The NAMA Levy

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.

33 replies on “The NAMA Levy”

@ KW

The bank levy doesnt feature at all in domestic or international analyst forecasts for the Irish banks, together with their 20% “haircut” leaves them able to “value” equity in insolvent banks. The government thinking here may be to try and attract foreign investors to capital increases in the banks in the future but i doubt they will be so kind as to avoid the hard question on what exactly the levy will be.

And dont forget to mention the “administration charge” that NAMA may be prepared to pay the banks to administer some of the transferred loans in house. A further example of an ill thought out plan, totally lacking in necessary detail.

Brian Cowen is on the record, not more two weeks ago, telling us that there would be a levy! Is this a two headed serpent that we are dealing with?

@KW

In your example you use an interest rate of 3 per cent for the NAMA bonds and a total interest bill of 21bn. But only a few weeks ago you claimed that NAMA would pay 5 per cent on its bonds and have a bill of 30bn. Why have you changed your mind?

Your change-of-mind is very interesting because for the past few months Brian Lucey has been pushing his spreadsheet which supposedly shows that NAMA will make a 30bn loss. Thing is, Lucey assumes an interest rate of 6 per cent on NAMA bonds. That’s right, 6 per cent!!! Is it fair to say, KW, that Luceys analysis and all the overheated commentary which was based on it should now be put in the bin?

A possible levy that might be imposed by a government in 10 or 20 years time.

Will we even be an independent state in 10 or 20 years time?

Eoghan
Im not aware that I have been “pushing” anything?

As for the figures, they are, to use the technical term, examples. Neither KW nor I , as far as is known, possess (except in an overlapping generations DSGE model) perfect foresight.

For what its worth, and thank you for (not) emailing me to check these, I stand by my suggestion of 6% average coupon on the NAMA bonds. Thats based on the assumption (which could be wrong) that they will be medium term in duration, and that the effect on the national debt (statistical shenanigans aside) will raise the cost of borrowing. Note however that in my spreadsheet we assume that the costs decline 7-6-5 percent over three tranches. Of course, all that was explained in the Sunday Times article to which the spreadsheet is an adjunct.

Finally – as I have noted and quoted, what people do and say with the analyses of me, KW, or anyone is their own business. All we can do is to analyse and call things as we see them at the time. Now, as all it takes is an email to me to get the spreadsheet, feel free to do so and you can play away with the loads of colourdy input assumptions and make your own conclusion.

B

@ KW

A levy is actually a damned stupid idea.
The whole purpose of NAMA is risk transfer-so a levy negates that. Banks would prudently build a reserve to cover any future liability. This lowers profits and ultimately the capital generation of these banks. Less capital means less lending. As you point out, lower profitability could be made up by increasing the cost of credit or more fees…hardly good. Expect the levy to be quietly dropped once its perverse implications are explained. the better way would be to pay the right price for the assets in the first place.

I think Bran is wrong about the cost of the NAMA bonds. They will be FRN probably of 10 year maturity. At the moment the coupon could be Libor +100 something like that-say 2%. Obviously the risk is that rates shoot up as the world reflates. However, if that is the case property values probably go up.

@Eoghan

Despite the overheated tone you’ve adopted (to borrow your own phrase) I’ll answer your question because there are some important issues here.

Why am I using a different interest rate in my calculations? Events, dear boy.

Because the bonds issued by NAMA have to be marketable if they are to be used in repo operations at ECB and because they are, in effect, issued by the Irish government, any estimates I ever reported were based on the assumption (no more than that because information about the bonds was never made available and is still very sketchy) that these bonds would have the same yield as other bonds issued by the Irish govenment.

Yields on Irish gov bonds have gone as high as 6% so nothing crazy about BL’s figures when he put them together. Recently, these yields have been closer to the 5 percent range. So that’s where the 5 percent comes from. Nothing strange. No attempt to mislead people.

Now to recent events. My interpretation of the NAMA Q&A and other gossip is that the bonds will pay something like Euribor (perhaps plus something or other, we just don’t know.) Euribor is very low right now but will go higher in the future and 3 percent is just a random illustrative number I used for this calculation. I had not expected snarky questioning about this dramatic “change of mind” but, if you must know, here’s how I’d defend this figure. Ten year safe euro area gov bonds are at about 3.8% now — see
http://www.ecb.int/stats/money/yc/html/index.en.html — so subtracting off something for a liquidity premium, then 3% looks like a reasonable (perhaps slightly low) guess of the average short-run floating rate for the next ten years.

But, of course, there are risks in issuing floating rate debt. The average rate may turn out to be higher.

