NAMA Purchases of Good Loans

On today’s RTE Radio News at One, David Murphy made a point about NAMA that I’ve heard many times recently but that I’m having great difficulty understanding.  Murphy explained that the government bonds issued to purchase loans for NAMA would imply a large interest bill and that the idea behind NAMA purchasing good property loans as well as bad was so that the good loans could help to pay the interest on the NAMA bonds.

Let me explain why I don’t understand this.

Let’s imagine a portfolio of property loans with a book value of €90 billion. If these loans perform, then they pay an interest rate of R%.  Then some of the loans start to under-perform: Let’s assume for illustration that €30 billion of the loans are just fine, while the other €60 billion have problems. 

Now let’s imagine NAMA buys all of these assets for €60 billion, with the €30 billion of good loans bought at original book value and the bad loans bought for half price. One can assume that the bad loans have been written down to a market value so that they can, ultimately, yield the same long-run return as the good loans. At the same time, one can also perhaps assume that, for some time, they probably will not deliver much in the way of income (unfinished or empty estates, hotels etc. are hard to get much income from.)

Now let’s suppose that the government buys these €60 billion in property assets (good and bad) by issuing debt at an interest rate of I%.  The current “cash flow” problem for the scheme is that the government is paying interest of .01*I*60 while it is receiving interest of only .01*R*30 (the interest on the good loans.)  

So indeed, only the good loans are helping to pay the interest burden.  However, is this a good reason to purchase good loans for NAMA?  If the government only purchased the bad loans, then it would only have to pay out €30 billion and at that point it would have an interest bill of .01*I*30 but not be receiving any income on its properties.

Is the government better off purchasing the bad loans? The difference in net flow income between the two cases is .01*(R-I)*30.  In other words, issuing debt to purchase good loans increases the government’s revenues if the rate of interest on these loans is higher than the rate of interest on government debt. 

But if this is the argument for purchasing the good loans, then why stop at loans to property developers?  Why not purchase corporate bonds or equities or any other security with a higher risk-adjusted-return than Irish government debt?  Purchasing the good loans essentially amounts to the government deliberately running a huge property hedge fund and there is little good reason to want our government to be doing this.  (Of course, we have a track record here because the Pension Reserve fund was exactly a hedge fund of this sort—our officials decided that it was a good idea for Ireland Inc. to go long on equities and short on debt.)

Two other points on this.

First, the above discussion starts from the premise that covering the flow of interest payments on NAMA bonds is the key concern relating to NAMA. However, technically, the NAMA bonds don’t have to pay interest at all—they could be zero-coupon bonds that pay off at a long-time horizon.  Even if they are not, the bonds will be long-term in nature and they key issue will be that NAMA can cover the principal on these bonds when it needs to be paid back. The purchase price for the bad loans remains the key issue.

Second, it is my understanding that when AMCs have been used to solve banking crises, they have specialised in only taking on underperforming loans. The rationale for a different approach here has not been well articulated.  I suspect the rationale for transferring performing as well as non-performing loans may well be partially a bureaucratic one—the government may want NAMA to just take over the property lending departments of the participating banks in full, rather than engage in sifting through the portfolios in a careful manner—and I don’t think is a good argument.

A more disturbing rationale would be that many of the “good” assets are not so good at all but that there are vested interests who like to see parts of the portfolios transferred without a discount. Even if one dismisses such stuff as mere conspiracy theory, the optimistic results from the PWC stress tests may well stem from classing various loans as “performing” even though their long-term recovery prospects may not be so good.   

13 thoughts on “NAMA Purchases of Good Loans”

  1. @Karl: What vested interest (other than a bank) could possibly want performing loans transferred without a discount and why?

    The reason for transferring performing loans may be to prevent any perceived rescue of builders. If I am right then it is purely a political reason.

    The hoi polloi want to see the builders destroyed. The politicians are happy to help to save their own skins. If you need to liquidate a developer then you will be better placed if you own the charges over all related properties. Otherwise you may be into a quagmire where you want to chase assets that other banks have a charge over.

  2. You are absolutely right. What it reveals is the lack of independent thinking by most of our media. They ask “what’s the line?”, get it and then propogate it without asking themselves “does this make sense?”

    The facts that The Irish Times hasn’t replaced Paul Tansey (RIP) and that RTE plans to replace George Lee with an economics correspondent rather than an economics editor speaks volumes. That’s one major reason why this website is so valuable.

