NAMA Bond Yield Formula Finally Revealed

Finally, and only after questioning prompted by Brian Lucey’s earlier appearance on Morning Ireland, the Minister for Finance decided it was appropriate to let us know exactly what type of bond he was issuing with €51.3 billion of our money. The regular NAMA bonds will be issued with a six-month rollover period with an interest rate set at a half percent above the ECB’s main refinancing rate. This ECB rate is now one percent but there is general agreement that it will rise over the next few years (click here for historical values).

It should be clear now that there is nothing especially good for the Irish taxpayer about the current low yield on these bonds. At a time of low short-interest rates, it can always appear as though one is saving money by borrowing short and rolling over this short-term debt. However, because bond market participants aren’t stupid, long-term rates are determined with reference to this short-term rollover strategy, so there is no “free lunch” from issuing short-dated rather than longer-dated bonds. (Here are my own teaching notes on this issue.)

Those who think that the NAMA bonds are an especially good deal for the taxpayer might also note that the government is currently able to borrow at a six month duration at a rate of 0.5 percent—the yield on the latest six-month NTMA Treasury Bill auction. The extra amount being paid on the NAMA bonds can be justified as reflecting the higher sovereign default risk associated with longer dated debt.

I would note also that, given the relatively unremarkable nature of these bonds, any claims that their current low rate reflects some sort of special deal with the ECB—claims I never understood—need to be retired from circulation.

In relation to NAMA “washing its face” (it was washing its hands on Morning Ireland earlier—perhaps because of swine flu) there is no reason to expect the coming ECB interest rate hikes to generate corresponding increases in income from the 40% of NAMA assets that are generating income, so claims NAMA will always break even on an income basis appear to have little basis in reality.

Of course, we still don’t know anything yet about the maturity of these bonds. Or about the yield on the €2.7 billion in subordinated bonds. Or about the exact conditions under which the subordinated bonds will fail to pay off—though statements that they will pay off as long as property prices bounce back by 15% suggests that, as I had feared, the definition of “NAMA making a profit” will exclude interest costs.

But hey, Pat McCardle still reckons it’s all a secret EU conspiracy, so who am I to disagree? Perhaps Pat might enlighten us as to what changes the ECB have made to their current operational procedures to accomodate NAMA. Perhaps not.

94 replies on “NAMA Bond Yield Formula Finally Revealed”

Minister Lenihan said maturity profile would be 6-months and would pay 1.5% or 0.5% above the refinancing rate

There is no mention so far of NAMA paying any periodic interest costs, the Exchequer does (part of the “free-lunch” guise) on behalf of NAMA

It is wholly unsatisfactory that the first time we hear about the nature of these bonds is on Morning Ireland today. Of course it is good that the ECB is providing repo operations but it seems to be a far cry from Q.E.

The Minister said on Morning Ireland that we would all be in trouble if the property market sank lower. Why is that? If it is being used to justify an overpayment then we are entitled to know why.

Also, what earthly reason is there to think that NAMA will stop the fall in property prices. I just don’t see it.

Also, the Minister said on Morning Ireland that rents have not decreased. The rents reserved may nt have decreased but the renst actually being paid and accepted bby Landlords have decreased hugely. Perhaps he didn’t notice the lease advertised on Grafton Street with an offer of a “huge reverse premium”?

I am feeling decidedly frosty towards the Minister this morning.

@ Zhou

the whole thing seems odd to me. Would it have been that difficult for the DoF to put out a 2-pager on the funding and some of the assumptions there in? On a plus note, Lenihan appears to be forcing the banks into providing NAMA with the mother of all ECB-tracker mortgages….

Ref my post here on 8 September. What they are doing, as I suspected, is a very very simple interest mismatch. Bottom line if you don’t want to read below is that the good stuff will most likely be paying fixed, the bad stuff will be paying (a bit) of variable and the ugly stuff nothing at all. And to hedge that the Government goes all variable in a rising interest rate environment? Sounds political or incompetent but it is certainly not a prudent hedging of a massive interest rate exposure.