Plus, issuing very low interest debt isn’t necessarily the greatest news as regards getting the banks re-capped. If these instruments were marked to market, they would sell at a large discount to face value because they would be inferior to similar other bonds issued by the Irish government. Even if they are held on the bank balance sheets at par value, the low interest rates paid will reduce bank profits considerably and very possibly lead to further recapitalisations.

So, there you go, that’s my thinking on this issue. And as you can see, at all times I’ve tried to put forward examples that mislead as little as possible. Perhaps you might consider phrasing future questions in a less theatrical manner if you really want answers.

News at one on RTE1 had an FT journalist commenting on NAMA. He praised the legislation but stated that the levy would be a problem. Obviously, this guy did not read the draft legislation( bit like BC and Lisbon mark 1) which has no mention of a levy. What value a statement of intent from government who are likely to be out of office when the day of reckoning arrives. Buying the levy nonsense is like buying a pig in a poke.

@Brian Lucey
If your figures on the bond yield are correct (or even close) does that make nonsense of the claim that the performing loans being acquired by NAMA and reported to be yielding 2% over Euibor will cover the remainder.

Further to my remarks above:
A “here-today-gone-tomorrow” government says that a distant successor government of unknown political complexion will place a levy some time in the indefinite future on whatever banks are still in existence then.

Personally I would prefer a committment to Drain the Shannon

Right now irish bonds are trading at 4.9% for ten year money. Say 5%…..
One year EURIBOR is 1.3% – a premium of 150bp is being muttered so say 3% round figures. But NAMA wouldnt issue ten year bonds with 18m ratchet floating coupons would they?

@Brian Lucey

Please outline why you think NTMA should not issue 3monthly re-set libor linked floating rate notes at say 100bps over 3 month Libor.

In answering the question please deal with the scenario where inflation would rise and short term interest rates would rise.

@KW

No I dont buy it. The 5 to 6 per cent rate you and Brian Lucey use is the rate for Irish Gov 10-year paper. This rate includes a large Ireland Inc country risk premium. How could it make any sense for the Irish State to pay Irish banks 10-year bonds with yields that include a country risk premium for 10 years???? The only sensible thing to do is to pay them short paper with a floating rate near ECB. How come that never occurred to you?

You say “the low interest rates paid will reduce bank profits considerably..” You complain about allegedly overpaying the banks, now you are worried about the State giving the banks too little interest payments. Make up your mind. Banks should make profits by making sensible loans to good customers, not from ridicously high interest payments from the State.

@BL

You say “I stand by my suggestion of 6% average coupon on the NAMA bonds.”

Do keep up!

http://195.7.33.37/newspaper/ireland/2009/0731/1224251763759.html

“The Government would pay the Euribor rate on bonds issued to buy loans”

I don’t buy this accounting stuff as the reason for not legislating on a levy. Surely the banks can model the expected liability? And we have been assured by both our large leader and our larger leader that NAMA will make a profit. In which case it is only an issue if the banks reckon that NAMA is going to take a bath on the loans it buys from them…

Hmmm.

Securum lost two thirds of the face value of the loans it acquired from Nordbank, didn’t it? (in USD terms). Surely the same isn’t going to happen here? I mean, they can’t be planning on it making a loss, but telling us, ha, ha, it is going to make a profit?

@Eoghan

“How could it make any sense for the Irish State to pay Irish banks 10-year bonds with yields that include a country risk premium for 10 years???? ” ?????? Please translate so that the reasonable person can figure what you are getting at. Some of us are not Professors. Are you?

Thanks

@JL

can i repeat my question, why do KW & BL think there is a problem with NAMA bonds being low coupon, 3month duration FRNs? Also why does KW think there is a problem with ECB eligibility?

My understanding is that the bulk of the loan book would if it was paying interest be paying 3 month Libor plus a margin. In that respect respect NAMA receives floating and pays floating to the bank. They “asset side” of NAMA are not fixed rate loans to any great degree.

Also, I see no problem with ECB Repo eligibility. they are not benchmark govt bonds. they would be tradeable but in practice they will not trade.

The characteristics of the bonds & indeed the levy are a sideshow. The ECB has probably already signed off on a facility of up to 90bn. It is all about i) price ii) accountability and governance of NAMA & iii) what are the implications for bank capital and ownership post NAMA-hw big a stake will the state have.

@Jl
Wow. must put that on the credit instruments msc exam.
I agree the ECB is on side. The maturity of the bonds is to me the issue more of concern.

