Archive for the ‘NAMA valuation methodology’ Category

It’s not new news that John Mulcahy – NAMA’s most senior property man from the start in 2009, he was an adviser before NAMA came into being and appointed the Head of Portfolio Management in February 2010has a €2.3m shareholding in his former company, Jones Lang LaSalle. This was reported in 2010 and addressed by NAMA at its first outing at an Oireachtas committee hearing in April 2010 when the following exchange occurred

Deputy Joan Burton –  At our last meeting, I raised with Mr. McDonagh the issue of conflicts of interest between NAMA employees and either the banks which are having their loans taken or some of the individual loans. Mr. McDonagh went to great lengths to assure me that he and other people involved in NAMA had made extensive declarations in regard to their own interests and so on, and that these were published. There was a report in a Sunday newspaper that Mr. Mulcahy, who attended the last meeting as the valuation expert for NAMA, retained shares to the value of €2.3 million in Jones Lang LaSalle, his former employer. That company is providing key professional advice to NAMA. Can Mr. McDonagh comment on this? On the face of it, there seems to be a conflict of interest.”

NAMA CEO, Brendan McDonagh – Deputy Burton raised issues about NAMA’s employees and conflicts of interest. Under section 42 of the NAMA Act, every person who works in NAMA must complete a statement of his or her interests, assets and liabilities. This is also true of everybody — myself included — employed by the NTMA who will be assigned as NAMA officers. I will not comment on newspaper speculation about a particular individual because it would be unfair to do so in the public domain. All I can state is that there was full disclosure by all employees who joined NAMA. We ensured full disclosure”

Deputy Burton – A statement was made — whether true or not — in a major Sunday newspaper about what by most people’s standards was a significant investment of a couple of million euro by NAMA’s chief valuer. I am not sure what is his official title, but that is what he seemed to be when he appeared before the committee on a previous occasion; he was the person advising on valuations. He has a major shareholding in one of the key providers of professional services for NAMA. It is very reasonable for the Oireachtas committee to ask Mr. McDonagh whether this is correct and, if so, what measures have been taken to ensure there will be no conflict of interest where there is a crossover in the provision of services and where someone is a significant stakeholder in one of the service providers. That is what conflict of interest is all about.”

Brendan McDonagh –  I can answer that question for the Deputy. The individual in question worked as managing director and chairman of that organisation inIreland and would have built up shares in it prior to joining NAMA. He would not be permitted to take part in any allocation of work to his former company — this applies to anyone who joins the NTMA or NAMA. This is a house rule and how we manage conflicts of interest. Effectively, there would not be any inference of favouritism towards a former employer. We had to recruit people with experience from the market. Many people would have potential conflicts of interest and the question is how we manage them. We have an internal procedure to manage them”

Deputy Burton – It is obviously true that he has a significant shareholding in a business providing significant services for NAMA for, presumably, reasonable amounts of money. Mr. McDonagh has stated the individual in question is not allowed to allocate work to the company in which he has shares and that is fine, but what about his shareholding? Is he allowed to be an active shareholder in that company with regard to the management of his holding and interest in it?”

Brendan McDonagh – No, he is not allowed to be an active shareholder in that company. To be realistic, it is a publicly quoted company and once a senior employee declares he or she has a shareholding, that is what is required under the NAMA Act. All employees are required to make a full disclosure of their assets, liabilities and interests. It does not mean to say the conflict is not managed. It is. That is all I can say to the Deputy.”

It is not clear if John Mulcahy still has that shareholding, but we do know that John’s star is in the ascendant at NAMA where he was recently appointed to the board as Director of Asset Management.

What is news is the response from Minister for Finance, Michael Noonan yesterday to a question from Sinn Fein’s Gerry Adams in which Minister Noonan set out the fees paid by NAMA to companies providing valuation services to the Agency. In total NAMA has spent  €13.3m to date – €4m in 2010 and €9m in 2011. The Top 10 recipients of NAMA’s largesse are:

So JLL is top beneficiary, and NAMA’s most senior property man is John Mulcahy who holds or held a substantial personal shareholding in JLL. Take NAMA’s assurances at face value and conflicts of interest were avoided by NAMA having an internal procedure to avoid them.

