On Thursday last in the Dail, the Minister for Finance, Michael Noonan replied to a question from Sinn Fein’s finance spokesperson Pearse Doherty about what is beginning to look like a very controversial accounting method. The Sinn Fein finance spokesperson was again probing the methodology used by NAMA to account for the interest it shows as income in its accounts, in other words, the amounts developers are paying in interest on loans now owed to NAMA. I recommend you study the question and answer because given the state and outlook for Irish property, NAMA looks to be producing financial information which is deeply misleading and may well be hiding losses which will only become apparent in years to come.
At this point, I know from experience some of you will switch off but this is a very important issue. NAMA is showing €786m of interest income in its accounts for the first nine months of 2011, but in fact it has received only €537m in cash which is €249m less.
If you were NAMA and you had a €100 loan given to a developer, then you would expect to collect perhaps €3 or €4 per annum in interest, and you would expect that in cash. Obviously many of the loans in NAMA are underwater and are not performing, so in some cases you might get zero and in others you might only get part-payment of the sum due, maybe €1. That would be “cash accounting” and most people don’t need an accounting qualification to grasp this. But NAMA is not using “cash accounting”, it is using something called the “Effective Interest Rate” method to calculate the interest income it shows in its accounts.
The “Effective Interest Method” means that you estimate what the developer will receive for his property when it is disposed of. So the developer might owe you €100 and is supposed to be paying you €4 per year in interest but he isn’t because he doesn’t have any cash, but if you estimate the developer will sell his property for €104 in two years, then the “Effective Interest Rate” will allow you to show €2 as interest income this year and €2 next year because you will then receive €104 from the sale and after deducting the principal, you will have €4 to apply against the interest due from the previous two years. But how do you estimate the future value of the property? Minister Noonan answered that question when he said “NAMA determined the effective interest rate for the loans it acquired using this collateral based valuation model which projects the property related cash flows and the realisation of the property collateral. The model assumes the realisation of the property using its value at the end of November 2009, as adjusted to reflect its long-term economic value where appropriate.”
Now we know that Irish residential and commercial property has declined by 20-30% since November 2009, and we also know that NAMA paid approximately 9% over the market value of property in November 2009 as a premium which came to be known as Long Term Economic Value. The Long Term Economic Value regulation prevented NAMA from examining any data after 10th January 2010 so NAMA paid way over the odds for its loans – we know that, that’s not new but what is new is that NAMA is calculating its interest income on the assumption that it will realise what it paid in November 2009.
In other words, if NAMA is calculating its effective rate by reference to values at the end of November 2009 as adjusted by its long term economic value at that date, then we can categorically state that NAMA is overestimating and misrepresenting its interest income in its accounts. The NAMA CEO last week told a London audience that the Agency expected to announce a profit before impairment of €750m in 2011. That will be based on the Effective Interest Rate methodology – on a cash interest basis, the figure will be considerably less than €500m, and remember that is before the 2011 impairment charge which is estimated on here to be in the ballpark of €1bn. It is now high time for NAMA to come clean about the methodology it is using to show interest income in its accounts. Fianna Fail’s Sean Fleming has promised NAMA a “show-down” on the issue at the Committee of Public Accounts, and it is not acceptable that NAMA produce fantasy income figures based on valuations from two years ago which was a time when the knife was still falling.
It is like pulling teeth to get a drip-drip of snippets from NAMA as to how it calculates the income shown in its accounts. Sean Fleming has robustly criticised the information provided by NAMA, and Pearse Doherty has been doggedly pursuing this issue. Where is the Banking Expert Peter Mathews when you need his experience as a banker and his in-depth knowledge of how NAMA acquired the loans, and how “Effective Interest Rate” calculations work? Below is the worked example of how the “Effective Interest Rate” works as communicated by Brendan McDonagh to Committee of Public Accounts – the letter itself which contains the worked example is here:
We now know that the €120 above shown as the cash value in 2015 is the NAMA value at 30th November 2009 plus long term economic value. And if this loan is for an Irish property we know that the present value is about €80 (€120 less €10 for long term economic value less €30 for declines since November 2009). So NAMA needs a 50% uplift in values by 2015 in order that its Effective Interest Rate methodology is proven to be valid.
NAMA Wine Lake 
And who makes up the shortfall, I wonder?
@Miriam, when we get to the disposal of assets and if NAMA doesn’t make back what it paid based on November 2009 valuations plus the “long term economic value” it paid, then it is NAMA that will incur the loss, and as we ultimately own NAMA and have guaranteed its bonds, the loss will be borne by the nation – but you probably sensed, if not knew, that!
