Honohan on the NAMA valuation task

all the commentary surrounding Nama says things like “Nama will own sites, land…” etc. Don’t want to be technical and acknowledging I have not read the legislation, but will Nama not be buying the loans rather than the sites? If that is the case does it have to utilise Receivership legislation to recoup its loans? And if that is the case is it allowed to buy the underlying asset from the receiver for its own account? Otherwise, if it does not want to crystallise proceeds in the short term, it sits on loans with the assets still legally residing in the special purpose companies owned by the developers……

A nice idea. A simpler approach of course would be to say “sorry, the company you purchased shares in is bankrupt”. That would share the pain in a much more sensible manner, absorb billions of losses that the taxpayer would otherwise bear the cost of, and mark a clean break. Whats with the obsessive desire in this country to protect investors from their own mistakes?

Can AIB really be classed now as a ‘going concern’?

Given that the government is corrupt, then it is likely to alter the apparent regime when it comes to the passing of the legislation. It may have reaped the benefit of the optimism on the part of banks and bank bondholders by then. Milked it for what it might be worth. And then, knowing that the riding instructions to NaMa management on valuation is crucial, may accidently, as happened earlier with regard to IMF involvement, it may surprise these people with predictable effects on the bondholders and the share price.

Need I point out the opportunities for making a killling if party to this plan? The values rise, they fall and then who knows?

We preach to “third world” coutries about the need to readicate corruption. Yet we seem to think there is no cost to business and consumers in Ireland due to the corruption here. Banana republic? We are now an internationally significant banking centre. Like Switzerland, we also have a strong but mobile pharmaceutical sector. We do not yet have an arms industry. But Switzerland is now landlocked by non-neutral countries: the EU. What games are we playing? Is 90Bn enough to get us played by the big boys? If risking say 30Bn, it would be wise to invest say 100Mn to ensure a good result. Any evidence of this degree of due diligence? How far out of our depth are we?

@ Brian Lucey

But what does the legislation say?

Could we have situations where NAMA pays 50 cents in the euro for a loan, the SPV limps on for a couple of years rolling up interest, NAMA sends in the receiver who sells it to the same developer’s SPVII for 25 cents even though the loan has rolled up to 120 cents?

If that is the case, NAMA will never have land banks but loans with land banks as collateral. May seem a semantic point but it will not be a property owning vehicle but rather a loan holding vehicle and that gives it far less control to strategically manage the recoveries it is trying to maximise.

“Fortunately, the risk to the taxpayer can be considerably reduced with a bit of ingenuity. It is worth tweaking the language of the Nama legislation to make sure that it can achieve this risk-reduction.”

Why is that so many of our economists still trust that those implementing Nama are working in the public interest?

What is the point in economists trying to give them ideas that will make things fairer for the tax payer?

Its fairly obvious that if they wanted to do this they would have done what Brian suggests above.

I guess its a good way of testing if they are just ideologicly opposed to nationalisation or are also just plain giving digouts to the bond holders at the expense of the general population.
Personally I think that ship has already sailed but I will be delighted to be proven wrong when the government implement Patricks idea.

Keeping the risk with the banks is of course good, but since the risk is with the banks already now without NAMA so what is the point of NAMA then?

Also, if the banks were to get more liquidity through NAMA, I believe they would use that liquidity for maximising profit for the shareholder. Easiest way of doing so would be to buy back their bonds at a discount from the market thus boosting profits. So in effect, any liquidity inserted into the banks will first generate profits for the shareholders and then when that has been done maybe some of the liquidity that is left will actually reach regular, smaller customers.

I can’t fault the banks if they are putting the interests of their shareholders before the interest of the Irish people, as their managment team are employed to do so. The Irish government on the other hand, should know that the Irish government should protect the interests of the Irish people.

Even if pricing was made right and somehow a way was found to keep risk with the bank, I do not see how NAMA can work. Nationalise is the only realistic option.

“With all the talk of Nama and how it will behave in the future, it is easy to forget that it is to the banks that the economy will mainly be looking to finance the recovery.”
Banks financing the recovery? I wonder.

Time will tell, but I suspect banks will be very risk averse for quite some time. Eventually I expect the state will have to take direct action in saving the economy and eventually promote a hard bought recovery. The banks debt problems and private debt burden will be a serious and ongoing drag on stabilising the economy. Economic recovery is further down the road.

@Jesper
“I can’t fault the banks if they are putting the interests of their shareholders before the interest of the Irish people, as their managment team are employed to do so. The Irish government on the other hand, should know that the Irish government should protect the interests of the Irish people.”

Couldn’t agree more – the need for value growth combined with the structure of employee bonuses was a root cause of the entire problem in my opinion. The activities of the banks were misalligned with the national interest and what ever solution we apply now should at least make some attempt to re-align them – not sure that NAMA does much to acheive this.

@Brian
I agree we should penalise the existing shareholders who have assumed the risk when purchasing the assets. I still think a good method would be to nationalise and immediately denationalise a portion by issuing a portion of shares to general public for free. This should serve to realign the banks interests with the general publics. In the absence of a scheme like this or nationalisation, is there another method to do so? Given that the bank must be recapitalised and that shareholders will have ownership of the recapitalised bank I don’t see an obvious alternative method.

@Tony
Its not about penalising shareholders – im a shareholder. Its about telling them that their investment is gone. Sorry about that, but thats capitalisim folks.
I do like the voucher idea – anybody with a a PPS number who has paid tax in the last three years, self employed to have a tax clearance cert, send them out….