On the other hand, there will be surprise at the fact that JLL’s bigger and assumed main competitor in Ireland, CB Richard Ellis (CBRE) doesn’t even make it onto the list at all!  CBRE was one of the five valuation companies which were appointed for national valuations inIreland in December 2009 – the other four were JLL, Lisney, Savills and DTZ Sherry Fitzgerald.

UPDATE: 14th March, 2012. Industry sources have suggested the reason for CBRE’s surprising absence from the Top 10 might be because of that company’s disproportionate success in winning contracts to value property for the banks, and that when the loans were transferred from the banks to NAMA, CBRE might consequently have been compromised in its position,

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The Minister for Finance, Michael Noonan gave the green-light this morning for the publication of the report and accounts for NAMA for the quarter ending 31st December, 2010. The outstanding feature of  the accounts is the €1bn provision that NAMA has created for losses on the loans it has acquired from the NAMA Participating Institutions (PIs – AIB, Anglo, Bank of Ireland, EBS and INBS). To summarise, NAMA has acquired loans worth €71bn at face value, paid €29bn for them but now believes the loans are worth €28bn. This entry examines the €1bn provision and argues that it vastly overestimates the current value of the loans that NAMA has acquired.

First up, it should be said that the €1bn provision is an estimate and is unaudited. But that said, NAMA claim that the full accounts for the agency were handed over to the agency’s auditor, the Comptroller and Auditor General, in February, 2011 so you would expect the €1bn provision to be not too far off what will be reported in NAMA’s audited annual accounts in June 2011. Secondly, the provision is prepared in accordance with International Financial Reporting Standards (IFRS) and it is IFRS 9 that will be particularly applicable to the valuation of the €29bn of loans in the annual accounts; and that IFRS will still allow NAMA to value loans in the same optimistic way that banks here have been valuing loans in recent years. Although the IFRS is going through some changes, organisations like NAMA can, until 2013, choose a method of valuing loans which can be divorced from the underlying value of the security.

But if you were to revalue the loans by reference to their underlying value, I believe the loss booked at the end of 2010 should be closer to €3bn. Here’s why:

(1) We don’t have a precise breakdown of the location of NAMA assets but the latest we have from NAMA is that 67% of NAMA loans will be in the State, 6% inNorthern Ireland, 21% in the rest of theUKand 6% in the Rest of World.

(2) NAMA is valuing loans by reference to the 30th November, 2009

(3) Although NAMA has valued the current market values of loans by reference to 30th November, 2009 it had applied an uplift – a long term economic value premium – to help out the banks on the assumption that November 2009 was the bottom of the market. The average uplift applied appears to be 10%.

(4) NAMA is paying for loans with NAMA Bonds (making up 95% of the payment) and NAMA subordinated debt (making up the remaining 5%). The subordinated debt will only be honoured if NAMA makes a profit. So if NAMA makes a loss then these subordinated debt instruments won’t be honoured. NAMA paid roughly €29bn for the loans of which €1.5bn approximately was in subordinated debt.

(5) The breakdown of tranches 1 and 2 shows that 13% of the loans relate to completed residences. In addition 26% relates to development and presumably some will be residential. I assume that residential makes up 20% of all loans acquired in all territories. And commercial makes up the remaining 80%. NAMA has not issued any detailed breakdown of the loans since 23rd August 2010 when it provided details on tranche 2.

(6) Irelandand the UKcomprise the majority of NAMA assets. We keep track on here of the commercial and residential indices for bothIrelandand theUK. See the top of this page for the most up-to-date price movements. As you can seeIrelandhasn’t done so well whereas theUK’s commercial index has performed quite well.