I wonder too because the state is completely broke. Don’t bet the farm on a Nama bailout.
Roughly how big of a loss/hit will we be looking at when NAMA doesn’t lift off? Assuming prices bottom out next year and stay stagnant for close to a decade? Will the losses come in the form of bonds falling due but NAMA won’t have the revenue to cover it? 1 billion? 10 billion?
@WAR, you might do worse than examine Deputy Peter Mathews’s contribution at the last finance committee hearing with NAMA a fortnight ago:
” I will be finished in five minutes. Will the delegation agree that the €74 billion are classified into three main groups? These are the quality assets which represent about €18 billion out of the €74 billion; the limited liquidity assets, which are €20 billion out of €74 billion; and the illiquid assets which are €36 billion out of €74 billion. At the acquisition date, including a 10% long-term economic value premium, the €18 billion came in at €14.4 billion, the €20 billion of limited liquidity assets came in at €8 billion and the illiquid assets of €36 billion came in at €9.1 billion. This implies write-downs of 20% on the good loans, 60% on the middle ones and 75% on the worst ones. As at December 2011, those three categories of loans can be restated as the €14.4 billion becoming €13.7 billion, the middle category of €8 billion becoming €5.6 billion and the €9.1 billion becoming €5.9 billion. This implies write-downs of 5%, 30% and 35%, a total of €25.2 billion. I think it would be reasonable that at December 2012, there would be no further write-down needed on the good quality assets; a 20% write-down on the middle group and this is in line with forecasts, which would bring the €5.6 billion to €4.48 billion; and the illiquid assets would be written down by 30% on the €5.92 billion, bringing it to €14.14 billion. Adding up the restated recoverable or realisable values, this would suggest a €22.3 billion recoveries collection out of the original €31.5 billion. If one also adds to that about €200 million a year in operational costs for NAMA, there is the prospiect of a total loss of anything between €7 billion and €10 billion. If the delegates agree with those broad parameters, we should be saying that this is what we should be preparing for. If the delegation does not agree, I would ask them to explain why they do not agree.”
http://debates.oireachtas.ie/FIJ/2012/03/14/00003.asp
NAMA is sitting on €5-10bn of losses and if the property market does not recover faster than NAMA runs up interest and operating costs, then that loss will fall to the taxpayer in 2020 when the NAMA bonds, which are guaranteed by the Irish state, fall due.
Thanks for the swift and perfect reply. Perfectly terrifying too mind you!
So closing the deficit through cuts will devastate the economy until 2016
Thereupon under the new treaty, the devastation will continue with the new national debt repayment schedule in the Austerity Treaty until god knows when.
The austerity will continue/intensify when the NAMA bonds following due in 2020
It will further continue/instensify when the now sovereign Anglobonds are due in 2023?
Are we to live out this crisis until the 2030s?
@NWL, Did you read the NAMA “response” to Peter Mathews? It was a non-answer. There was no explanation as requested. The answer provided the NAMA CEO read:
“In terms of the figures the Deputy produced, I do not know the genesis of his figures other than the fact that the board of NAMA and I do not accept that we are heading to the loss territory about which he is talking but I fully accept he has his own views on that.”
Well, to answer what he does not know (which is shown to be a lot), the genesis of Peter’s figures was this website. They were published here and obviously Peter Mathews took them seriously. His question remains unanswered.
This question and answer routine is skewed in favour of NAMA by grouping numerous questions so that the thrust and core of any one Deputy’s query is lost. The same method was used by the Troika at their recent Press conference – except Vincent Brown, old pro that he is, outmaneuvered them. As a result, I now firmly believe that the PAC and Oireachtas committees are a complete waste of time and allow the NAMA representatives to “fudge” answers.
The only way to ask the hard questions and get honest answers from NAMA is in writing. That way they can’t dodge the issue.
[…] is cooking the books Astonishing claims from namawinelake here: NAMA It seems that NAMA is using a methodology called "Effective Interest Rate" to account […]
Embarassing post.
“Effective Interest Method” is the normal method accounting for premium/discount assets as valued at acquisition time. If valuations change later, provisions will be taken or if valuation becomes hopelessly unrecoverable, impairments will be taken.
@Alea, no-one is disputing that EIR is not part of internationally recognised accounting standards. But
Garbage In Garbage Out
NAMA last revalued its impairments at 31 Dec 2010. In 2011 it has published its interest income based on EIR based on Nov 2009 acquisition values but NAMA has not revalued its impairment during the year and won’t until 31 Dec 2011.
@Alea, Embarrassing for whom? NAMA who are trying to misrepresent the accounts and declare profits that are non-existant?
