The Morning After

The Minister for Finance appeared on Morning Ireland today.  A strict interpretation of his comments would suggest that NAMA is going to apply a very large haircut.

For example, he started his interview with the following comments:

We start with the market value and that’s clear in the legislation. The market value is fundamental and, as I pointed out yesterday, there are some assets which will not go beyond the market value. For example, demographic factors and population trends may mean that some of the land which was acquired for development will never have any additional value and therefore must be pegged at current market value. However, some of the land is at present not sellable in what is a very illiquid market, and some allowance can be made, and it’s a limited allowance, but some allowance can be made for that in the determination of what’s a fair price. But we start with the market principle.  I think that’s fundamental in this valuation procedure. Some allowance can be made for longer-term economic value but it can’t be used …  to benefit shareholders of banks. It has to be on the basis of the fundamental fairness of the price.

One can quibble a bit with parts of this statement—for instance, any deal in which the taxpayer offers to pay more for a bank’s assets than anyone else will is, by definition, a deal that will benefit the shareholders of the bank relative to the scenario in which the government doesn’t set up a NAMA. However, in general, the sentiments are more hawkish about the discount to be applied than one might have expected.

But, of course, it’s not so simple.  Given what we know about house prices, about prices for development land, about the financial situation of property development groups such as Zoe and, most importantly, about the equity capital positions of the banks, a tough valuation process would point to the banks being insolvent and thus being nationalised.  However, it is clear that the government does not intend this as an outcome—for instance, in the Q&A notes given out to the press yesterday, one of the first questions answered was an explanation of why the government does not want to nationalise any banks.

And if the Minister’s comments were being taken seriously as an indication of a large discount to be applied, then why are the bank share prices up this morning? As of 10.30, AIB was up 7% and BOI up 9%.  This suggests that equity investors haven’t interpreted the Minister’s comments as being so tough.

One other thought comes to mind on this. While I have been focusing on the long-term economic value element of the valuation process, the Minister’s comments that there will be limited room for such adjustments may push back the focus to the figures being put on market value. We know that the government has appointed the good people of Jones Lang Lasalle to advise it on property values.  If these people are anywhere near as optimistic as previous government advisers such as PWC, then perhaps there won’t be much need to engage in so much long-term value chicanery to arrive at a high price.  Conspiracy theorising perhaps but one to watch out for.

42 thoughts on “The Morning After”

  1. @Karl

    “We know that the government has appointed the good people of Jones Lang Lasalle to advise etc. “.

    I still find it incredible that a bank (HSBC) and an estate agent (Jones Lang Lasalle) are the appointed ones. I still maintain that these people all play golf together…. but then I do subscribe to conspiracy theories where it comes to people desperate to hold on to power and/or wealth.

  2. Roll on the Tribunal for the investigation of the practises of Nama.
    Now might be the best time for negogiation of prices with the legal professions.

  3. @ Joseph

    HSBC are hoovering up the best of the Irish bank’s client base. They ain’t friends of AIB/BOI.

  4. Its a bit like the Mad Hatters Tea Party. With Lenny as the host.

    He doesn’t speak in riddles when saying the rules of the game….The NAMA chairman must not embarrass the Hatter…. Nobody in NAMA can ever be sued….It is worth what I say it is worth.
    The rest of the time Lenny riddles away. Every time someone asks a question, another riddle.

    In NAMAland words mean whatever you want them to mean…

  5. I am wondering how Nama will affect future planning. As stated above, Nama will take over land which will probably never be developed. Some of this land should probably never have been given planning permission in the first place. So if you have counties and towns who want to start planning in a more sustainable way, is there not a risk any new regulation and planning done by the councils will negatively affect the landbanks which the government now owns. Could there be a conflict of interest in this case, as the state/Nama is best served by these sites being developed, but when maybe the best option is to review all planning, and get necessery development built now in a more sensible place and structure, but then ofoucrse undermining the value left in the original development land

  6. If we won’t use experts from relevant industries then who should we use? Street sweepers? They might be independent but it won’t make for good business for anybody! The people appointed are capable, the will to do the job right is there.

    Regarding haircuts, marking to market is appropriate in areas where there is likely no development future, but doing the same in the middle of city would be pointless, some model has to be applied and the haircuts dished out accordingly, the implication that this is automatically bad for the tax payer is on the premise that the alternative would be better and it wouldn’t, zombie banks, or nationalised banks (Anglo being our only example so far) would not cure the situation, in fact, NAMA or something like it really has to happen and happen fast.