(7) Taking into account the assumed split of NAMA’s loans between Ireland and the UK and the assumed split between residential and commercial and using the indices shown at the top of this page as at 31st December, 2010 and assuming that NAMA on average paid a 10% long term economic value premium but will not need honour its subordinated bonds if the agency makes a loss would point to the €29bn of loans being worth €25bn. NAMA won’t need honour €1.5bn of the €29bn consideration paid, if the agency makes a loss so taking €1.5bn from €29bn gives us NAMA’s consideration in a loss-making scenario, that is €27.5bn and yet the underlying security of the loans is only worth €25bn today. So NAMA should recognize a loss of €2.5bn.

What’s potentially wrong with the above?

(1) It uses a lot of assumptions – based on the best published information, I would argue, but assumptions nonetheless

(2) NAMA says that it found the value of residential property in Irelandt o be an average of 50% off peak in November 2009 whereas the official index, the Permanent TSB/ESRI, indicated it was 30% off peak at that point. An implication is that NAMA’s losses on Irish residential property won’t be as great as the official index implies.

(3) NAMA claims, it is reported, that the “majority” of its UK assets are inLondon. And it seems to be accepted that London has recovered from the 2007/8 financial crisis quicker than other parts of theUK(Northern Irelandstill seems to be suffering most).

(4) NAMA can claim that the relevant IFRS allows the agency not to value on the basis of underlying security.

And what about the future for NAMA?

NAMA was conceived on the principle that we were close to the bottom in terms of property prices in 2009. Minister Lenihan pointed to record high property yields at the time as indicative of the state of the market. He was wrong, or wrongly advised. The outlook for the residential market is still shaky forIrelandwith the Central Bank ofIrelandindicating in March 2011 that prices were still some 30% off the bottom. The CBI was more upbeat on commercial prices but it acknowledged if the government were to abolish Upward Only Rent Reviews that prices might fall another 20% plus. The outlook for the UK is more positive but there doesn’t appear to be a boom in prospect there – residential seems to be bouncing along more or less flat and commercial generally seems to be modestly increasing (less than 5% per annum). However NAMA is a 10-year project and part of the skill of managing assets will be in optimizing the timing of disposals. It’s a long way of saying that NAMA might see some recovery in prices though it needs also consider the ongoing interest charges on unredeemed NAMA bonds as well as its operating costs.

The agency has not had a good year in 2010. It lost more than €2m per day (based on an inception on 27th of February 2010, being 304 days to 31st December 2010 and a loss of €714m). However, even if prices had stayed flat, NAMA would still have potentially have reported a loss as it was paying a long term economic value premium to the banks. It remains to be seen if NAMA can turn a profit, it would be helpful to get some detail on the €3bn assets which the agency says has been approved for sale. The accounts today however do place NAMA at a disadvantage, just as Minister Noonan is considering the future operation of the agency.

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“It [NAMA] already did a very good deal last week with Google, we saw the kind of deals it can do here….The cash is already gone back to government and a dividend gone back”

Micheal Martin, Leaders Debate, RTE 22nd February, 2011

It was last week when NAMA made an unscheduled announcement with some details of current events. It’s always welcome to get news on how the agency is performing though it would be better to get the quarter three, 2010 report and accounts which have now been sitting on Minister for Finance, Brian Lenihan’s desk for the past 54 days. Included in the announcement last week from NAMA was news of the sale of the Montevetro building on Barrow Street in central Dublin to internet search engine giant Google. This is what NAMA had to say in respect of the transaction:

“Noting the announcement earlier today by Google of its purchase of the 15 storey Montevetro development on Barrow Street in Dublin, NAMA confirms that it has recovered in excess of the combined amount of [1] the monies it paid to acquire the REO plc loan which was secured by the Montevetro development and [2] the additional funding advanced to REO plc in the form of development working capital to enable it to complete this landmark building so that it could be sold on the market.

