Loan to Value Ratios

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.

26 thoughts on “Loan to Value Ratios”

  1. @ Karl
    I think you mean LTV=88.5% in your above example not 12.5% (assuming no change in the value of the development land at the end of the 3 year period).

  2. Is there another complication here, namely the losses (if any) that have already been booked on these loans by the banks. If in KW example above the bank has already written off a portion of that €100m, wont the NAMA haircut be on the already written down value of the loan as opposed to the €100m? If this is the case the ‘original’ LTV is not of much interest. Would I be right in saying that if the banks have already booked some of the losses on these loans then the haircut might not be as large in money terms?

  3. Surely the original LTV is irrelevant.

    If the banks issued loaned at 75% LTV why should NAMA purchase these loans at any less than a 75% LTV?

    Alan Ahearn used a strange example which I will use as well.
    €90bn loans, €120bn property and a 50% fall in property making the property and the loans now worth €60bn.

    But why would the government not insist on a similar 75% LTV when it take over the loans. So the loan with €60bn property backing should only be worth €45bn.

    Unless 100% motgages/financing is back in vogue.

  4. Karl,

    Does your calculation not implicitly assume that all loans were written at the top of the market?

  5. @dreaded Estate

    Lets assume that NAMA operates as announced and forget about any “pay some now and some later” or risk sharing stories emanating from the usual suspects.

    So NAMA operates by removing all risk from the banks which is done by crystalising the losses. LTV ratios don’t really come into it.

    The developer will still owe €90 billion.
    The property will be worth €60 billion.
    So the “loan” to value ratio will be 150%.

    For arguments sake NAMA want to pay €65 billion because that is the long term economic value plus arbitrary Lenihan adjustments required to prevent the banks being nationalised.

  6. @RO’T

    I imagine that any loan from years before would have been refinanced in order to maximise leverage.

  7. @RO’T and MO’L

    If we take the Zoe group as an example, it would indeed appear that it is leveraged beyond 100% The group having debts of 1.3 bn and a liquidation value of 420 mn
    http://www.irishtimes.com/newspaper/finance/2009/0722/1224251064844.html
    Even if we are charitable and say that the liquidation value is down 60% from peak, so the assets were once worth 1 bn, this still leaves Zoe leveraged 1:1.3, that is, an LTV of 130%…

    (Apologies for the maths errors, I was never very good at it – programming aircraft fuel loads is more my thing…).

    The IT article concludes with:
    “Last month ACC threatened to liquidate companies across the group due to the inter-dependency of companies within his business and cross-guarantees. ACC is owed €131 million on its loans and €4.8 million in unpaid interest.

    The bank, which is owned by Dutch group Rabobank, warned it would pursue a legal action in Jersey, where Mr Carroll’s holding company Morston Investments is registered, and realise any value by liquidating his other firms. Among the properties secured indirectly against Morston is Gordon House, Google’s Dublin offices.”

    To take the LTV question from a logic point of view – how likely is it that 25% of usable leverage would be sitting idle? That 30 bn euro in equity is not making any money?

    (Very glad you took this one up Mr. Whelan, it has been exercising me a lot – 70% LTV was what I’d heard/read – http://www.thepropertypin.com/viewtopic.php?f=50&t=24542 ).

  8. In the article…
    “…..However, in addition, they have put up additional collateral in the form of another property they owe…..”

    I presume you mean “they OWN” though it did set me thinking……?

  9. @Karl

    All this false concern by Brian Lenihan and Alan Aherne about the quality of their critics’ estimates of the cost of NAMA is pure smoke “rolling over the surface of highly polished mirrors ..If somebody tells you how to look, there can be seen in the smoke great, magnificent shapes, castles and kingdoms, and maybe they can be yours.” Jimmy Breslin “Notes from Impeachment Summer”, 1975

    Those castles will be very valuable in say 5 years time and we will all live happily ever after.

  10. I am actually beginning to believe that prices will have recovered within a few years.
    Maybe as little as 5.

    The reason for my bold forecast is an examination of the average new house price in Ireland from 1975 to 2007 as provided by the CSO. There does not appear to be any figures for commercial properties.
    Not very scientific I agree…but the figures make for interesting analysis.
    Despite periods of high unemployment and low growth the figures just kept growing.

    When you look at them it begs the question what bubble years NAMA would exclude when establishing a long term economic value.

    Forget buying stocks or Gold…Irish property has to be one of the best investments in the world….a staggering 1620% increase between 1977 and 2007

  11. Hi there

    Just an average Joe here, trying to come to some understanding of the complexities of this LTV stuff, as it applies to NAMA.

    Is it OK to quote here from a debate on Politics.ie?