If it is “the normal method accounting for premium/discount assets as valued at acquisition time”, what exactly does that mean in English and in relation to NAMA? Because the agency has not been forthcoming with us as to what method it is using to calculate the discount.
Is the basis the acquisition value plus a premium or is it some other calculation based off a projected future valuation? Because, if it is the former, NAMA is adding to its accumulated loss on a daily basis by the amount of the interest not collected but calculated as part of their annual “operating profit”; and if it is the latter, NAMA should tell us if they used Nancy Reagan’s fortune teller or Gypsy Rose Lee to forecast the future price levels.
The valuation at acquisition time was wrong and NAMA is taking impairment charges which reduces the original valuation, NAMA is not hiding anything.
Was “Embarrassing post” a reference to the previous poster, or a title for your own?
The “Effective Interest Method” is a normal, recognised method, yes, but like any accounting method that avoids marking to market and instead relies on assumptions, it can be abused. This is a clear case of abuse, as the assumptions underpinning NAMA’s bookings are ludicrous.
@Alea, We are in agreement that the valuation at acquisition time was wrong. Specifically, the assets (loans) were overvalued.
There are two impairments.
The first impairment charge relates to write-downs in the capital value of the loans based on the underlying security (the property). The capital write-downs to date are understated by any analysis – See Peter Mathews’s question. Also, when looking for updated values, NAMA has asked its consultant valuers not to provide them in writing, just to give them verbally over the phone (that’s hiding).
The second impairment relates to the interest charged, but not paid, on the loans. No impairment charge has been taken for this. In fact, the method is being used to increase and falsify NAMA’s profitability. Hiding? NAMA is hiding the valuation basis on which it is calculating the EIR.
It also allows NAMA to play around with % of performing loans,by utilizing a fictional future ballon payment,thus classifying the loan as “performing”.
The number is also extremly large,disturbingly so,250 million over nine months out of 786 million,is based on NAMA’s crystal ball skills.
@John, I think NAMA has been very prudent on its classification of performing/non-performing in that it classes a loan as non-performing if it provided for rolled-up interest and is performing in accordance with the loan agreement. NAMA requires full cash payment of interest annually for a loan to be classed as performing, as I understand NAMA’s notes.
@JG, +1, The whole thing is smoke and mirrors. Totally dishonest and disguising a true loss of over €5 billion to date.
@NWL so NAMA,to better explain this absolute nonsense picked a non performing loan, as per the example above,to illustrate and explain this.
@John, I’m laughing as I write this, but yes, NAMA chose a non-peforming loan to illustrate the EIR methodology. In fairness, it makes the example clearer but yes it’s funny!
@NWL, That is accepted. But it is just a veneer that can be pointed to as being candid, and it is useful in covering the reality that “profits” are being enhance by the use of interest charges that have not been paid – and in all likelihood will never be paid, other than by financially engineering a transfer from the capital side.
@WSTT, don’t get me wrong. I think it is deeply misleading for the NAMA CEO Brendan McDonagh to be swaggering around the place saying NAMA will make a €750m profit before impairment for 2011 when that “profit” already contains interest accounting which will be marked down. Deeply misleading.
But on its calculation of impaired and non-impaired loans, I think NAMA is being prudent.
@NWL, Agreed :-)
@NWL ahh the were trying to make it clearer….what does it tell us about the arrogance and culture,if they blatantly utilize a non performing loan to answer an elected representatives written question.
Based,on some recent excellent questioning by Sean Fleming,I think it’s fair to say he can follow an example with a performing loan.
Alea : NAMA is not hiding anything is it? Thats why its as opaque as the hybrid son of the kremlin, the papal conclave and the inner workings of the stonecutters? If its so not hiding anything, why they should EMBRACE FOI. After all, whats to hide? Nothing….
@Brian, and on that, it’s worth pointing out that NAMA is presently fighting in the courts the decision by the Information Commissioner which made NAMA subject to environment information requests. The case is set to be heard at the High Court in May 2012. The taxpayer will obviously be funding the legal costs on both sides.
Gavin Sheridan comments on the matter here.
http://thestory.ie/2012/03/24/mcdonagh-on-the-nama-case/#comments
@brianmlucey: it would make no commercial sense to disclose details of individual loans and would be against taxpayers interests.
my point is that the accounting method is entirely legitimate (not a “very controversial accounting method” at all but run of the mill) and if valuation were initially wrong, provisions or impairment charges should be taken.
I certainly agree with @NWL that trumpeting “profits” before taking impairment charges is pretty ridiculous.