Working with CIE, the State’s transport holding company, and REO, NAMA provided extensive resources, including working capital and expertise, to ensure the development was completed on time and to a high specification. Frank Daly, Chairman of NAMA said; “the successful completion of the Montevetro development and its sale again reflect the positive potential of NAMA to support the commercial property market in Ireland without compromising its objective of recovering monies owed to the taxpayer. NAMA played an intrinsic part in brokering the deal between purchaser and seller and in putting this deal  together. It is an excellent example of NAMA’s ability to enhance the value of its assets for the benefit of taxpayers.

I believe the sale of a building of the size of 210,000 sq feet will be seen as a very positive sign for the future of the Irish Commercial property market. I also believe that having such an internationally renowned purchaser demonstrates continuing confidence in Ireland and particularly in our attractiveness to major global businesses.”

The sale of Montevetro was regarded as a first but I don’t think that is the case. There were some €1.6bn of disposals under NAMA’s auspices last year and this sale of Montevetro was yet another sale by the developer under NAMA’s auspices. NAMA may feel that it played a greater role in this sale than others but, on the face of it, there is nothing original about this sale.

The building: a 210,000 sq ft, 15-storey with three additional basement levels office building on Barrow Street in the Grand Canal Dock area of Dublin 2 (central Dublin). Architecturally it’s more lines than curves and occupies a broadly triangular footprint.  At 67 metres, it is Dublin’s tallest commercial building. The tallest building in Ireland is the Cork’s 71-metre Elysian Tower which is mixed residential/commercial.

Its history: The application (ref: DD385) for a certificate under section 25 of the Dublin Docklands Development Authority Act 1997 was submitted to Dublin Docklands Development Authority in August 2006 by Montevetro Limited and the certificate was awarded in October 2006 subject to certain conditions. According to Treasury development commenced in March 2008 and completed in January 2011 (according to the Docklands Authority, development had already commenced in 2007)

The sellers: The developer of the property was Montevetro Limited, a company in the Real Estates Opportunities (REO) group which in turn is controlled by Treasury Holdings. The land was owned by CIE (state owned transport company) and it is understood CIE retained an interest in the site and has benefited from the sale to Google. It is also understood that NAMA Top 10 developer, Derek Quinlan had an interest in the development, possibly 30%. The loan underpinning the building was acquired by NAMA in April/May 2010 and since that time, NAMA has had a degree of control over the property through its ownership of the loan.

The underlying loan: Details of the loan have not been disclosed but we might be able to make an informed stab at the value of the loan. If the application for the development was made in 2006, which was close to the peak for commercial property prices in quarter three of 2007, and if the loan was advanced back then, then it seems that the completed development would have been valued in excess of €150m. This is based on the separate reported development by Ashdew Limited (a joint venture between Bernard McNamara and Jerry O’Reilly) beside the DART station on Barrow Street where the 100,000 sq ft development was valued at €70m in 2002. Rents for prime office space in Dublin had reached and exceeded €60 psf at the height of the boom which would have equated to a €180m price tag at a 7% yield. Standard loan to value (LTV) rates were 70%+ so a €150m valued property would have been capable of attracting a loan of €105m. Interest payable would typically have been the ECB rate plus 2%. If it had been rolled up, which was a common feature of property development, then the nominal value of the loan securing the property might well be in excess of €120m today. Because we don’t know the loan terms, we do not know if the loan was non-recourse, that is, secured on the Montevetro site only without recourse to other assets owned by the borrower. We also don’t know if a special purpose vehicle (SPV) was used to obtain the loan – the significance of a SPV is that its liabilities tend to be ringfenced to assets owned by that particular SPV. Of course it may be the case that the loan is secured on other Treasury/Derek Quinlan assets/companies or by personal guarantees – we don’t know because NAMA didn’t provide details.

The sale price: €99.9m in cash. Equates to €476 psf. It is understood that part of these proceeds will be handed over to CIE, the original owner of the site.