@JL

I didn’t say there was a problem with ECB eligibility. Whatever they issue has clearly already been cleared as being eligible with the ECB. My point in relation to that was just that if the bonds were marked to market, they would be marked down to reflect their low interest rate.

I’m not sure how the ECB will value these bonds (at their par value you’d have to guess) but at some stage, unless the Irish banking system is going to funded by the ECB indefinitely, we are most likely going to need to get the liability-to-deposits ratio down and this would have to involve selling these bonds on the open market. Economics teaches us that there are rarely free lunches in life and there are downsides to issuing a low-interest coupon bond. Despite what other people have written in this thread, I am interested in getting a fully recapitalised Irish banking sector up and running as soon as possible.

And, as I noted, there are risks in issuing very short term debt because rates might go up and this is a big risk now. Most companies do not use short-term debt to finance long-term projects.

By Post Author

If the banks are insolvent now, all profits earned from now to perpetuity is due to the fact that they are not liquidated or nationalised.

If they are solvent, then I don’t see the need for NAMA.

A share in an insolvent company is usually put to 0. If the shares aren’t worth anything, the shareholders are not risking anything.

My belief is that if the banks are insolvent, the shareholders are taking no risk whatsoever and it is the owners of NAMA that are taking all the risk. If the shareholders are to be rewarded proportionately to their risk, then their risk exposue of 0 € should give a reward of 0 €. (Leading to a levy of 100% of profits for perpetuity).

Stop NAMA. See where the shareprices ends up. Buy them. Clean up the balance sheets. Insert equity capital. Sell them.

Could the govt. strategy be to inflate share prices via NAMA prior to recapitalisation so that when it occurs the govt. does not have majority control? In which case perhaps the overpayment won’t be as severe as we fear if it were to be the sole solution…

I recall that when the National Pension fund took preference shares in the Banks, the banks were given the option to repurchase them at par value within 5 years – which i presume also inflates the share price since the par value was low at the time (I think?). I’d be interested in any other thoughts on why the banks were given this option as I most likely am completely wrong!

The levy is a bed-time story to give the uncertain populace a warm, snuggly feeling that all will be well in the end with Nama. If it isn’t, we’ll just levy back the shortfall. But as has been pointed out, the threat of a levy is a virtually unpriceable option which would make the bank’s balance sheet just as uncertain as all the sour loans they currently hold. Can anybody really imagine the government coming back in 20 years and trying to hit the banks with a levy?

@yoganmahew sweden have a single giant bad bank . each big bank set up its own. Securum was the biggest and it belonged to the already state-owned bank, nordbanken. the private bad banks, however, remained the property of the private banks from which they were removed.

nobody traded toxic waste at the height of the crisis in sweden. such trade is an unnecessary complication. NAMA’s task is to isolate the rotten apples so that they do not contaminate the good loans in the cleansed banks. [NAMA will take some of the good stuff too.]

The bad banks sold off their assets at a leisurely pace over several years to maximize their value – here is where the anti-nama spin begins because lately ‘market value’ is being used interchangeably with ‘economic value’ and they are far from being the same thing.

the swedes avoided excessive depreciation of assets through fire sales and the problem of forced trading in undervalued assets. In the end securum even made a small profit. note: PROFIT.

there are other ways to levy banks, during the ICI issues with AIB in the 80’s, the central bank changed its rates on deposits but kept capital rules in place which ultimately meant banks were paying for help, instead of paying on deposits (for instance) 8% they paid 6%

@karl deeter

Hi,

You said “[NAMA will take some of the good stuff too.]”

I must misunderstand, so please let me ask a couple of (possibly really stupid) questions. I apologise ahead of time! 🙁

1) I didn’t think that NAMA had any powers of assessment on the banks’ books, so would they know which loans were “good stuff” or “bad stuff” ahead of taking them on? I mean I though the whole problem was lack of good knowledge of values.

2) I also didn’t think NAMA would get to pick and choose from the loan books. I guess this is also a wrong assumption then?

It seems that the prevailing opinion is that it would be catastrophic if there were “fire sales” of the property assets that underlie these loans, as their values would fall steeply. But to me it doesn’t make sense. Even the FT stated that real property in Ireland was the most overvalued in Europe, and I certainly agree. No one bitched much when the values INCREASED steeply, even though some of the more honest economists twigged that it was a warning sign. The upshot is, that if you want wages to fall, the cost of living has to fall, and a lot of the past inflation was driven by property prices. Otherwise, those that can leave will, and those that end up staying will either be land barons or dirt poor.

