There’s quite a lot of confusion out there relating to the role a bank levy will play in the Nama process.
Some people have been surprised that the legislation made no reference to a levy. However, it has been public knowledge at least since the appearance in May of Interim NAMA CEO Brendan McDonagh at the Public Finances Committee that a levy would not be in the legislation. He told the committee:
If there was a clawback within the NAMA legislation affecting the balance sheets of the banks, they would not be able to reduce the assets transferred to NAMA because effectively there would be an unpriced option in terms of what the clawback would be in the future. One cannot do this because it would not be possible to take risk weighted assets off the balance sheets of the banks if the levy was imposed in the NAMA legislation.
To translate this into English, let’s give an example. Suppose a bank has a loan with a book value of €100 million. Now NAMA buys it for €60 million. Suppose it turns out to be worth €40 million and the government decides to levy the €20 million loss on the bank that sold it. In this case, the bank may as well have held onto the loan—and the accountants will have to reflect this in the bank’s balance sheet. But the point of the exercise, at least in theory, is to get the loans off the banks, re-capitalise and then draw a line under the whole episode.
The only mention of the levy in any public document released since the NAMA draft legislation appeared is in the NAMA Q&A which tells us only that
In the event that NAMA makes a loss, the Government intends that a levy will be applied to recoup the shortfall.
The questions left unanswered by this are considerable. For starters, on what basis will it be decided to assess whether “NAMA made a loss”? From a taxpayer point of view, the interest on the NAMA bonds should be included in the accounting for the total cost of NAMA.
Here’s an example. Suppose NAMA buys €90 billion in book-value assets for a price of €70 billion, a discount of 22%. Suppose now that the average floating interest rate on the NAMA bonds over the next ten years is 3%. Then the total cost before disposal of assests will have been €91 billion (the original €70 plus the interest cost over ten years.) Will we receive an assurance from government that the levy will be factored on a basis that includes the interest cost or, if this example panned out and NAMA finally retrieved €70 billion for the assets, will we be told that NAMA has broken even?
My suspicion is that no guidelines at all will be given over the next month on how the levy could operate and that the reasons will be more or less as outlined by Mr. McDonagh. Not only would a bank-specific levy that explicitly tied a charge to the losses on an individual bank’s specific loans have to be taken into account by accountants and investors, we can also be pretty sure that if the terms were spelled out clearly enough to ensure that it had to happen, an industry levy would also have to be factored in to the valuations of AIB and BOI.
My suspicion is that a levy may never happen. Future bank CEOs will argue that a levy would destroy the Irish financial sector and, sure, the sins of the fathers shouldn’t be visited on the sons, and so on. (Others will argue that the costs will just be passed on to consumers.) This lobbying would quite possibly be successful. Or else there will be a sort of notional levy implemented to placate the public that something was done. For instance, if NAMA losses (however calculated) are €20 billion over the next few years, then a levy could be introduced in 10 years time that pays €1 billion a year for 20 years, recovering a small fraction of the current net present value of the losses incurred. (See the example at the bottom of this post.)
The supposed benefit of the levy is the idea of sharing the risks with the banks. However, as Patrick Honohan has proposed, there are far better ways to do that. Patrick’s proposal introduces risk-sharing with the shareholders, while freeing the banks once and for all from the bad loans with no future levy hanging over them. But, of course, this up-front risk-sharing precludes the possibility of escaping altogether from risk-sharing at a later date or rigging the risk-sharing so it doesn’t involve sharing too much of the actual losses.
So, as I noted the day after Bacon’s NAMA proposals were released, the idea of relying on a post-dated levy to protect the taxpayer is a pretty terrible one. Still, it is disappointing to see international commentators such as the FT criticise the NAMA proposal solely on the grounds that the levy is unfair to the banks. I guess the interests of the Irish taxpayer are not high up the FT’s list of priorities nor would a full exploration of the underlying reality of the proposal be worth their while. For instance, if they investigated this issue, the FT might wonder why the Irish banks are so keen on the NAMA plan.