    I would just like to get a handle on this, and I will not be offended if ppl here tell me to get stuffed.

    ===============================================

    Contributer adrem on Politics.ie said:

    On the “haircut” – the 15% to 30% haircut that is being talked about does NOT represent the reduction in property values. As I’ve already outlined a few times now, a 30% haircut is equivalent to an assumed fall in property values of more than 50%. A 20% haircut is equivalent to a c45% property value fall etc. Whilst some property values have fallen by way more than that (ag land etc) most commentators are putting the overall fall in value at something in the region of 40-50% so therefore a haircut of 20-30% would be in line.

    Irishpancake(me) replied:

    Are you assuming here that the Deleloper put in 30% Equity and got a 70% loan??

    For Example: Property Price = €100m, Developers Equity = €30m, Bank Loan =€70m

    Assume 20% Haircut to loan, Loan Value now is €56m, which is a c45% fall in Value, as opposed to €100m initial valuation.
    or
    Assume 30% Haircut to loan, Loan Value now is €49m, which is a c51% fall in Value, as opposed to €100m initial valuation.

    However, most developers did not inject anything like 30% of their own cash into a developement, as can be seen from the Carroll case, and others.

    Mostly, there is gigantic cross-collaterisation, and multiple loans taken out on properties.

    So, your figure of overall fall in value 40-50% being reflective of 20-30% haircut is unlikely, as probably all the money to fund the developemant is borrowed.

    Therefore, Haircut should be closer to 50-60%, to reflect the actual level of borrowing undertaken.

    Contributer adrem replied:

    Wrong (but don’t let that stop you) – the original LTV across the book of assets was c75% it has now been written down (again the entire book not one specific property) to c65%. My numbers are correct – yours are wrong. But as I said – don’t let that stop you – it doesn’t stop the rest of the “experts” !

    ===============================================

    Now I feel that I’ve just been put down by “adrem”, and my understanding is poor.

    Anyone?

  12. The LTV at 75% a red herring?

    It’s late 2007. Borrower A buys zoned development land for €100m financed by a loan of €100m, LTV = 100%. The bank insists on additional collateral. “A” pledges the equity in his commercial building worth €80m on which he has a loan of €35m LTV=44%. Combined he now owes 135m on property valued at 180m LTV =75%.

    Fast forward to 2009. Now let’s say the €100m loan is bad (omit accrued unpaid interest for simplicity). The land bought with the €100m has lost 70% in value and is now worth €30m LTV= 333%. The commercial property has declined by 50% in value but still washing its face, barely, in financing loan repayments from it assaigned rents. It’s a good loan but linked to the bad loan. Commercial Property LTV is now 87.5%. The combined exposure is now €135m loans against property worth 70m LTV=192%.

    Now what happens if NAMA calls in the €100m? It triggers a call on the other collateral – the good loan becomes bad even where it is performing.
    How does NAMA price the good loan and bad loan or package of both?

  13. What I am picking up from these discussions is that no one knows the true position. Given past events there is no reason to believe the government does either. Alan Aherne is approaching this situation as an economist. Due to professional pride he believes he knows what the situation is. To really find out what we are getting into we would need not economists but brutal non-Irish liquidators with experience of extreme property crashes. In, “The Unsinkable Rubber Ducks,” the scientists doing the testing were fooled by the cheating of the charlatans claiming psychic powers. As an expert on psychic scam artists remarks in the book they should have hired an illusionist to assist them – but they were too confident in their own technical abilities.

  14. @Ronnie

    The examples are really meant to be purely illustrative so I don’t think I’m making an assumption about when the loans are written, just giving examples to show people how this stuff works.

    However, now that I think of it, the 50% example hardly seems far off as an average. Anglo’s report said the following “Since September, land values, particularly in Ireland, have fallen by up to 40% bringing the total estimated fall in values to between 50% and 70% from peak levels, and this has been taken into account in assessing the impairment charge for the period.”

    The “particularly in Ireland” I take to mean that Ireland is the 70%. So, if 50% is a weighted average of stuff down 70, stuff down 50, and stuff down 30, then maybe it’s not so bad an assumption.

  15. Am i right in saying there is no right answer to this question? we have a property market today with no buyers and reluctant sellers from what I can see. Estate agents may tell you “transactions are going through”, why not, lil bit more BS wont hurt anyone!!! but the bottom line is that no matter what answer Lenihan comes up with on September 16th, he will have his reasoning (however tenous) and Karl, you and your friends will have yours, Joe soap in the pub will have his opinion and the dogs on the street will have theirs. The only real answer is time will tell???

  16. @LD

    Time & Trust

    “The only real answer is time will tell???”

