Here’s a couple of issues relating to the property loanbooks of the banks that will have some bearing on interpreting the average discount paid by NAMA, but which I don’t have good handle on yet.
First, when the banks report their loan profiles, they divide property loans into commercial and residential development and commercial and residential investment. Page 181 of AIB’s 2008 annual report explains that
Loans for property investment comprises of loans for investment in commercial, retail office and residential property (the majority of these loans are underpinned by cash flows from lessees as well as the investment property collateral).
Whereas development loans presumably don’t involve the purchase of buildings generating cash flow. But what about the following scenario? A businessman purchases a site of land in, let’s just say Dublin 4 for illustrative purposes, and the land already contains, let’s again say a hotel for illustration. Now suppose the businessman is still running the hotel and getting some income from it. However, his ultimate ambition, now temporarily thwarted, is to knock down the hotel and build a replica of the Taj Mahal.
By a narrow interpretation of the definitions above, this purely illustrative businessman has taken out a commercial investment loan. But because the prospective Taj Mahal development project promised to be so profitable, he’s actually paid far more than the hotel is worth. (Let’s just say he had more of a long-term economic value price in mind.)
This question matters because most of the analysis has focused on the loans categorised as “development” as being the main source of problems but if loans of this type are being counted as investment rather than development, then much of this stuff could also be pretty bad. And, to give an example, AIB reports having €7.9 billion in commercial development loans and €19.9 billion in commercial investment loans.
Do people have an idea how loans of this type are classified and how significant projects of this type are? More generally, how are true commercial property investments performing?
Second, Constantin Gurdgiev has been raising the issue of rolled-up interest on developer loans. It seems pretty clear now that delinquent developers will never pay back any of this interest. But if this rolled up interest is still being added on to the book value of the loans, then this will have to be kept in mind when interpreting the haircuts being applied by NAMA. Applying a 25% haircut to a loan for which 15% of the book value is rolled up interest is effectively applying a discount of only 10% to the original underlying loan.
So, again, do people have an idea about how large an issue this is? How much of the famous €90 billion or so of loans that we’re buying is likely to be accounted for by rolled-up interest?
Also, this is something to watch out for in the supposedly upcoming “detailed NAMA valuation methodology”. Will this methodology separate out rolled up interest and will it apply the correct discount of zero to this portion of the loans?