In interpreting the write down on loans that NAMA is intending to announce in mid-September, an important element will be the loan to value ratios. A commonly cited figure has been that original loan-to-value ratios on development loans were about 75%.
For example, this ratio would be consistent with a property purchased for €100 million with a loan of €75 million. If for instance, this property had fallen in value by 50% and the developer had insufficient cash flow to repay the loan, then bank would only recoup €50 billion, for a one-third loss on the original loan. A 70% decline in property value, as Anglo Irish noted for Irish property development land back in March, would imply a 60% loss.
So far, so simple. However, the real world is not so simple. Here are two complications that seem likely to have pushed loan to value ratios above 75%.
First, there is the fact that many (most?) development loans allowed developers to roll up the interest from day one. This then gets incorporated into the principal that they owe. So, to take the example above, three years of rolled-up interest at a six percent rate will have left the developer owing €88.5 million, leaving an LTV of only 88.5%.
Second, it’s my understanding that the average loan-to-value ratios generally quoted include a quite different form of loan to the one outlined in the fictional example above. For instance, a developer may have borrowed 100% of the money for the project. However, in addition, they have put up additional collateral in the form of another property they own. If this additional property was worth one-third of the value of the new property being purchased, then this would count as an LTV of 75%.
For example, the developer may have borrowed €75 million to buy a property worth that value and then pledged €25 million in additional collateral. In this case, not only is the property that the loan financed declining in value but so is the additional collateral (the “equity” component.) It is also widely reported that the same piece of property may have been put up multiple times as additional collateral in these types of loans.
From my ivory tower, I’m afraid I don’t know how much this stuff affects overall LTV rates but both practices seem to have been pretty prevalent and they both point towards higher ratios than 75%. I would really appreciate if those with more detailed knowledge of these issues could give us some estimates on the magnitudes at hand here.
Beyond that, I think it will be important that the mid-September announcement of NAMA’s intended purchase prices include information on true underlying loan-to-value ratios, including the amount of rolled-up interest and the valuation of additional collateral pledged.