NAMA’s purchase price and development costs: Not disclosed. NAMA Chairman Frank Daly did say that NAMA’s purchase price and additional development costs were less than the sale price. And on that basis, NAMA claimed a profit from the sale. The purchase price of the loan should have reflected the value of the Montevetro development on 30th November 2009 (NAMA’s valuation date). In addition NAMA paid the banks a Long Term Economic Value premium which has averaged 10% for the first two tranches acquired by the agency in 2010.

The good news: In my opinion the price achieved by Treasury under the auspices of NAMA in the current marketplace is outstanding. And NAMA also did very well to generate a profit on the transaction despite firstly, commercial property values dropping 10%+ since November 2009 and secondly, NAMA paying a long term economic value premium.  With a paucity of large transactions of similar buildings recently it is difficult to ascribe values but I note that the Department of Transport bought a more traditionally prestigious, though internally dated, building for €283 psf this month 500 metres away on Clare Street. Furthermore it is my opinion that the outlook for commercial prices is challenging for the next two years with a general oversupply, a difficult economy and the prospect of retrospective downward rent reviews. The sale to Google, one of the world’s great companies is most welcome to the economy now, both for the vote of confidence in the country’s future and for giving us one of the few major commercial transactions we are likely to see in 2010/2011. And our reputation as a technological hub for non-EU companies will be enhanced so in the years to come, we may well attract the EU operations of baidu , yandex or guriji.

The bad news: The sale of the building to Google is likely to have resulted in a loss to the taxpayer because the nominal value of the loan is likely to be more than the €99.9m sale price achieved by NAMA. The State owns 100% of Anglo, INBS, EBS and effectively owns nearly 95% of AIB. The State owns 36.5% of Bank of Ireland and were it not for the Minister for Finance concluding that he didn’t have the mandate to fulfil Ireland’s commitment to the IMF/EU, then by next Monday 28th February, we would likely have majority control of BoI as well. So the loss incurred by the banks is in fact a loss to the taxpayer. Because we don’t have details of the price paid by NAMA for the loan, NAMA’s development outlay or the nominal value of the loan we are not able to conclude that there was a loss or the quantum of the loss but we can arrive at an educated proposition. NAMA may care to comment if the proposition is invalid.

No news: it is not clear why NAMA sold the property at this time and didn’t wait for a recovery in prices. Given that the IMF was urging the agency to dispose of assets sooner rather than later and with rumours of an IMF staff member permanently occupying a desk in NAMA’s offices at Treasury Building, perhaps the final decision to sell was not NAMA’s to make…

UPDATE: 1st March, 2011. It seems that Simon Carswell at the Irish Times has been dabbling in the Black Arts as he is today seemingly able to bring us some inside details on the project. There was, he claims, an AIB loan of €30m advanced after April 2009 to REO/Treasury for the development. This was acquired by NAMA at a nil haircut because of a deal done between NAMA and the banks that post-April 2009 lending would not attract a haircut as otherwise banks would be reluctant to make the advances. It is not clear what pre-April 2009 lending had taken place. Simon claims that in total there was €40m of development lending on top of the €30m post-April 2009 from AIB. This €40m presumably includes the pre-April 2009 lending PLUS the additional advances made by NAMA to finish out the project. Whilst AIB and NAMA “declined to comment on the transaction” Simon also claims that the CIE obtained €21m from the deal (they apparently had a development deal with REO and CIE was the original owner of the land) – this echoes the claim made by Michelle Devane in the Sunday Business Post a couple of days ago. Simon concludes today with “the profit made by Nama is estimated to be less than €10 million, according to sources familiar with the finances behind the property”. It is noteworthy that at least 3/7ths of the lending was made after April 2009 when Montevetro was well advanced at that stage. Of course what we would all like to know is how much the taxpayer lost on the deal, but NAMA is not likely to reveal that voluntarily but who knows what the Black Arts might reveal.