@ Brian
By penalizing I meant that they should suffer the consequences of their poor decision – i.e. to lose their investment if it is now truly worthless – not as a punishment [I don’t think they are the only people culpable for the mess – indeed I’m sure many smaller investors assumed the banks were scaling back housing loans etc. when it appears they weren’t but thats a separate issue]

I have said before that Patrick’s pricing proposal has a lot of merit, e.g. in my presentation to the Greens — http://www.karlwhelan.com/IrishEconomy/gp-presentation.pdf.

Four points.

First, I think the rhetorical element of op-ed pieces are as important now as the substantive proposals and on this, so I must quibble with the opening sentence:

“EVERYONE IS agreed on one aspect of Nama – the need to get the valuations right so that it does not overpay for the assets it acquires from the participating banks.”

The legislation defines a market prices as one that would occur in an exchange “between a willing buyer and a willing seller in an arm’s length transaction where both parties acted knowledgeably, prudently and without compulsion.” It then points out that we are going to pay at least that much, and it seems pretty clear that in most cases we will pay a lot more.

In this basic sense, everybody does not agree about not avoiding overpaying. In fact, the framers of the legislation are explicit that a form of overpayment is the point of the process.

Second, I’m not sure that the difference between “confidently be expected to be attainable” and “reasonably be expected” is quite a sharp enough dividing line. I would prefer to phrase this plan as “the government should pay the market price” as defined in the legislation in bonds and the rest in equity in NAMA.

Third, a problem with arguing that there needs to risk sharing is it can quickly run afoul of the government’s claim that losses will be recouped from a levy. Though, of course, there is no levy in the legislation and there may never be levy no matter what happens.

Fourth, Patrick doesn’t state this, but it should be understood that any pricing scheme along the lines suggested in this article is highly likely to result in nationalisation of at least AIB. That said, as I noted in my comment on Brendan Keenan’s article, the government should already be looking to involve private equity as soon as possible in the post-Nama ownership structure.

Assuming the govt. will put its head down and muddle through with some version of the Nama scheme, Prof. Honohan’s two part pricing proposal appears to be a step in right direction: reducing taxpayer over payment/extent of the contingent liability.
He proposes bonds plus some equity in NAMA SPVs. Fleshing this out, payment could equal bonds + call options on Nama subsidaries SPV equity. The options could be exercised at ‘maturity’.
There are other, far more complicated option structures, that could be used to get around the very thorny issue of tranching distressed asset cash flows. It is also fairly obvious that the cash flows on these asset pools will not behave the same ways as any ‘normal’ commercial real estate transaction. Therefore, as the govt. have hired HSBC, this is one area where the govt. should put their hired quants to work for the taxpayer.

More thinking might be needed on the incentives for sub debt or equity holders to participate voluntarily in this type of scheme. At the moment, they are gambling on resurrection, and hoping that their claims appreciate in value. However, unless some type of resolution mechanism is attached to the Nama legislation which can alter the rights of holders of securities in various parts of a bank’s capital structure, imposing unilateral or forced debt/equity swaps may not be a runner.

“Time will tell, but I suspect banks will be very risk averse for quite some time”

A little anecdotal evidence. One of the banks is basing its lending criteria on a firm’s ability to pay based on 2009 trading which of course is pretty dire hence the need for the loan. Forecasts showing improved trading in 2010 on are ignored. The sad fact is they may be right as repayment will be contingent on business improving which it might not.

We all want the banks to reintroduce good old fashioned lending criteria but that will mean most the businesses looking for a loan to tide them over the difficult trading period won’t get one as no one knows when the recovery will take place. Are we (i.e the government) going to make them lend to get the country going again which will mean ignoring proper lending criteria i.e the ability to repay the loan. If so NAMA mark II is not far away.

“Since the banks will be relatively free of problem assets when Nama has finished its acquisitions, it may be possible to attract new equity investors to make these injections. Vigorous efforts should be made to find such investors. If they are not immediately forthcoming, the Government will, on an interim basis, be the backstop investor”.

This appears to be at variance with the report in the Times today to the effect that 25% of all loans at AIB are impaired in one form or the other. Is the Professor being a tad optimistic. If these numbers reflect the situation at other banks then we are in deep water.

@Joseph – “Can AIB really be classed now as a ‘going concern’?”
On the basis of these numbers it would not appear that it could. Davys are forecasting AIB having a Tier 1 ratio of 2.9 post NAMA 20% haircut.
The EBS managing director states that international investors require a 7.5 Tier 1. I think HSBC have a Tier1 of 10+
If these forcasts are reasonably accurate the chances of raising equity capital are zilch and they will have to remain on the ECB life support system.
One aspect of the stance being adapted by AIB is odd, Sheehy has again reiterated that they will not dispose of the US and Polish shareholdings.
If their capital position is so dodgy (as forecast by Davys) why not bring home up to 2billion.
Perhaps they see the taxpayer as a soft option.

The goverment really need to be asked why they are not going down this route. The only reason they wouldn’t is to protect shareholders and bondholders

AIB’s figures tell another story. Look to the rising mortgage and consumer loan impairments + declining loan book (demand) + declining net margin (funding costs) and fall off in customer deposits (savings burn rate and switching) = Nama mark 2. The first wave shock is being accounted for albeit with an eye to Nama: the second wave shock is now appearing. SME volume approvals are unconvincing – overdraft faclities are renewed annualy – aib’s figures appear to include renewals of existing loan limits etc. Factor in the decline in private sector credit and all that’s now needed is for BOI to produce its figures…(BOSI is writing down €1bn of a €28bn book).

17 replies on “Honohan on the NAMA valuation task”