@karl deeter: If NAMA pays 30 billion for the bank assets, I am pretty sure it could turn a profit too.

@ karl,

My apologies,I misread your post.

If NAMA were to issue 10 or god forbid 30 year fixed coupon bonds to the banks in return for the toxic loans then if rates rose by say 200bps over the next couple of years then they would have significant capital losses. This would create another capital crisis for the banks. Better to issue low duration floating rate coupons which adjust upwards. these should never trade far from par, unless of course their is a sovereign crisis.

I think NAMA would be wiser to issue a range of these bnds with say 3, 5 , 7, 10 year maturities so that if NAMA is selling assets it can retire debt easily. Although. I wonder if NAMA will ever retire debt, given that it will be a developer and not a straight seller into a hopefully rising market.

@Aidan C

I’m no professor but I worked for 6 years in London as a bond trader and I know it’d be a stupid move for NAMA to issue 10-years bonds at current market rates to buy the loans. Foreign funds are charging Ireland Inc a premium to borrow because they are pricing in some risk of the country defaulting. How could it make sense for NAMA to pay a premium to the banks on the bonds issued, in effect compensating them for the risk that the country might default? Doesn’t.

Karl Whelen is wrong to worry about rates going up. Jl is right. Higher rates mean NAMA pays out more on the bonds but brings in more on the loans it owns. NAMA is hedged.

@ eoghan

2 caveats though
i) NAMA has loans that actually pay floating coupons so that if short rates rise, income increases and offsets higher interest. Only about 33% of NAMA loans (at best) are likely to pay interest-the associated loans.
ii) higher Euro short rate are symptomatic of a rising tide in Europe-this should help property values on the non Irish stuff in NAMA at the very least. Asset values can go up.
NAMA is probably right to issue a lot of FRNs at the moment-curve is steep & sovereign spread is wide. However, this may not always be correct.

90bn is expected to be invested. The expected return? The best is to get the same 90bn sometime in the future (possibly adjusted for inflation or interest).

An investment with no upside but with a big risk is to me a very strange investment. No matter how it were to be financed.

The smaller investment of buying equity shares is at the very least a smaller investment, has an upside and leads to recapitalisation.

@Karl

Show me where Securum made a profit? Everything I’ve read (like the Cleveland Fed study I pointed you to) has it making a loss. It disposed of all its assets in five years. It sold into a distressed market. There were firesales. It made losses.

The Swedish government made money in devalued krona terms as it sold off the shares it had in the nationalised banks and in the repayment of recapitalisations. This is very different. The Irish government is not proposing to take equity stakes in the banks in return for NAMA, in contrast, it is paying the banks for their bad loans. The Swedes nationalised their bad banks. We are gifting ours oodles of cash.

NAMA contains no mechanism to implement a levy.

Once upon a time – lately, in a not so far off place…
A mad friend of mine wanted to borrow 100 punts to build a mad-cow shed, now as it happened I knew of a bloke (Bond, Jaysus A Bond) who wanted to invest 100 punts for a return, I gave him an IOU + interest. I gave the dosh to mad-cow shed building man after taking a % return cut for myself, obviously.

Some time later, all of the mad-cow sheds in the not so far off place started to mysteriously buckle (some upstanding pillars of the mad-cow shed world had been predicting this for some time). My mad-cow shed building mans, mad-cow shed crashed on his cows, killing them and rendering him unable and unwilling to pay. Luckily for me I had an older brother (Brain) who could be talked into things, after persuading him that the Sun would fall out of the sky, the families lands and titles would be lost, that Kenny would rule over all that land, he promised J.A. Bond than he would cover the IOU.

Soon after I told him of Bonds promiscuous ways, his extended family, that in fact there were multiple Bonds and the 100 punts had morphed into 100billion (Brain didn’t really understand that a billion was different that a punt, he just heard 100; everyone else knew a punt was a punt).

Some time later Brain found out the real value of a Bill and he was to be heard muttering that he was going to Biff Bond, or something like that.

Not so long later Brian came up with a grand plan to sort out me (some time earlier he had stared calling my the Rhyming Punt), along with mad-cow shed man. He told us all the grand plan, but none of us understood it and the more he explained the more no one really understood it, not even the pillars, but we told him it was a good plan, not bordering on the fanciful and that everybody would think it was a good plan and that it would be seen to try and sort things out. Bless old gullible Brain.

All the cows spent ages discussing the plan. The mad-shed disease was not cured. Brian had biffed himself and the cows… again. Bond was laughing all the way to/from the bank, and me, well, bonus time is coming around it should be a big fat one this year again.

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