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The Sunday Business Post yesterday reported that NAMA is to take a “significant” impairment charge in 2010 in respect of its loan acquisitions from Irish banks. The newspaper appears to have had some direct contact with NAMA and quotes the agency as saying “the view of the Board is that it would be run counter to its statutory objectives under the Act for Nama to take this impairment charge while paying the interest on the Nama subordinated debt.” The newspaper does not estimate the impairment charge but misleadingly says “a subsequent fall [from 30th November, 2009 – NAMA’s valuation date] of 8 to 10 per cent in commercial property values has meant that it will have to write down this value [the value of loans acquired]”.

It seems that some people have deduced that if NAMA is paying €30bn for loans then it will therefore have lost €2.4-3bn. It is more complicated than that and you need bear the following in mind when trying to estimate the losses at the agency for 2010.

(1) NAMA has taken over loans relating to both residential and commercial property. Some associated lending may relate to assorted securities eg wine collections, helicopters. The rough estimate on here from examining NAMA’s business plan and tranche detail information is that 80% of NAMA loans relates to commercial property and 20% to residential.
(2) NAMA has taken over loans secured on property in Ireland and in other territories. The security representing 66% of loans by value was supposed to be in Ireland, 5% in Northern Ireland and 21% in mainland UK (mostly thought to be London). The remaining ~8% is scattered around the world.
(3) We track on here the change from 30th November, 2009 in index prices for both commercial and residential property in Ireland and the UK. You can see a summary at the top of this page.
(4) The consideration given by NAMA in return for loans comprises senior bonds  and subordinated bonds, the former making up 95% of consideration and the latter 5%. The subordinated bonds will not be honoured if NAMA does not make a profit over its estimated 10-year lifespan.
(5) NAMA has paid a premium to banks on top of the market value of the property underpinning the loans, The premium is called Long Term Economic Value and on average has been 10% of the market value of the loans in tranches one and two.
(6) NAMA has acquired €71bn of loans to the end of December 2010 and paid a total of €30bn in consideration.
(7) If NAMA makes a loss overall at the end of its lifespan, then a levy can be imposed on the participating NAMA banks in proportion to the value of the loans they transferred to the agency. Given the condition of Anglo, INBS, EBS and AIB, this levy business is rubbish. And even Bank of  Ireland which will account for less than 15% of NAMA’s loans may not be in any position to pay any levy.

Taking account of all of the above, it is calculated on here that the value of the loans bought for €30bn will be €25.5bn but since €1.5bn of the consideration representing subordinated bonds will not be honoured if NAMA makes a loss, NAMA’s net impairment will be €3bn. The detail is below, you might also like to look at the entry on the NWL index

As it happens, the estimated net impairment.for 2010 at €3bn is close to the figure calculated by taking the (incorrect) SBP estimate of commercial property decline in Ireland and multiplying it by the NAMA consideration. That is co-incidence.

It should be said that NAMA is a 10-year project and the hope on NAMA’s part is that prices recover. Indeed NAMA just needs a blended average increase of 12% in prices to break even at a gross profit level. I think Ireland will be challenging for the next couple of years. After that we’re into true crystal ball territory but I would have said that if the economy is competently managed and we confront our debt then NAMA can still break even or indeed make a profit but it will be a challenge and I do not think the next two years will be pretty for the agency.

And to conclude it should be said that accounting rules may allow NAMA to avoid full revaluations of the loans in 2010 and I would be surprised if the Q3, 2010 accounts which are now very overdue will revalue the loans. It should also be said that the above calculations are based on general indices and don’t examine territories beyond the UK and Ireland. NAMA has taken over specific properties which may perform better or worse than the indices and NAMA has not published a reliable split of property outside of the UK and Ireland.

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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 30th 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 28th 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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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 31st 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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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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Despite criticising the Comptroller and Auditor General’s (CAG) report on NAMA last week as incoherent and aimless, it does contain some interesting information. And aside from the payments (bizarrely including VAT) made to some third party companies, the detailed worked example of a NAMA valuation of a loan is possibly the most interesting nugget in the entire report. This entry examines the worked example.