  7. @Karl
    “If we won’t use experts from relevant industries then who should we use? Street sweepers?”

    I would hope they are involving high profile people outside banking and property. There are plenty of business people who understand how to value assets and indeed even include a few theorists. Their presence would at least serve as a counterbalance/alternative view.

    I agree with you though this needs to happen fast – the middle of next year does not sound great if the effect is to leave the Irish economy devoid of credit for a further 12 months

  8. @Karl Deeter

    Heard your interview on Newstalk earlier. Interesting stuff and very well done, but you must have got a feeling for the anger and resentment that so many people feel against the banks and developers, not to mention the government, and their outrage that the ‘ordinary taxpayer’ has to carry the can, as always.

    Ruairi Quinn was also on Morning Ireland today and – perhaps he didn’t mean to and will in due course be forced to recant – suggested it was time to move on and deal with NAMA as the option that will be followed rather than the one, nationalisation, which his party would have preferred. From various interviews with Government Ministers, it appears that we’re involved in a public consultation of sorts on how NAMA will operate and that suggestions for improvements to the framework will be welcomed – and not just from the opposition parties either. That being the case, it would be interesting to know what specific improvements the economists blogging here would suggest?

  9. By the way I see Carroll’s attempts to have an examiner appointed to 6 companies has failed. Presumably ACC are now gooing to proceed with receivership.

    Are we going to see a two speed approach going on or will the government try and get the Dutch and others onside?

  10. Failure of Liam Carroll to get protection is huge.

    He doesn’t think that there is any point in Carroll “pouring money” continuing to finish his developments into a “grossly oversupplied” market for office space.

    Surely the same logic applies to every other developer of office and retail space.

  11. @Veronica

    Do I take it that the various suggestions that have emerged here for a pricing process not based on vague aspirations or for keeping the banks that made these loans from managing them again or for planning to deal with potential outcomes such as insolvency don’t count for you as “specific suggestions”?

    Perhaps you meant “incremental suggestions”?

  12. @Maurice O’Leary

    interesting the one arm of Government regards pouring in money to property development in this market as folly.

  13. @Karl,

    At the Greens talk on NAMA which you were at Eamon Ryan mentioned (for not the first time that I’ve heard publicly) that the government will not shy from increasing its equity shareholding to whatever necessary. So while you’re right it saying the government do not intend nationalisation as an outcome, I don’t think its so clear they’ve ruled it out when push comes to shove.

  14. @barratree.

    As Eamonn Dunphy would say “RYan is a spoofer. He does not have the pace to beat a top class international defence.

    What Ryan says is unimportant. It is the delphic utterances of Lenny the Lion that we must listen to

  15. @Maurice O’Leary

    Mr. Justice Kelly is correct in being sceptical.

    Who will fund these half completed projects and new ones to begin projects on expensive sites?

    Accountants were good at producing statements of affairs to support loan applications during the boom.

    The judge correctly didn’t buy blue-sky scenarios when the market is “as flat as a pancake.”

    It just illustrates that the official attitude of expecting a new dawn around every corner, could be the road to ruin.

  16. Karl,

    What I’m asking is how these suggestions might be applied to Sections 1-187 of the proposed Bill as amendments to the current text, and any new additions particuarly in the areas of transparency, oversight and valuation.

  17. Where is the bank LEVY gone. A word search on the document came up with “no match”. Mr. Lenihan, was at grave pains, to placate us in his mini budget assuring us that the banks would not walk away from the mess they created. They would be hit with nothing less than a levy if things went wrong for the taxpayer! Anyone who questioned NAMA was pointed towards the “Levy” but now it seems the “levy” has done a disappearing act!

    There is a LEVY alright and it is on the tax payer backs. I would love to gamble with other peoples money too! What about GA gamblers anonymous has he tried that! He is so optimistic that he must have attended a Tony Quinn indoctrination seminar!

  18. Karl D
    Given the losses now being exposed via Zoe (400m only to repay 1.1b) and others, whats your take on my suggested 50% as max credible value to pay for the loans..

  19. @RobertBrown
    The levy is not there because it would defeat the true intent of the Bill -rescue
    banks and developers.
    @Brian Lucey
    50% may be too little given the evidence emerging- Zoe and other reported cases.

