Irish commercial property – a continuing decline in Q4, 2010 with the pace of decline picking up

Jones Lang Lasalle (JLL) has published its commercial property series for Ireland for Q4, 2010 (free registration required). The JLL series is one of the two Irish commercial indices referenced by NAMA’s Long Term Economic Value Regulations (Schedule 2) and is used to help calculate the performance of NAMA’s “key markets data” shown at the top of this page. The other quarterly Irish price series is published by SCS/IPD but because it is generally published after JLL’s it is not used here but the index does historically show a close correlation with JLL’s.

The Index shows that capital values are continuing to decline and the pace of decline is picking up. The Index declined by 3.0% in Q4, 2010 compared with Q3, 2010. Overall since NAMA’s Valuation Date of 30^th November, 2009 prices have declined by 11.7%. Commercial prices in Ireland are now 60.2% off their peak in Q3, 2007. On an annual basis prices are down by 10.5%. The NWL index is now at 897 which means that NAMA needs to see a blended increase of 11.5% in property prices across its portfolio to break even at a gross profit level (taking into account the fact that subordinated bonds will not need be honoured if NAMA makes a loss).

In terms of commercial components, Retail was down 3.3% in the quarter, Office was down 1.8% and Industrial was down 6.7%. JLL are, perhaps not surprisingly, upbeat about the figures saying that the 3% decline in Q4 is the smallest quarterly decline since 2007 – in fact they are talking about Q4 declines and I am not sure there is any seasonality to Irish commercial property prices. In 2010 prices declined as follows : Q1 (2.1%), Q2 (4.7%), Q3 (1.1%), Q4 (3%).

Quarter 4 was a momentous quarter in Irish economic history with an IMF bailout being rumored from mid-November and confirmed on 28^th November. The two largest potential deals in Q4 seem to have fallen through (1) the €110-120m Royal Liver portfolio sale to TPG Capital/Green Property and (2) the €350m Liffey Valley Shopping Centre sale. In the first case the IMF bailout was blamed.

JLL report that rents fell by 5.6% in Q4 (ERV index of 645 versus 683 in Q3) which represents a slight pickup in the rate of decline in rents and the annual decline in rent is still 24.3%. With rents falling with 20%+ per annum and capital values still dropping the 8.67% yield currently available on Irish commercial property is, contrary to what JLL assert, not particularly attractive.

The outlook for 2011 is challenging. Hopefully NAMA and non-NAMA banks will bring more product to market. There should be some stabilization in the overall economy though domestic demand is likely to decline. Credit for Irish property is still scarce though there are reportedly pots of €10m available for quality assets with reliable rent rolls. The prediction on here is that capital prices will decline 10% this year.

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Why did NAMA agree to depart from its own valuation methodology and acquire certain bank loans for more than they were worth?

The Irish Independent today makes clear something which has been alluded to in previous reporting but which has hitherto been shrouded in vagueness. Emmet Oliver claims that the Independent has seen a “document” (presumably a letter) written in May 2009 by the Central Bank of Ireland governor, John Hurley (Patrick Honohan’s predecessor) and the then-acting CEO of the Financial Regulator, Mary O’Dea.

According to the Independent, the letter to the banks gave an undertaking that new lending from April to November 2009 which was NAMA-eligible (remember that NAMA was only supposed to take loans created before 31^st December 2008 and additional advances on those original loans eg to complete projects). The letter hamstrung NAMA by compelling the agency to accept this additional lending, estimated at €1bn, without applying a haircut. In the event NAMA succeeded in rejecting half of the €1bn because of unacceptable security. If NAMA had applied its average discounts so far then it would have acquired the €500m of loans for €210m – an implication from the Independent article is that NAMA overpaid by €290m.

The background to this episode was that banks were fearful of making additional advances in 2009 if these advances were to be subsequently acquired by NAMA at a discount and the Central Bank/Financial Regulator wanted to avoid a liquidity crisis with existing developer loans by giving the assurance of “no haircut”.

The previous reporting on this matter was in the Comptroller and Auditor General’s (CAG) first report on NAMA in November 2010 which said “following direction by the Governor of the Central Bank and Financial Services Authority of Ireland and the acting CEO of the Irish Financial Services Regulatory Authority, no discount was applied to advances made by banks to borrowers after 7 April 2009 provided that it could be shown that the moneys were advanced as part of normal commercial banking arrangements. For loans that transferred in the first tranche, NAMA accepted that €299 million of those loans, issued after 7 April 2009, qualified for payment in full.”

The EU gave approval to the NAMA project in February 2010 and the published decision described NAMA’s valuation methodology in some detail. There is no reference whatsoever to any letter or commitment to ignore the valuation methodology for certain loans. Presumably a commitment to pay in excess of the loan’s value (using NAMA’s own valuation methodology) would constitute additional state-aid and would necessitate EU approval.

The EU has given its approval to the valuation of NAMA’s Tranche 1 and 2. Tranche 1 included €299m (according to the CAG report referred to above) so presumably the EU has given ex-post approval to the additional state-aid but shouldn’t that approval have necessitated something more formal and public, particularly since NAMA seem to have departed from the terms of the approval given by the EU in February 2010?

The Independent refers to an exchange between NAMA’s CEO, Brendan McDonagh and Minister for Finance, Brian Lenihan in June 2010 (the Independent refers to June 2010, not June 2009) where Brendan reportedly said “there are certain monetary consequences arising from implementation of this direction”. You would have to ask why NAMA didn’t invoke section 84(1) of the NAMA Act which states “NAMA is not obliged to acquire any particular, or any, eligible bank asset of such an institution on
any grounds.” The NAMA Act provides for the Minister issuing directions to the agency and such a direction could include an instruction to acquire certain loans but no such direction appears to have been issued (NAMA published ministerial directions in October 2010 and they were the first such published directions)

So two questions emerge from this affair – why didn’t the EU flag this extraordinary state-aid and why did NAMA not invoke its right to reject this lending on which it was forced to pay an additional premium?

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