    You are absolutely correct to highlight the importance of time in the resolution of the banking debacle. It could take a long time to pay for the reckless gambling of bankers, developers and financial investors facilitated by the FF?PD governments since 1997.

    Trust is also crucial in the resolution of the banking crisis and the restoration of a sustainable economy and a fair society.
    Would you trust political parties like FF and the PD’s who were cheerleaders for the recent unsustainable debt driven housing boom to sort out this mess? I don’t.

    Do you trust the figures of a Department of Finance who have consisitently got their tax projections wrong in good times and bad? I don’t.

    Do you trust the government to disclose all the information (warts and all) to the public before they try to railroad this NAMA Bill through the Dail? I don’t

    Do you trust the bankers to lend to households and small businesses if they get the €90bn of Irish citizens money? I don’t.

    Name-calling about imprecise estimates on NAMA is a useful distraction for a government that has lost the trust of the majority of Irish citizens on governing the country, not just on the way they are handling the banking crisis.

    I think it is time to consult the citizens of Ireland in a general election and ask them who they trust to rebuild a sustainable economy and a fair society.

  17. @LD
    “Estate agents may tell you “transactions are going through”, why not, lil bit more BS wont hurt anyone!!! ”

    Yeah but these are the same estate agents who BL has hired to come up with realistic property values for the present. He then is going to try and extrapolate a long term economic value based on past performance.
    He obvoiusly doesnt listen to the end of those financial product adds
    ‘Past performance is no indication of future returns’.
    Then the irish tax payer buys at this reasonable price.
    What can possibly go wrong?

  18. It looks like Brian Lucey is accurate in his assessment of current values.
    REO the Treasury Holdings controlled property investment company has reported a 70% decline in NAV from 104.1 to 30.9.
    As these are real numbers they surely expose the potential risk of overvaluation.

  19. Take a look at what Constantin Gurdgieve has said on http://www.trueeconomics.blogspot.com/ in answer to a query….re LTV etc….

    http://www.trueeconomics.blogspot.com/

    If rabo estimates are within reason…which they probably are…

    ‘… You have paid (at 30% haircut) 90.62 (2009 is included because by the time Nama actually pays for the property this year’s interest rate accrued will be counted in) for a property that is worth 50-60% less today than in 2007, i.e a property that is worth today €80-100.

    Now, Nama financing this transaction at 5% (say) interest rate into 2021 (10 years ahead) and I also assume that the market bottoms out in 2010 at 60-70% decline to the values of the assets underlying these loans.

    So in 2010, Nama would have paid (assuming zero inflation in 2010) €95.15 for a loan that will be (under my assumptions) worth only €60-80.

    Plus, Nama has also paid the banks 8% recapitalization cost – raising the amount paid by Nama to €102.40.

    Now, this is assuming the loans are non-performing at the worst. If we are to write off 20% of the loans as useless – i.e. defaulted – you get the risk-adjusted value of the loans in 2010 at €48-64.

    You say the banks have written down the loans by 10 percent already. Ok, take a margin on the above value of say 15%. But let me remind you that I have not factored in the ECB discount on face value of the bonds (10-15% reasonable to assume)? And the cost of running Nama (including the cost of managing the loans on behalf of Nama by the banks – 3%), less the yield on Nama assets (6% for performing loans is a high enough number, but only roughly 50% are performing, so 3% across the entire book would do?). All in, you have -15%(banks writedowns)+10%(ECB shave)+3%(management costs)-3%(yield)= net correction to be applied to my numbers above should be around 5% in favour of Nama. Let’s do that on the asset value side.

    Net result, under your and my assumptions: Nama – by 2010 will have paid €102.40 for assets worth (risk-adjusted) €50.4-67.2.

    August 27, 2009 10:50 PM
    Blogger Dr. Constantin Gurdgiev said…

    continued…

    But the racket does not stop there, since the Government does not want a firesale, so costs multiply into 2021 (or beyond, in fact, as the Government has stated that Nama will run 15 years). These are compounded at 5% to be offset, under my assumptions by 3% yield against (my assumption) 3% inflation. You quickly get into my territory here.

    Of course, I am using Rabo figures as a background for declines in property values. But hey, does anyone really think that buying a portfolio of loans accumulated by some of our most aggressive developers will be like buying assets that have seen a temporary correction of 30%? 40%?

    Let us face the reality here – in 2006 when I was shopping for a house, a property with listed price of 600K went up to 635K barrier within an hour of the doors opening for the first visitors. Mark ups on listed prices were in the region of 5-10%. Now, asking prices have fallen by ca 30% plus since the peak. And you get to bid below the asking price with properties selling at 10-12% discount on asking price. So take a property in 600K range in 2006. It sold back then for 640K and at the peak went for ca 650K. It now would list for 420K and would sell in the region of 378K. A 42% decline on peak prices.

