB and BoI specifically.

So what to make of it all? The IMF’s Ajai Ckopra tells us this morning that we got a good deal compared with the existing costs of bonds. Ajai also praises the Irish negotiating team (John Corrigan and Patrick Honohan were credited yesterday but Eamon Ryan says that the Department of Finance and Matthew Elderfield also played a role). The government commends the deal. The Opposition is aghast at the loss of the pension reserve and the protection of “bondholders”. Olli “don’t mention the 60% debt:GDP limit in the Stability and Growth Pact. I’m not listening. Lalalalala” Rehn commends it as he sees it as providing wider stability in the eurozone. In Ireland the only stakeholders that seem capable of organising protest are the unions and although they criticise in general terms the austerity elements of the four year plan, the plan itself was sufficiently vague as to public sector reforms that it didn’t directly lance the unions’ interests so I’m not sure there will be further protests.

I have sympathy for our negotiators. Putting aside the fact that the terms of the deal with the ECB have not been disclosed, it seems though that we have paid a high price by not getting to haircut the lenders to our banks, a 6.75%+ interest rate from our European neighbours and the loss of a strategic asset up front. In return we continue to have a functioning banking system which is far from optimal and I doubt if the €35bn of additional funding would result in a “wall of cash”. If banking losses are ultimately in the €80-90bn zone then we will need default or at least restructure if we are to have a society that any of us would recognise as acceptable. Would a restructure at this point have weakened or collapsed the banking system? The scaremongers might claim that but I’m not so sure. What I do know is that if we decide we want to restructure in 12 months time we won’t have a strategic reserve and will be truly dependent on others that won’t have our national interests at heart.

What now? The agreements (and I hope this include agreement with the ECB) are to be set out in a Memorandum of Understanding which will hopefully be published and debated. The Opposition doesn’t seem to be confident that it will get a vote on the matter and is seeing the Budget 2011 vote next week as possibly the opportunity to reject the agreement. Constitutionally some Germans are seeking to have this latest bailout set aside (by amending their previous case which is yet to be disposed of and which related to Greece). Could there be a constitutional challenge here? Given that the banks are potentially getting €87bn of State money I think there is an arguable case that the government does not have a mandate to enter into this agreement without oversight, debate and voting in the Oireachtas. And I understand that a challenge is being mooted. If unions make use of their economists, they might arrive at the conclusion that a default or restructuring is inevitable that might lead to savage cuts for its members and that may bring more protest or indeed a general strike at this point when we at least have a strategic reserve.

Bottom line for me though – this wasn’t a negotiation for bluffing our way with threats of default or withdrawal from the euro, it was a negotiation where we needed to honestly address the scale of losses in the banking system and conclude that we need a partial default on debt – to that extent it was less about poker and more about chess.

UPDATE: 30th November, 2010. RTE report that the proposed deal will be debated in the Dail today though it is unclear if there will be a vote.  The Irish Times raises the prospect of a constitutional challenge to the agreement on the basis that it is an international agreement and according to Article 29.5.2 of the Constitution accordingly requires a referendum.

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