  20. Important to note that Zoe have been given until tuesday to appeal to the supreme court. Will that buy Carroll enough time for nama to save him?

  21. Karl/Brian,
    I think it is time that the term ‘hair-cut’ is dropped from discussion as it is misleading and falsely gives the impressision of discount uniformity. The pricing methodology will clearly follow an individualised pricing scheme. The scant details on the valuation methodology to be adopted are sufficient to indicate that payments will be a complex function of the numerous property attributes.

    If the NAMA are smart they will seek to adopt existing Machine Learning approaches in order to develop a scalable pricing mechanism, given the limited valuation resources. My view that a prediction market would enhance the accuracy, speed and transparency of this methodology is certainly reinforced by the draft legislation recently published.
    A paper to be presented in UCD at AICS’09 in late August outlines this suggested approach. See http://www.4c.ucc.ie/~aholland/goto.php?w=publications/holland09predMkt.pdf for more details.

    Alan

  22. I hope no white knight buys ACC… if a deal is done……hopefully ACC manage to offload their property debt and stay outside NAMA….

    (if NAMA overpay for debt it would probably pay the most exposed Irish banks to simply buy all ACC’s debt, they will lose more if ACC torpedo NAMA by forcing liquidations….yet another example of blowback)

    Then ACC wont need to make the same margins as everyone else just to survive…..a strong competitive advantage over the incumbents, a lower cost base and lower legacy costs. And hopefully a parent bank that has learned to keep them on a tight leash.

    Offer a decent online service like Rabo, plus support for direct debits, ATM cards and they are in a pole position to become the Irish good bank.

    That would be the best case scenario for the Irish consumer. Who cares if there are a load of zombie banks provided there isn’t a cartel of them.

  23. @Alan

    I think it is clear to anyone following this debate anyway closely that when people talk about “the haircut” being applied to the assets purchased, that they mean the average haircut applied.

    I would note also that people may think the valuation process is going to be a complex one involving painstaking assessment of each individual loan but I can assure you that all involved will be keeping an eye on the top line here—what’s the average haircut involved and how much new capital will the banks need after this is applied.

  24. Alans point does have some merit…. maybe not on doing the valuations, machine learning requires a lot of records with the answers already worked out before the machine can have a go……A training data set…Of course, if were spending tens of billions, why not?

    It could also be very useful on identifying outliers on valuations that have been agreed or ideally even those proposed…

    Outliers, i.e. valuations that are too low or too high to be explained by the myriad factors that professionals use to make their decisions….

    While professional valuers may claim their methodology is complex, there is unlikely to be more than a few hundred variables that make the decision, Im sure the actual number is lower. and I suspect much much lower in a lot of cases 🙂

    I have used some of these tools in the past, they are capable of handling thousands of variables. I would be more than happy to contribuite whatever expertise I have in this area for free to NAMA if it helps ensure a consistent valuation process.

  25. Looked at Alans site, his prediction market relys on inputs from people trying to match the predicted price… People are incentivised to get it right…

    Again, assuming the developers or banks identity could be hidden while showing sufficent details of the asset, this could help identify suprising values.

    +1 to all efforts to validate the valuations.

  26. Karl,
    The majority of people do not follow this debate closely. I am aware that some commentators intend hair-cut to mean an average reduction, but it is also clear that many politicians and journalists have taken it to mean uniformity of price reduction across classes of assets. The use of the term by economists has therefore caused confusion.

    I believe the confusion is further added to by comments that seem to indicate that the NAMA are seeking to establish a cumulative average discount in advance of transactions. For example, you previously claimed that a prediction market would have little value and that “A 15% discount relative to book value seems to be a popular prediction with stockbroking economists and their explanations for these predictions have little to do with asset valuation.” (see http://www.irisheconomy.ie/index.php/2009/05/26/a-prediction-market-for-irish-toxic-assets/). Clearly, a valuation methodology that focuses on individual assets (as made clear in the draft legislation) will not be targeting an average cumulative reduction. This will only be known at the end of the acquisition process. The problem is to establish accurate individualised asset values and not the cumulative discount percentage. Subsequent capital requirements will be met via other means.
    Moreover, even if you do subscribe to the conspiracy theory that the government will overpay to meet capital requirements, given that multiple banks are involved your argument that the objective will be to meet a cumulative discount percentage still doesn’t make sense.