Firstly it should be said that despite a NAMA Act, a Long-term economic value (LEV) Regulation, an EU Decision, Tranche 1 and Tranche 2 reports, extensive debate on Irisheconomy.ie (here and here would be the best examples) and indeed an email response from NAMA shown on here, it has never been entirely clear how NAMA value loans and we should be thankful to CAG for at least including the worked example in what is overall a dreadful report.

The worked example looks horrendously complicated when you consider what the objective of the valuation is: to figure out (1) what the property was worth at 30th November, 2009 (2) what it is worth long term and (3) deduct a sum for due diligence and enforcement as these are costs NAMA is incurring. I would have expected the 5.25% due diligence and enforcement to be calculated on the par value of the loan but the worked example shows that it is calculated on another (much lower) figure. I am also confused by the calculation of the current value of the loan and why it makes use of a different discount rate (for which I can find no support in the various legislation and EU Decision). So for the time being I present what the CAG has presented with some better explanation but this is a post to which I expect to return.

The worked example appears at Annex A to CAG’s report from page 49 on and consists of  three pages – the worked example, explanatory notes and a graphic illustrating the calculation of the “state aid” element within the NAMA payment for the loan. The “Asset Acquisition Process” in Chapter 2 of the report (pages 29 onwards) provides further explanation as to how some of the rates have been derived.  The worked example relates to an investment property loan.

Here’s the worked example.

Here’s the explanatory notes.

Here’s the graphic showing the State aid element of the payment.

The explanatory notes are not very explanatory in my view and I have set out below the components to the valuation.

(1) The loan balance is the sum outstanding on the loan – straightforward enough. NAMA of course needed to do a reconciliation between when the valuation was undertaken and when the loan was transferred (additional interest, repayments, additional advances). In this case we assume the loan valued doesn’t change.

Derivatives can be confusing creatures. In this case let’s assume the “derivative” of €2,955,704 is an interest rate swap. What’s that I hear you say? Okay, let’s assume the developer took the loan out a couple of years beforehand. At the time the bank was insisting on an interest rate equal to the ECB main rate plus 2%, in other words a variable interest rate as is usual. At the time the main ECB rate was 3%, so the developer would have been paying 5%. The developer though was concerned that interest rates were going to rise and if they did then he might lose his profit on the development. So he wanted to lock in his interest rate, pretty much like a fixed rate mortgage. So he bought a “derivative” from the bank fixing the rate at 6% and that’s what he is supposed to pay. Now of course the ECB rate came down to 1% so it wasn’t a good deal for the developer and now in addition to the outstanding loan, he owes a further €2,955,704 on the derivative. Now if interest rates had shot up to 7% then the bank would owe the developer.

(2) The Current Market Value (CMV) of the property on 30th November, 2009. What would the property fetch on the open market at that date.

The Long term Economic Value (LEV) of the property is the CMV increased by a subjective % by the valuer to reflect the long term value of the property based on a number of considerations (which are set out in sections 5 and 6 of the LEV Regulation) which are subjectively interpreted by the valuers.

The Standard Discount Rate in the example is 5.57% comes from section 2(2) of the LEV Regulation “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)” Why 5 years? That comes from 7(b) of the LEV Regulation “where the bank asset is a bank asset for which the security is land for which the adjustment factor is more than 10 per cent of the land’s value but less than or equal to 15 percent of that value, NAMA shall take into account the projected cash flows of the bank asset over a period of 5 years using the NAMA 5-year discount rate,” Why is the adjustment factor 15%? Well that’s going to be a subjective assessment by the valuer based upon the factors set out in sections 5 and 6 of the LEV Regulation but I think it is worth noting that NAMA engaged a British consultancy, London Economics, to report on likely property trends in key NAMA markets and “the report concluded that the range of implied property price changes (in nominal values) for the period 2010 to 2016 for a combination of commercial and residential property was   Ireland – 17.7% to 28.8%,   UK – 14.7% to 20.3%,   US – 10.5% to 23.7% (page 38 of the CAG Report). In addition to a valuer working out the CMV at 30th November, 2009 (what would the property sell for at that date on the open market on the basis of a willing buyer and willing seller, both in possession of perfect market knowledge), the valuer is required to look at cash flows on the property in the relevant period (5 years here because of the above)