1. Pa Bandit Says:
September 8th, 2009 at 2:04 am
But what is the “coupon”?
Typically, a floating rate coupon will run at a defined euriobor (eg 3, 6, 12 month) plus a margin. So what is 1.5%? Euribor plus margin? Given that 1 month rates are c. .5% and 1 year are c 1.3% it implies the bonds will carry a margin of between 1% and 0.2% depending on what interest roll period is selected.
The size of the margin normally relates to the riskiness and tenor of the loan. However, in this instance the normal borrower/lender relationship is inverted with the Government doing the borrowing and deciding the terms.
What does this mean for Nama? In one sense paying floating whilst receiving floating makes sense – IF amounts and tenors are matched. To answer a previous question presumably they will be callable bonds and therefore can be paid off as the cash just rolls in when Mr Mulcahy’s 88% comes true. So no problem with tenor then.
To answer another question in my experience most development loans will be floating rate but most longer term loans will be swapped into fixed.
The big potential mistake is that the bulk of the good loans will be longer term paying fixed rates – via interest rate swaps (which although they are technically derivatives, are not toxic and really are only prudent ways of matching fixed rentals to fixed loan repayments). These loans will be the properties that are let to good corporates, government etc with tenors of 7-15 years and repayments tailored to rents. Although beware the personal guarantees for interest rate shortfalls at rent review time that were so beloved of credit committees.
So using the crude 30 billion, 30 billion, 30 billion for worthless sites, half built developments and good loans would translate to 30 billion paying nothing, 30 billion due to pay floating but struggling to do so and 30 billion paying fixed.
Doesn’t look like a perfect interest rate hedge to me because when rates go up the fixed portion will stay the same and the floating rate parts will struggle even more.
Unless of course, John Mulcahy is right…….

We all know the yield curve bit and yes Lenny is a bit disingenuous in comparing 1.5% with 4%.

But the key question here is the maturity profile of these bonds. ECB+50bp on a 10 year bond would be very cheap borrowing in terms of default spreads and whenever we see a market for these that will be confirmed.

And it is very clear that the ECB would not allow these bonds to be used for ordinary deficit financing, unless of course sold on the open market in which case they would get way below par.

The main weapon of the ECB in this global crisis was to slash interest rates to 1%. Unfortunatley Irish default spreads countered all the benefit. By allowing these 1.5%ers the ECB has in effect allowed the Irish government enjoy the full benefit of the rate cuts in the context of detoxing the banks, but not in any other context.

Can somebody clarify for me what the Minister said? Are the senior NAMA bonds floating rate notes at 50 bp above the ECB main refinancing rate? What’s their redemption date?

Has anybody assessed the Minister’s statement that a 10% rise in prices will allow NAMA to break even in 10 years? This seems exceptionally low to me if rising funding costs are taken into account.

Andrew

@Zhou

I agree that the Minister’s idea that “if the property market falls much more we’re all screwed anyway and sure what does it all matter” is a pretty odd one.

For a start off, it’s very apocalyptic. Economies have had large property busts before and recovered. It also ignores all the positive knock-on effects on competitiveness of lower rents etc.

The implication that we need to focus attention only on good property market outcomes because further declines in house prices imply “an appalling vista” suggests the Minister’s outlook is a sort of mixture of Marc Coleman and Judge Denning.

I’m afraid that these comments won’t help to deflect opposition criticisms that the Minister of effectively doubling down on the property market.

@ Brian Woods

The minister stated that the maturity profile = 6 months

Essentially they are Bills not Bonds and as such may be issued as discount bonds/notes i.e. Coupon = 0% and Price of around 99.25

In theory, (Legislation allows for this), they could re-issue varying amounts every 6-months i.e. increasing amounts to redeem them at Par

@Andrew

Podcast up now
http://www.rte.ie/news/2009/0917/morningireland.html

No annoucement on maturity. The 10% breakeven comments (also in the detailed supporting documentation) suggest that—as I have always suspected—the costs of NAMA will be counted by government in a way that ignores funding and operational costs. I always suspected this would be the case in relation to to any levy to be applied and it now appears to be the case with respect to the sub bonds.