    Garry,
    It shouldn’t be necessary to hide the identity of the bank or developer for these assets. All information pertaining to assets being acquired on our behalf should be published in full. If this is done, then it is easy to initiate a prediction market and if a benefactor wishes to sponsor the contest, this may provide the necessary liquidity to establish more accurate predictions on what will be paid. The main research challenge is to determine the precise convex combination of prediction market and internal estimate to
    apply for the workload minimisation/convergence rate trade-off.
    But NAMA should utilise Machine Learning for their own internal valuation estimates in any case. As they proceed through the innumerable properties, they should be building up a database with which to calibrate decision trees and/or neural networks that can be used to accelerate the valuation process for subsequent properties.

    Alan

  27. @Alan

    “Clearly, a valuation methodology that focuses on individual assets (as made clear in the draft legislation) will not be targeting an average cumulative reduction. This will only be known at the end of the acquisition process.”

    I’m afraid Alan I do not think this is nearly as clear as you believe. The process will involve HSBC and Jones Lang Lasalle, paid consultants who have a good idea of the (pretty narrow) range of outcomes the government wants.

    Do you really believe this process will involve hundreds of totally un-coordinated assessments, which will finally arrive on the Minister’s desk and then, and only then, he finds out what the average discount is when he adds them up? Perhaps you do. I don’t. I’m not sure how much the HSBC people really know about Irish property, but I reckon they’ve mastered addition.

    My attitude to the prediction market idea is the same as before—you’d be better off to run a market on what people believe the final discount will be that the loans will end up fetching relative to original book value. This will be a concrete number, published in the final NAMA reports, and may give us an insight into what the assests are really worth. The NAMA pricing process is about something else.

  28. @Alan holland
    Wait a few years, youll be as cynical as KW and I.
    What you say makes sense….in theory. In practice, unless we derail it, the fix is in

  29. @Veronica: I can both see and understand the resentment and anger by the public, I’m not removed from being a taxpayer myself! 😉

    Having said that, I always took what I feel is a pragmatic view of the situation on this site and equally I have always stated that the the Govt. will probably overpay (http://www.irisheconomy.ie/index.php/2009/04/23/ahearne-on-nationalisation/ ) [even managed to get what I almost construe as a compliment from Karl W for being so frank about it]

    As for carrying the can, it isn’t confined to NAMA, the way the state handled almost every area of fiscal policy has been found wanting, the lack of counter-cyclical planning is equally a joke, crashes are nearly always accompanied by the collapes in tax receipts we are seeing now so to harken back to McCreevy saying things like ‘I spend when i have it when i don’t, i don’t’ is totally depressing. People are starting to forget our deficit and focus only on NAMA, that is an error in my opinion as Joe Taxpayer is covering much more than just development loans.

    having said that, i think it would be best to get something running and fine tune it en route rather than continue with the stagnation in both markets and politics that we have seen to this point, if nothing else there is the hope of progress now.

    @brian lucey: Your research? I thought you had gotten those figures from Morgan Kelly? That’s what you said on this thread: http://www.irisheconomy.ie/index.php/2009/05/26/mcdonagh-and-bacon-at-dail-finance-commitee/

    And then of course there is the issue of marking to market in the current time v.s. marking to model which NAMA will use, it’s apples and oranges. If I wound an individual up tomorrow who had a mortgage they would be in a similar situation, hence the need to cure the problem over time and not go on ‘liquidation today’ prices.

    The difference is subtle: you stated on bloomberg that loans should be marked down by 50%, but this isn’t the repo-market we don’t have to prove ourselves in 24hrs, removing timelines from time factored lending can create that kind of figure but it is largely manufactured in the face of NAMA because that will remove the very problem you are talking about.

    Obviously you also can’t use a single developer as a gauge of the entire market, and prices will be determined accordingly so I still don’t buy into a mass 50% writedown. Nor was every LTV on original loans as high as Zoe was getting – they were seen as a ‘sure thing’ so lots of their book is likely at higher LTV’s reflecting the trust banks had in LC, many others would have been much less and depending on when the lending took place then even with massive market drops it will be a different situation.

    There is a fundamental value in these portfolios and to seek market value at the bottom is as ridiculous as those who championed market values at the top, its just the flipside of the same deluded coin.