  3. Good article.

    Too many people think just because the government have “decided” on Nama then we should just get on with it.

    The basis for Nama seems to be highly political.
    not that we should be surprised as consultant reports are often used to give a veneer of independence to highly politicised decision.

    Dr. Bacon appears to have reported under two constraints.
    No overt nationalisation.
    No default on subordianted liabilities.

    Taxpayer risk was not a constraint.

  4. Generic European AAA CMBS spreads are in the region of 1,000bps.

    If you’re willing to take commercial mortgage risk, this is a much better option. You’re diversifying risk across countries, there is subordinate risk and you’re getting a much higher coupon.

  5. Karl
    See the Sunday Times article by myself and Constantin G. There is NO WAY that the good assets can pay for the bad….feel free to ask for the spreadsheets.

  6. I thought the idea of taking both good and bad was

    a) So much shysterism has gone into this via creative accounting its hard to seperate what is genuinely good and genuinely bad
    b) If a developer keeps his “good” loans with the bank and leaves the rubbish with NAMA, how are we going to force the guy to pay anything bank to NAMA? The definition of not performing is it wont pay back….

    Obviously, he will try to keep the bank sweet focus on the good stuff to make some profit, whilst walking away from the bad stuff…..

    The creation of NAMA who owns all the bad stuff without visibility into any of the good stuff puts NAMA at an even bigger serious disadvantage when dealing with an individual developer.

    No, if youre a developer and you have some good stuff and some bad stuff, lump it all together with one entity, ban that developer from any dealings with any other institution and bring out the rubber gloves….

  7. Will it not be the case that the PV of the bonds (depending on coupon and whatever term structure exists at the time) will match the forecast PV of the transferred loans and that this will balance each other out. i.e. give a zero coupon bond matching the PV of the loan or a bond with fixed coupon matching the PV of the loan? Thus the issue is how much working capital is required to get NAMA up and running? The sooner the business plan for the agency is finalised and the funding requirement established the better.

    As clearly established by all the key will be the valuation of the assets with there having to be an exit plan from the beginning vis a vis asset disposal in order to fix the value of what is transferred – some plans regarding a target market for disposal of assets and sequencing strategy must be developed now. Part of this exit plan could be quick disposal of some of the assets to generate the seed working capital for the agency (or provision of some funds by government during its establishment)? These initial disposals could of necessity be at the lower end of the valuation range and this fact built into the overall loan markdown.

    Looking at NAMA as a project the NPV of NAMA should be zero – the value of bonds issued to the banks should reflect this aspirational position and take into account all the projected costs (including that of working capital, coupon payments, salary, fees etc.) and repayment/asset disposal cashflows in determining this value.

    Removing all performing and non-performing loans can imply a wish to have a cut it all away and “what is left is ok” approach or alternatively bringing all loans with associated guarantees etc. into the same pot is driven by need to give as much more visibility as to overall status of each borrowers portfolio and facilitate working out on a borrower by borrower basis rather than a project by project basis?

  8. I think for the time being the word good in conjunction with loans should have surrounding quote marks. Taxpayers should assume for the present “good” loans just haven’t gone bad – yet. However, saying you’re buying in “good” loans at first is politically more saleable than having to do a NAMA Tranche 2.

  9. Surely the repayments on the good loans will service them? Where does the Murphy stream of income come from to pay for anything else unless its being suggested the discount paid is so hefty that asset sales can be converted into net positive cash flows.

  10. No matter how much lipstick is carefully applied to the lips of a pig, it is still a pig.
    By introducing NaMa, we talk about NaMa. A master stroke. No analysis of what happened or why: a solution is presented.

    A black box. Just don’t open the box…… But we will in a few years time. Like torturing children, the longer the events are in the past the less anger there will be. Justice delayed is justice denied.
    Remember Iceland!

  11. Isn’t the proposed ‘NAMA method’ a repeat of the sub-prime? i.e anough loans overall, the good will pay off the bad? Thank you Karl, on listening to Murphy (the mouthpiece of the gov/ntma press office) my reaction was exactly the same as yours. Your professional analysis is perfect.

  12. Hello
    I think this blog is great, timely and has a refreshing independence – but alas I am a lay person; I follow most arguments, but I get lost with some of the short hand: any chance of a link to a glossary, explaining some of the terms like zero coupon, PV, etc.

    Tom

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