The relationship under the Act is banker/client. Therefore, there is client confidentiality. That does not preclude NAMA from discussing loans on a segmented basis. I don’t see how disclosing details of individual loans would be against taxpayers’ interests. That to me is a red herring. Whether or not a competitor knows the par value of any loan is irrelevant. Disclosure may however be against the individual borrower’s right to privacy.
The point about NAMA’s use of the EIR, is that it is NOT taking impairment charges to balance it and is using it to illegitimately, and possibly illegally, enhance NAMA’s profitability.
@who_shot_the_tiger’:
EIR is the accounting method and provisions or impairment charges are adjustments made ex-post, reported separately and NAMA has taken impairment charges before (http://www.nama.ie/news/nama-publishes-annual-report-2010/) well in excess of operating income.
@Alea, As I said before, NAMA is not taking impairment charges against the interest that it is adding to its bottom line, but cannot collect. Neither is it taking enough impairment charges against the accumulated capital losses on its loans. I’ve detailed it here previously and Peter Mathews is asking NAMA questions about it and getting no answer.
And the TRUTH is that NAMA is enhancing its operating profit, but in reality it is making a loss.
P.S. Ms Justice Mary Finlay Geoghegan found that NAMA has a duty of candour. Perhaps Paddy McKillen’s counsel will remember that next week when NAMA’s representatives take the oath in London.
Candour: The quality of being open and honest.
When it is convenient the original lost 40odd billion (74-32 supposedly) is forgotten……watch it be remembered when a place is needed to hide the losses a few years down the line
@ca sf writer; The €40 billion (74-32) is like last winter’s snow – It’s gone. The taxpayers swept it up, courtesy of Cowen and Lenihan.
We will end up having to recapitalise NAMA. I firmly believe this.
Well if you’re right maybe we’re better off if they continue to mislead the public and EU about their financial position. It’s an age-old game called “Let’s Pretend”.
Is the unpaid interest on the loans compounded in the EIR? Over ten years, this can add up, no? I think it should be as it is a material loss.
Good morning. It seems that not everyone was out enjoying the good weather over the weekend :)
A couple of issues on NAMA’s ‘profit’ from sales and ‘cash interest received’. My concern is NAMA may be polishing turds and might be selective on how they describe things. I don’t know if this is the case, but they give themselves room to do so.
For example
1. “but in fact it has received only €537m in cash” – From NWL’s preceding post, NAMA “booked €2.7bn” of sales. I assume at a loan level the EIR creates an interest accrual, so that when the loan is disposed of the ‘interest accrued’ is earned. Is this included in the €537m interest in cash?
2. NAMA “booked €2.7bn” of sales & “NAMA has made a profit of only €132m on these sales” – has NAMA adjusted the profits to reflect interest already earned (via EIR) on these loans?
@Ahura M, In answer to your questions:
1) No. Under the EIR accounting method, the interest is not received, it is merely accrued. It is received when the property is sold. At that point, unless the property achieves its original projected value plus accrued interest, there will be an additional capital loss equivalent to the “rolled-up” interest.
2) Good question, but it is unlikely. I would think that the “profit” is gross, i.e. just the sales price less the NAMA acquisition cost, before any financial engineering or overheads.
Oops. “when the loan is disposed of the ‘interest accrued’ is earned.” I shouldn’t say ‘is earned’ as the interest is being earned all along.
@WSTT,
I probably need to be more precise. And this is in the context of ‘if’ NAMA wanted to be misleading. Say NAMA sold and received cash of 100m. And that they had previously ‘earned’ 10m of interest using EIR for that loan. They may decide to label 10m of the 100m as cash interest received regardless of whether the loan made a profit or loss.
What I’d like to know is if the “received only €537m in cash” includes this type of ‘interest’ at point of sale. NAMA gives the impression the €537m in cash flows from performing loans.
@Ahura M, Can’t answer that one with any certainty :-)…. but if the interest on some of the loans has been rolled up, the answer is probably “Yes”.
Alea – accounting policies should serve us not the other way around. The days when banks recognised NII on non-performing loans and then provided for its non-collection ‘below the line’ are long gone.
Lets keep this simple – NAMA’s McDonagh/Daly are claiming to have made €750 million operating profit when in fact c. €350 million of this profit is an estimate of possible future earnings.
It is possible that NAMA is claiming ‘interest’ profits on loans above the line for which it is simultaneously making provisions below the line!
If their estimates are optimistic, these profits have to be reversed in future years. Far better, simpler, clearer and more prudent is to report actual NII! Also, I would suggest to Mr. McDonagh that he avoid hubris unless he plans to be elsewhere when the potential overestimate comes to light!