    Now move forward to 2010. By then, my prediction, the property prices (asking) would take a hit of another 12-15% (or so), bringing the same 650K house of 2007 peak down to an asking price of 357-370K, or a selling price of 314-333K. A peak to trough decline of up to 52%.

    And this is for the resale markets. In new homes segment, prices have fallen deeper and earlier, so I would say that on average, we are going to see a 60-65% collapse in new homes prices at the trough.

    Now think of demand/supply relationship spatially. Despite prices ‘holding’ at smaller declines in the country as opposed to Dublin, this is not due to the demand/supply of there properties being in closer equilibrium, but because fewer people outside Dublin can actually afford selling their homes and many more people outside Dublin (within the commuter belt) are in deep negative equity (purchase vintages are younger in the new built areas).

    August 27, 2009 10:56 PM
    Blogger Dr. Constantin Gurdgiev said…

    Where do you think the development land, development projects, investment properties that are in trouble are concentrated today? Not in Dublin city center or South Dublin. Some high profile ones are there, for sure, but they are outnumbered by the sites outside the areas of real demand. What decline in values shall we assume for them? 70%? 80%? 90%? Or even 110% – as someone buying them would have to potentially pay for the removal of the rubble – the unfinished bungalows that have turned the countryside into a Soweto-styled slum.

    Are these the same 20% loans in default already? Some are. Others are not yet classed as such. Who cares if the banks have taken a 10% haircut on these so far? Or a 15% haircut?

    Sweden had to face a less steep decline in house prices, while having lower debt as percentage of household income than Ireland. It also had much shallower contraction in its economy and it faced short-lived shallow global recession. Despite this, having dealt with only 22% of its entire economy’s loans, after having forced the banks to write down their debts to mark-to-market levels and after having destroyed shareholders and some bondholders equity and debt, Swedish bad-bank set up has not achieved break even return on public investment in nominal terms. And Swedish housing prices have not regained (in real terms) their pre-crisis values to-date – almost 20 years after the collapse has begun.

    What low LTVs can our Brian Lenihan be talking about? What ‘unappreciated complexities of the situation’ per Dan Boyle have we (the critics of Nama) omitted in our analysis? Who – amongst those of our political leaders who fuelled the artificial bubble and wasted public tax revenues over the last 7 years in Government – shall we trust with doing the right thing, as our ex-stock brokers advise us from the Prime Time podium? Which economic advisers – including those who have changed their tunes as many times as their bosses have changed – should be take on their word when they have no guts to face their policies’ critics face-to-face?…’

  20. I think this is a very useful article; to workout a case… The numbers don’t have to be very accurate, ballpark is fair enough.

    I personally know 2 developers, both of whom are practically retired at this stage, with money made… I never discussed business with them in detail. But they would have been involved in projects whose total value was a few hundred million. Now, in one case funding wasn’t as simple as above; different people were ‘backing’ the project, either with their name and reputations and also raising cash/loans… Getting people involved (or at the height of it deciding who to invite in) and structuring it seemed to take a lot of energy. Having the right people on board made things run more smoothly… read into that what you will 🙂

    The point is that I think there are a few different classes of developers. The ones I hear about now from the papers seem to have been either one man or one organization outfits…. the bank has called in….

    But I know that in one case, there was lead developers, and backers…. I do know that in this case some of the backers were developers in their own right… But I dont know if calling in one of these would cause the others to fall over or not…

    And I’ve no idea if this kind of ad hoc syndicate was the exception or normal enough behavior.

  21. Only the market can decide without distortion. Another thing: the law will insist on fair value, if you can bring a case. Remember my contribution on locus standi? The property developer will be in a position to sue NaMa to ensure that they overpay. No one will fight vigorously for the taxpayer. OPM!

    So remember to add in buckets of legal fees for 4 SC and 2 JC per case. Say half a million. And the same issue will arise again and again. So another High court judge just to hear all the cases say 2M, including pension, so much for cutting the public service! Say another 100M. Peanuts to the nominal 90Billion. 90,000,000,000 euro. No, I did not forget the SC appeals, they cost so little that they aren’t worth mentioning! A rounding error, just like all the taxes paid …. A great little island! When I was at Kings Inns doing my dinners, in the 70s, we were duly informed that only one in 7 BL would be practising a year after graduation.

    I think this deserves a series of novels, after all that inquisitive bitch heroine inspired 2-4 movies just because someone paid c 50,000 pounds to have her rubbed out. Surely we could feature all the empty hospital beds to inject the needed pathos?

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