By Post Author

@Derek

My interpretation is that these are long-dated bonds with interest resets relating to short-term rates. In theory, you could be right that they are just six month bonds to be re-issued every period. But I suspect that they couldn’t take the risk of trying to re-issue that much short term debt every six months.

By Post Author

@Brian

“By allowing these 1.5%ers the ECB has in effect allowed the Irish government enjoy the full benefit of the rate cuts in the context of detoxing the banks, but not in any other context.”

I know we’ve been here before but could you run by me again how the ECB has “allowed” the government to issue these bonds?

By Post Author

@Zhou
“The Minister said on Morning Ireland that we would all be in trouble if the property market sank lower. Why is that? If it is being used to justify an overpayment then we are entitled to know why.

Also, what earthly reason is there to think that NAMA will stop the fall in property prices. I just don’t see it.”

I happen to think a further fall in property prices would be a good thing for Irish competitiveness and to kick start activity in the market. As discussed a few months ago we seem to have decided the best way to improve Irish competitiveness is a fall in wages. Logical enough but not good if we have lower average wages than our competitors but higher property costs. (Read residential as well as commercial)

NAMA though can stop a further fall in property prices by refusing to put distressed property on the market until they like the prices. Instead of selling half finished developments to the highest bidder they are going to finish them and then sell at the market price. Nama is going to control the property market.

Anyway I’ve worked out that when BL says “we” he means people involved in property. Nothing else seems to matter.

This would allow Frank Fahy & Willie O’Dea to go on radio/TV and say that not only are the ECB providing the initial funding, but it is also cashflow neutral for the taxpayer as more IOUs will be issued to rollover older IOUs

In reality, the 40% of the loans that are presently being serviced are probably yielding something like 4.5% to 5%, but then you have to increase the rate of return to reflect the ‘haircut’ so closer to say 6% on that portion of the portfolio that is performing.

So NAMA would be in a position to pay a cpn with interest cover of 2x

Personally, I wouldn’t pay a cpn. Investors like Disco’s cos’ of accretion

@ Karl

While I would take issue with some of the arguments put forward by Pat McArdle today, I think his view that NAMA is primarily an ECB sanctioned bail-out for the Irish Banks and crucially (by virtue of their significant and ongoing purchases of Irish government debt) of the Irish State, was all but confirmed yesterday. The risk of Ireland being the first Euro-denominated domino to fall in the debt markets was just too great for the ECB not to act and now they have.

All else is largely a sideshow – how ironic to be having a referendum on Oct 2nd, when we’ve just witnessed so emphatically who’s really calling the shots in this great little country of ours – you couldn’t make it up!

@Karl

They wouldn’t be issuing all at once – serial tranches as they transfer loans across (Oct’09 – Jul’10) and they amounts would certainly vary through time as & when they disposed of assets

There is a lot of confusion as Lenihan stated y’day that “NAMA bonds to be traded on World markets ” (his words), but if that is just bluster for the populace at large & media and the real intent is to just use the ECB window, then there is zero or little risk.

NAMA cannot afford a failed auction or book-building exercise, which is why I think they went the RePo route in the end

@Derek

That’s credible enough so you might be right. Still I think that they can’t rely on permanently issuing short-term debt and repoing at ECB, so I’m sticking to my interpretation that they’re longer dated bonds but will freely admit I’m wrong when it’s announced—probably the next time the Minister appears on a radio show in proximity to Brian Lucey.

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@John Looby

“I think his view that NAMA is primarily an ECB sanctioned bail-out for the Irish Banks and crucially (by virtue of their significant and ongoing purchases of Irish government debt) of the Irish State, was all but confirmed yesterday. The risk of Ireland being the first Euro-denominated domino to fall in the debt markets was just too great for the ECB not to act and now they have.

All else is largely a sideshow – how ironic to be having a referendum on Oct 2nd, when we’ve just witnessed so emphatically who’s really calling the shots in this great little country of ours – you couldn’t make it up!”

What shots were called by the ECB? What sanctioning?

Can you be more specific? These are important claims so it would help if people could explicitly outline the decisions and actions they are referring to.

By Post Author

From the McCardle article:
“This means that property prices need increase by only 10 per cent from their low point for Nama to break even. ”

Who ever said property prices are at their “low point” at the moment?? Is the current market price the “low point”? It seems as if everyone is basing their NAMA calculations on the assumption that property in Ireland is at its trough. Also the argument that “some of the loans are abroad, and these markets will recover more quickly”, doesn’t hold a lot of water, as I believe that 2/3 of NAMA loans are at home.
Considering we have the mother of all budgets on the way, and the prospect of plenty of bankrupt developers (that is if they are “pursued to the full extent of their liability”, as I have been told they will be by a friend with FF links), and households without huge amounts of disposable income: how can people assume the housing market isn’t in for more decreases before we see this famous rise of “only 10 percent from lowest point”?
To me this dishonesty beggars belief.

@Karl

Not a complete expert on this, but piecing together things that are being said. The normal process for defict financing is open tender. Government are completely free to do that any time. But 5oBn of 1.5%ers at open tender – no way. Even 5Bn would get below par IMHO.

It seems to me that the Government definitely needed clearance to simply “print” these and use them at par to purchase NAMA assets.

Do you think these could be used at par to, for example, finance the deficit?

Goodbody’s Eamonn Hughes estimates that post-NAMA, the average loan-to-deposit ratio at Irish banks will fall from 164% to 130%, which he suggests is still high.

The UK’s Northern Rock, which collapsed in 2008, had a loan-to-deposit ratio of over 300%.

Lex in the FT said on Wednesday, that as loans were written, largely to fund house purchases or property development, banks’ balance sheets expanded. Between 2002 and 2006 Spanish bank assets grew by 86% and Irish by 120%. The rise across the Eurozone as a whole was just 41%. The expansion of assets necessitated the shift to wholesale funding. In Spain and Ireland, respectively, only 63% and 37% of asset growth over the period was funded by deposit growth. Spain’s four mid-sized quoted banks and Ireland’s three big banks all have loan-to-deposit ratios above the European median, according to Citigroup. So do UK banks Bradford & Bingley and Alliance & Leicester.

British bank HBOS had a ratio of 177% when it had to be rescued by the UK government in late 2008.

According to a UBS survey of bank balance sheets, Ireland’s average loan-to-deposit ratio was 163.1% in September 2008 with Irish Life & Permanent (IL&P), recording a ratio of 277.4% – – rather high!!

The average ratio of loans to deposits at US regional banks was 113% in 2008, with the large bank Wells Fargo having a a ratio of 118.6%.

KArl
they cant be longer dated bonds, I suggest, as then they would have to be repod at a very significant discount to face ; and that would defeat even the ostensible purpose of the exercise. Valuation of bonds that reset every 6m on a ten year maturity is not that hard, but i suspect that the exercise wont be required. But hey, its entirely possible.

@Karl W, Derek B

Although there is a reluctance on this site to be constrained by the short term politcial imperatives, in this case it may be necessary to factor them in. The pressing political objective is to survive intact until next spring/summer. Who knows what the domestic/international landscape will look like then. The Government is hoping that the early signs of recovery in our trading partners will be sustained and built on. Increased emigration, as it always has, will relieve some of the short term fiscal strains.

We can’t know for sure, but the Government may have secured some commitment from the ECB that the current repo facility will continue until then – even though the ECB is keen to develop its exit strategy from support of the banking system. I doubt that the Government has given much consideration to what kind of bonds/bills NAMA will have to issue then.

@ Karl, Brian et al

the title of this thread is “nama-bond-yield-formula-finally-revealed”. We wish.

Lenihan appears to have provided a few crumbs of knowledge for us, but it seems there is still, infuriatingly, a lot more that needs to be revealed. I agree with Karl that the short term issuance seems impossible to maintain, but the use of the word ‘renewable’ both suggests short term as well as being vague enough to mean all sorts of other things. Annoying.

As Karl has discussed rates are at all time historical lows. There are two possibilities for future rates (up or stay the same) over the next 1 – 10 years. It is interesting to consider what the effect on NAMA would be under both

1. Interest rates go up?

NAMA runs at a loss

2. Interest rates stay the same?

NAMA breaks even

If you are generous and assume the probability of each outcome is 50%, therefore the expected return from NAMA is a loss.

It only makes sense for NAMA to be setup so that the financing is fixed rate for 5-10 years and it pays for itself from day 1.

why didn’t they issue €7bn of sub bonds and €47 of senior bonds….that way were paying current market value

re. Pat McArdle
“the banks should continue to be run according to business principles – continued (partial) private ownership offers the best prospect of this.”

Hm…If the banks had been so run up to now, would all this be needed?
With this history, who is now going to enforce such business principles – when the State is in effective control?

Are we to assume that ECB is exercising its “influence” to ensure that there will be the capability and power to run banks (and government policy/regulation) soundly?

Who will benefits most from the way in which ” business principles” will be applied by NAMA/DoF/Minister?

A 50 basis points carry trade gifted to the banks, even excluding the windfall LTEV has provided.

Wonder how the strategy will pan out for us poor taxpayers if, in a year or two, it looks like monetary authorities in general and the ECB in particular fall behind the curve and all this monetary pump priming might lead to some (expected) high rates of inflation.

One wouldn’t want to be caught at the short end of the curve.

The cost of this excercise could escalate further for taxpayers in some ways not yet enumerated in the media.

@zhou

“Minister said they are “renewable” every six months, whatever that means”

Maybe the bonds are environmentally friendly, who says the Greens have no influence!

Every time assets are sold off by NAMA the amount of borrowing should decrease. Assets acquired at MV should be sold off in the first couple of years. Some performing assets may be sold off too. The business plan we are promised might clarify. Better late than never I suppose.

@eoin,

perhaps “renewable bonds” are a sop to the Green Party, who like that kind of thing?

my view is that it does make much difference whether they are tbills or floating rate bonds with 5y or 10y maturity. the Minister has repeatedly confirmed they will be tradable and therefore will be treated as normal market securities by ecb. it is one of the few things he has been clear about. the difference is just an operational issue.

what intrigues me is the rigid determination to maximise interest rate risk for the taxpayer (and minimise it for the banks).

the opposition should lobby for some longer duration fixed coupon bonds, so that that IR risk is shared. at least that would flush out more of the dodgy assumptions.

@Zhou
“Assets acquired at MV should be sold off in the first couple of years”

It will be interesting to see which ones they are. Of course the banks will have to lend to the people buying the assets. They presumably are not going to dispute the “market value” imposed. Could all get very circular.

Slightly off topic:

On Morning Ireland this morning, (17/09), Brian Lenihan said that they, the Government, expect property prices to rise by 10 percent over the next 10 years and not the bubble increase of 250 percent. What gets me about this is that they have said that the fall in prices is 47 percent and so people who bought houses during the peak years will be in negative equity of roughly 40 percent, (as the rise will only be equivalent to 5% or so of the fall over that period of time) after 10 years. Inadvertently government have admitted that thousands of homeowners are going to be weighted down by negative equity for years to come. That seems like a big proplem for the governement, the banks and the people caught in the mess. NAMA 2 anyone!!

@ Karl

i’m worried that you consider this “fun”. My head is melting from trying to get a handle on all the figures, assumptions and known unknowns!

@Brian Lucey
“Valuation of bonds that reset every 6m on a ten year maturity is not that hard”

If we can get this type of bond accepted on the international markets (as the Minister stated) why don’t we forget about issuing 10 year sovereigns at 4.5%.
Something wrong somewhere. Could these 1.5% bonds that reset every six months be classified as inflation linked type bonds that the French issue.

BOI trading statement coming out….

*BANK OF IRELAND 6M TRADING `DIFFICULT’
*BANK OF IRELAND SEES NAMA DISCOUNT LESS THAN 30%
*BANK OF IRELAND LOANS TRANSFERRED TO NAMA COULD BE EU16 BLN
*BANK OF IRELAND NAMA DISCOUNT MAY BE `SIGNIFICANTLY LESS’
*BANK OF IRELAND SEES EU1.6B-EU1.8B IMPAIRMENT CHARGES IN 1H
*BANK OF IRELAND: COULD RAISE CAPITAL INTERNALLY OR IN MARKETS

*BANK OF IRELAND: THANK YOU TAXPAYERS, WE APPRECIATE IT
*BANK OF IRELAND: NO WE WONT LEND THE MONEY OUT, ARE YOU MAD?

@Karl

‘What shots were called by the ECB? What sanctioning?

Can you be more specific? These are important claims so it would help if people could explicitly outline the decisions and actions they are referring to’

A small point – I’m more comfortable with something like reason-based conclusions rather than ‘claims’.

Leaving that aside, I think the following is clear:

1) The Irish State will be reliant on borrowing large sums for the forseeable future.

2) The Irish Banks have been/will continue to be significant (crucially significant) lenders to the Irish State via their purchases of Irish Govenment Debt.

3) The likely insolvency of the Irish Banks (due to their now NAMA-destined loans) threatened to undermine the access of the Irish State to a significant (crucially significant) lender.

4) This raised the real potential that the Irish State could become the first Euro-denominated domino to fall in the debt market. The ECB could not stand idly by in the face of this risk.

5) The Euro 54 bln needed to fund NAMA (and hence ‘bail-out’ the Irish Banks) could not be borrowed in the ‘normal’ way by the Irish State.

My conclusion based on the above is that NAMA is the likely ECB sanctioned (possibly even designed) response to this situation.

I certainly make no claim, or have no belief, that any explicit evidence to support the above exists or will ever be uncovered.

However, the forensic and compelling dismantling of the ‘offical’ arguments in favour NAMA by you and others, suggests to me that we need to look elsewhere to understand what may be going on – and I don’t think we need to look further than Frankfurt.

@BL

Karl said:

“What shots were called by the ECB? What sanctioning?

Can you be more specific? These are important claims so it would help if people could explicitly outline the decisions and actions they are referring to.”

Doesn’t sound that rhetorical to me.

why didn’t they issue €7bn of sub bonds and €47 of senior bonds….that way were paying current market value

@BL, Pancake

Indeed, not really rhetorical. I don’t believe there is explicit evidence to support this theory, so I’m not expecting people to produce it. But I am happy for people to point to specific actions that are taking place and we can discuss what they mean.

For instance, let me make two observations.

1. The ECB has a list of eligible collateral which includes government bonds. They are also giving out unlimited amounts of liquidity (for now) provided banks have the eligible collateral. So, to my non-conspiratorial mind, the ECB have not made a “decision” to “support the NAMA plan” by accepting the NAMA bonds as eligible collateral. Rather they are sticking with their existing operational procedures.

2. John Looby says “The Euro 54 bln needed to fund NAMA (and hence ‘bail-out’ the Irish Banks) could not be borrowed in the ‘normal’ way by the Irish State.”

But let’s be clear. This bond issuance is a transaction between the Irish government and the banks. They could issue exactly these bonds to the banks in return for these loans even if there were no ECB.

Would it have the same effect on liquidity if the banks weren’t able to repo them at ECB? No, but the focus on liquidity is, imho, misplaced. People are assuming that NAMA is going to get 54bn in liquidity into the banks and lent out in Ireland. But that’s not going to happen.

By Post Author

@BL

Nope – the KW questions are not rhetorical.

@KW

“But let’s be clear. This bond issuance is a transaction between the Irish government and the banks. They could issue exactly these bonds to the banks in return for these loans even if there were no ECB.”

Of course you’re correct in what you say above – but the Irish State can’t pay the salaries and pensions of its obliviously happy Public Servants with half-finished ‘developments’ in the Midlands – they need Euro cash. To get it they need solvent Irish Banks to get it for them from the ECB.

“Would it have the same effect on liquidity if the banks weren’t able to repo them at ECB? No, but the focus on liquidity is, imho, misplaced. People are assuming that NAMA is going to get 54bn in liquidity into the banks and lent out in Ireland. But that’s not going to happen.”

In relation to your second point above – what the Irish Banks do with the rest of the ECB-sourced dough ie that not being used to buy Irish Government Debt, is clearly a crucial, but I would argue a different question from the one I’ve been trying to explore here.

Some guys is making a lotta doh outta dis! The vig ain’t de problem, it’s the upfront commission to the bag guys ….

@ all

ok, so at the moment, Irish sovereign CDS has come in slightly (5y: -7bps to 148bps), AIB/BOI LT2 paper is 4-5pts higher, and the bank stocks are c.20% higher, based mainly on NEW overseas demand, with the US seen to be particularly interested.

No matter what u think about Lenny, it appears he’s done a half way decent job 24hrs into the new NAMA world…

@Eoin

Not sure that this has much to do with the Minister’s performance in the past 24 hours.

My interpretation of these events is that the Minister is delivering—in an opaque and unsatisfactory way, admittedly—essentially the mean (as in mid-point!) expected scenario. Uncertainty has been resolved and reduction of variance is positive for stock and bond prices.

The haircut may not be too much different than expected but the small probability of nationalisation has receded, so share prices go up.

The state may be taking on extra debt but the sovereign bond market knew all about this already. They’re perhaps relieved that the bailout is about as expected though that is perhaps over-interpreting a tiny CDS move.

Is that a reasonable interpretation?

By Post Author

@ Karl

its probably a reasonable interpretation. But, without saying the ‘zero sum game’ theory doesn’t have a lot of merit to it, at this moment in time everybody is slightly better off, in terms of market pricing, than they were yesterday. As such, i would say that the first step in what is going to be a long long long long process lasting years has at least gone to plan. Its something everyone should be happy with. As i said this morning, would we be happier with AIB shares falling by 30%?

@Eoin

Yes, as a macroeconomist, I’ll acknowledge onen can write down models of the world in which a reduction in uncertainty benefits everyone. And without doubt, the NAMA process created a lot of uncertainty, which was partially resolved yesterday.

But beyond that aspect, in relation to everyone being happy, sorry to be a curmudgeon but yes, as a taxpayer and (unlike Brian) someone who doesn’t hold bank shares, I would have been happier if AIB shares had fallen by 30%.

I know you’re going to scold me know about the plaugues of locusts that would have descended on us in that case but you’d hardly expect me to say otherwise, right?

By Post Author

@ Karl

correct. I’m on perma-locust watch these days. However as a taxpayer you do infact own AIB shares via the warrants. I know the uplift in them may not end up being greater than any overpayment turns out to be, but with the overpayment now likely set in stone, shouldn’t we be looking for what positives there are for the taxpayer? Lower CDS/yields, more value in our warrants, some more stabilisation in the banking sector, more chance of private sector invovlement in the recapitalisation process?

I’m not saying you should give up highlighting/critisising the parts of NAMA you don’t agree with, but shouldn’t we also be willing to discuss the things that are apparently positive for all involved? It’s only one day, one trading session, but its better than nothing.

Pat McArdle’s use (after many others) of the phrase “the only game in town” set me to remembering where I first heard the phrase. It was the punchline to a venerable joke. Kurt Vonnegut’s version is here – http://www.vonnegutweb.com/archives/arc_onlygame.html.

“A guy with the gambling sickness loses his shirt every night in a poker game. Somebody tells him that the game is crooked, rigged to send him to the poorhouse. And he says, haggardly, ”I know, I know. But it’s the only game in town.”

@ Graham

ah come on, i specifically said “keep highlighting/criticising”! But i am gonna assume its the deal that gets passed, as the markets appear to have. That being the case, i think its encouraging how the markets have reacted on all sides of this. And that being the case, a fall in AIB’s share price benefits absolutely nobody, and certainly not the taxpayer. From an optical point of view maybe a slight fall wouldn’t have been a bad thing, but fundamentally we all need and want AIB’s share price to go higher.

@ All

btw, fwiw, having spoken with a few guys who work in banks in london on various sides of the markets, Lenihan was considered very impressive and on top of the issues yesterday. Cowen gets good marks, Kenny is considered weak, and Bruton is generally considered good but seemed slightly below par yesterday.

@Eoin

There is a downside for the taxpayer if the share price goes up because we will get less equity for our money when we go to recapitalise. FT Lex column mentions this today.

@eoin

“btw, fwiw, having spoken with a few guys who work in banks in london on various sides of the markets, Lenihan was considered very impressive and on top of the issues yesterday. