UK commercial property sees third consecutive month of declines in April 2012

Today sees the publication of the April 2012 IPD Monthly Property Index for the UK. The IPD (Investment Property Database) index is the only UK commercial index 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 Index shows that capital values fell by 0.3% in April 2012, following declines of 0.3% in both March and February 2012 and preceding that, several months of almost flat performance. Prices reached a peak in the UKin June 2007 and fell steadily until August 2009 when the current rally started. Prices then increased by 15% in the year to August 2010 but since then prices are up a measly 0.8% and in the last 12 months prices have actually decreased by 0.6%. Overall since NAMA’s Valuation Date of 30th November, 2009 prices have increased by 10.2%. Commercial prices in the UK are now 34.7% off their peak in June 2007. The NWL index  remains at 817 which means that NAMA needs to see a blended increase of 22.4% 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).

The table below shows the change in value of an index set at 100 at 30th November, 2009 and applying the month-on-month % increases in a compound manner.

The overall outlook for the UKeconomy is muted in the short term with the country suffering a double dip recession after a shock- though modest – 0.2% contraction in GDP in Q1, 2012. The UK has a so-called Office for Budget Responsibility (OBR) which is independent of Government and produces its own economic forecasts and commentary on fiscal policy. The latest report from the OBR was published on 21^st March, 2012 and it forecasts GDP growth from 2012-2015 at 0.8%, 2%, 2.7% and 3%, deficit of 8.3%,5.8%,5.9%,4.3%, debt:GDP of 72%,75%,76%,76%, unemployment rate of 8.7%, 8.6%, 8.0%, 7.2%, house prices of -0.4%,0.1%,2.5%,4.5% and inflation of 2.8%,1.9%,1.9%,2%. Last month, S&P of its top Triple A credit rating with “stable outlook”. Both Fitch and Moody’s have put theUK on a negative credit watch

Monetary policy is overseen by the independent Bank of England and the  current Bank of England rate is 0.5% and has been since February 2009. And there might even be another round of quantitative easing that has so far seen almost GBP 300bn pumped into the GBP 1.5tnUKeconomy.

About half of NAMA’s portfolio was located inLondonwhich has so far performed very well from Aug 2009 to Dec 2010 but has been more subdued over the past year. Supply shortages and money chasing a relatively stable investment have maintained prices and there might even be a short term fillip from this years Olympics. BeyondLondonand the English south east, there is evidence of prices waning amidst sluggish economic growth and stunted lending.

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The ESM is not the Goose that lays the Golden Eggs

“When you have to tackle a deficit, you have two levers, spending and taxes. I can’t believe that our Irish friends, in full sovereignty, won’t look at both since they have more room for maneuver given that their tax rates are lower.” Former French president Nicolas Sarkozy in November 2010. What will the French position be in 2014 if we have to rely exclusively on the ESM?

Whilst the debate continues over the source of Ireland’s funding needs from 2014, it remains the case that the European Stability Mechanism (ESM) looks like the main show in town – sure, the IMF may provide very limited funding with very strict conditions and we might be able to extend our programme with the existing EU bailout fund if we apply before July 2013, and of course there exists the possibility that we’ll be able to access the traditional bond markets. But despite the official line that a second bailout is “unlikely” or even “ludicrous”, the position on here remains that it is more than likely that we will need a second bailout from official sources, and that from 2014 that will mean the ESM. So if we vote “no” on 31st May, we may well have to run another referendum in 2013/4 to vote “yes”. There is a view that the ESM will be available to us even if we vote “no” because Europe won’t let us fail, particularly if we are complying with the terms of the first bailout, and that view may be correct. However both roads lead to the ESM and this blogpost examines why the ESM is not a Golden Goose for so-called “programme countries”.

The latest version of the ESM Treaty was signed on 2nd February 2012 by EuroZone countries, and it was later signed by de facto heads of state, including our own Taoiseach Enda Kenny on 2nd March 2012. The current version of the ESM Treaty is here, the old version from July 2011 is here and a summary of the changes is here. The press release from the European Council president announcing the new version is here.

There are two concerns on here regarding the terms of accessing funding from the ESM

(1) The cost. The old version of the Treaty made the pricing transparent. Programme countries would pay a margin on the cost of funds, and that margin was 2% for funding up to three years and 3% for longer-term funding. So if the ESM borrowed funds at say 2%, then Ireland would be charged 5% for 3-year plus funding which is our likely requirement. However the new version of the Treaty doesn’t provide an upfront pricing menu at all; it merely says “1. When granting stability support, the ESM shall aim to fully cover its financing and operating costs and shall include an appropriate margin. 2. For all financial assistance instruments, pricing shall be detailed in a pricing guideline, which shall be adopted by the Board of Governors. 3. The pricing policy may be reviewed by the Board of Governors.”

In recent days, there has been commentary from economists and others supporting a “yes” vote in the forthcoming referendum on 31st May, and a perception has emerged that the ESM would provide funds at cost. That is not correct, at least based on the wording of the current Treaty.

(2) The terms. Cast your minds back to November 2010 when we obtained the first so-called bailout. Remember the dreary November days, the rumours and denials. But do you remember the anxiety that any bailout might be conditional on Ireland agreeing to raise its corporate tax rate from 12.5%? Remember the French and Germans angling for corporate tax to be brought onto the negotiation table? No, then these articles might refresh your memory here and here and here and here.

Of course in the end, there was no conditionality which might have jeopardised our corporate tax rate in the Memorandum of Understanding. But that could be attributable to the moderating influence of the IMF. What will happen in 2014 when we will probably need a second bailout exclusively from the ESM? And we won’t have the IMF on our side? Bye-bye 12.5% corporate tax rate?

The above is not meant to be dismissive of the ESM – the view on here is that it is likely to be the main, and probably only, show in town – but it is a reality-check and highlights the fact that we will pay for a second bailout, and pay handsomely. And we may again feel pinned to the collar by other European interests who have not disguised their ambitions with respect to our corporate tax arrangements. And this time we may not have the IMF to stand shoulder-to-shoulder with us.

Sobering.

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