  30. Karl/Brian,
    “paid consultants who have a good idea of the (pretty narrow) range of outcomes the government wants.”
    I happen to believe that the government wants NAMA to break even or make a small profit, hence my belief that all efforts at improving accuracy should be examined. I see little benefit for them attempting to achieve otherwise. The future careers of all politicians in this government hinge on NAMA meeting this objective. Over the next ten years, the newspapers will be filled with final sales prices for these properties and every article will quote the original price paid by NAMA for the loans. I’m sure the Taoiseach and Minister for Finance are keenly aware of this. So this is why I don’t agree with your cynicism over their motives to overpay.

    If future capital injections are required it will be done via other means. The government will suffer less political damage if this is a state-sponsored support rather than NAMA overpaying. However, with the banks presenting a lower risk profile to investors, it is more likely that foreign capital will fill this gap.
    Alan

  31. Alan,

    Indeed, I’m sure the Taoiseach and MoF are aware of the desirability of NAMA breaking even. However, I can assure you that they are also trying to juggle other goals, one of which is minimising state ownership of the banks. You can either agree or disagree with that as a goal but to ignore that it is a goal, and will affect the pricing, is naive.

  32. Alan – its as KW said , there are mutually incompatible goals here. It depends on who shouts loudest/puts more pressure on politicians what they do. Right now, do you really think the longterm possibility of electoral decimation (over and above what will happen anyhow) on foot of something most voters havent a clue about is more important than the short term imperative of making sure that the incessant hard and soft pressure from “interests” cease forthwith.

    I think we need some politicos to come on here anon and tell us…

  33. @Garry
    I get the impression most foreign owned banks want/have to get out of Ireland. They’re packing their bags, licking their wounds and running for the hills. I’m sure they would be very happy if they were “bought” off so they don’t upset the Irish solution to an Irish problem

    Won’t be good news when the dust settles as there will be less banks to lend/compete.

  34. Fair enough Alan, though indeed, as I wrote before, I would still wonder.

    In any case, no insult was intended and I fully acknowledge that I might be wrong here and that your approach may turn out to be useful. I’d encourage you to keep at it on those grounds, though maybe you might give some thought at some point to a prediction market for the final value of the NAMA assets.

  35. With regard to the disappearing LEVY! Now you see it, now you don’t. Mr. Cowen is under a little bit of pressure and he has resurrected it once again! In saturdays IT he is quoted as saying, “In any event, if there is a shortfall, it would be met by a levy on the banking system.” Really? and why then in the proposed legislation is there NOT ONE mention of the word bank levy!
    They just make it up as they go along.

  36. @ Robert Browne

    They already have the legislation for the levy, they were using it while allowing the banks to not pay DIRT and to use the capital, mainly cash evaded from the Revenue, in the banks’ capital. They can pass new legislation at any time too. The state tends to pick up the tab for security when conveying cash also.

    Are you Robert Browne the famous society dentist?

  37. @ Robert Browne

    the levy cannot be brought in as a part of the NAMA legislation, i believe, as it would mean that there would still be a contingent liability resting on the bank’s balance sheet, so there would in fact be no “clean slate” from disposing of the loans at the NAMA-ascribed values. Expect the levy, if it does come into existence, to be a more broad based one, and not enacted until the banks are well and truly on a sound financial footing and finished any of their likely capital raisings.

  38. One of the aspects of the Nama proposal which worries me is the funding costs of the bonds which Nama / the Irish State will issue in payment for the ‘toxic’ loans. My understanding is that there is an assumption that some of the loans to be taken over by Nama would continue to generate interest at rates higher than the rates paid on the bonds and that ‘on average’ the interest paid on performing loans in Nama will cover the total interest payable on the bonds.

    In my opinion, that is a very optimistic assumption as it is hard to see how borrowers can continue to service loans when the underlying assets securing the loan are falling in value and are more than likely generating little or no income. As more ad more loans in Nama stop ‘performing’, there will be a net funding cost to Nama. As time passes, this net funding cost will accumulate and if Nama is to break even (in other words, if it is not going to be a burden on the ordinary taxpayer!), underlying property values will have to increase to even greater heights to cover the deferred funding cost!!!

    In my opinion, this is an aspect of the Nama proposal which has not really been explained and analysed. I would welcome comments.

    PS Anyone have any idea at what rate the bonds would be issued?

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