(3) The loan collateral valuation is what NAMA actually pays the bank for the loan and is calculated using three components (it seems derivatives are valued at zero)

(i) the LEV of the property expressed in current terms by applying the Standard Discount Rate in (2) above of 5.57% and

(ii) then deducting 5.25% representing the costs that NAMA will incur in undertaking due diligence of the loan (0.25%) on acquisition and the predicted average costs that NAMA will incur in enforcing loans (5% – the standard enforcement fee is supposed to be 15% but NAMA convinced the EU that less than a third of loans would require enforcement) plus the cashflow from the property discounted using the discount rate in (2) above, that is 5.57% in this case.

(iii) and adding the present value of the future cash flows discounted by the Standard Discount Rate

(4) The haircut (or discount) is the difference between the value of the loan (including derivatives) on the bank’s books and what NAMA actually pays. So the difference between (1) and (3) above. The haircut % is the haircut divided by the value of the loan (including derivatives) on the bank’s books. The haircut shown in the example is 30.02%. In reality the haircut on Tranche 1 total was 50% and Tranche 2 total was 56% and the weighted average in Tranches 1 and 2 was 52%. So the example shows a relatively high valued loan.

(5) State-aid has not really cropped up in discussions up to now in the context of the detailed valuations but CAG put a number (quantum and %) on it – basically it’s the difference between the Collateral Current Market Value (from (3) above) the Loan Current Market Value. And this would be where the CAG lost me. It refers to the CMV of the collateral (€62m), the future rental income (€3.7m in 2010 and 2011 and €5.7m in 2012, 2013 and 2014). And then there is a discount rate applied. This discount rate of 11% is different to the Standard Discount Rate and seems to be a NAMA invention and is shown on page 44 of the CAG report and I reproduce the table here.

I am still lost as to how the CAG arrives at a value of €50,391,460 based on a CMV of the loan collateral of €62,000,000 and future rental income of €3.7-5.7m per annum. Plainly the figure arrived at is less than the CMV of the loan collateral which is partly why I’m confused.

So there you have it. I must declare that I have valued property before so what the CAG presents should not be alien to me, but I must also admit that the calculation of State aid (and in particular the CMV of the loan) is puzzling to me. I expect to return to this entry in future with clarifications.

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So says one of the NAMA US and GB valuation panel members, Cushman and Wakefield’s, periodic economic reports published yesterday (free registration required to access the report). Together with Oxford Economics, the C&W estimate is that the State’s economic growth in the 2009-2012 period will be twice that of Dublin (Figure 6, page 7). For those involved in spatial analysis of the State’s future needs, this will be of interest. In terms of housing demand, it may give support to those who argue that demand in non-Dublin areas will be greater than in the capital.

The report itself has lots of interesting data and it sets an overall context into which C&W’s predictions for commercial real estate sit. In brief for western Europe, C&W are expecting Grade A commercial property to recover soonest  (“pricing is now about as good as it will get”) whilst there may be further falls in prospect for secondary property. This supports the key conclusion in a report by property company rival and fellow NAMA valuer, CB Richard Ellis last week.

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So says Frank Conway, director of the Irish Mortgage Corporation in today’s Examiner when talking about the cost of funding “some substantially reduced properties being launched onto the market” in recent weeks. Elsewhere in the article research undertaken by Myhome.ie shows that two thirds of first time buyers intend buying in the next 12 months – that’s the same proportion as intended buying in the next 12 months last September 2009. A consequence of the tumble in property prices is that banks are phasing out 40-year mortgages. Hopefully the latest Permanent TSB/ESRI house price index due out shortly will throw some more light on settled prices.

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