As I write this, the government is continuing to mull over its NAMA proposal. The proposal has been around so long that it is easy to forget that we are actually still at an early stage with this process, with the legislation yet to be published even in draft form and no vote due for a couple of months. For these reasons, it is still worth discussing why alternative approaches may be worth taking.
I’d like to set out one such approach. But before doing so, let me explain why I think things have moved on since the NAMA proposal was introduced.
Earlier this year, a number of analyst reports were released which suggested that the major Irish banks could be sitting on property-related losses that could wipe out their equity capital and render them insolvent. I think that from today’s perspective the evidence that the losses are likely to be on this scale (particularly for AIB) has strengthened considerably. I’d cite three pieces of evidence here:
- The continuing rapid fall in house prices.
- Anglo Irish Bank’s assessment of the losses it is facing on its development loan book based on its position that development land is already down 70 percent from peak.
- The evidence emerging from the High Court of the full extent of developer indebtedness, in particular the fact Liam Carroll’s Zoe Group are only in a position to pay back quarter of their debts.
NAMA is a plan for dealing with a banking system that has some bad debts but is not insolvent. I think events have now moved beyond that point. It may be embarrassing for the government to admit this, but I believe Mr. Keynes has provided the appropriate response to those who would wish to accuse them of a lack of consistency (“When the facts change ….”)
Here’s a suggestion for an alternative approach to NAMA.
- Introduce a Banking Resolution Act along the lines of the UK Special Resolution Regime. This would give the government wide-ranging powers to intervene to deal with banks that are insolvent or close to it.
- Where banks are deemed to be clearly insolvent without state help, nationalise them.
- Set up a mechanism for compensating shareholders of nationalised banks. One possibility would be to offer to pay the market value on the day after the introduction of a Resolution Act has been announced.
- Deal in a systematic manner with subordinated bondholders of nationalised banks.
- Those with stronger claims but with debt expiring outside the guarantee period can be offered a cents-on-the-dollar deal in return for the issuance of new guaranteed debt.
- Any remaining unguaranteed subordinated debt holders can be offered a debt-for-equity swap to become partial owners of this new bank. It has been known for some time that these are distressed instruments which are unlikely to deliver par value. I suspect that, by and large, they are no longer held by those who originally purchased them with the current owners more likely being experts in distressed assets. These guys may be more happy to play ball and take an equity stake than might be thought.
- Write down bad loans by a realistic amount and re-capitalise the banks. Whether the write-downs are done as part of a process of transferring loans to an Asset Management Company is less important than one might think based on the recent NAMA-centric debate. However, if an AMC approach is to be taken, the bad loans should be management by experts in property development, rather than sent back into the original lending banks. It may still be possible as part of shareholder compensation to set up a risk-sharing mechanism (along the lines of Patrick Honohan’s NAMA 2.0 suggestion) so that if losses on property assets turn out to be less than the original value of shareholder equity then the shareholders receive compensating payments in the future.
- Open negotiations with major international private equity firms. In exchange for advice on bank restructuring and decisions on senior management, the government could open negotiations with interested private equity firms regarding them quickly taking an ownership share in any nationalised banks. These negotiations could include the government offering to extend the guarantee to these banks for a number of years.
I believe that a systematic approach along these lines will cost the taxpayer far less than the current approach and also has far better potential to quickly resolve our banking problems than the NAMA plan, which is likely to get bogged down in controversies over asset valuation, legal disputes and endless suspicions of crony capitalism.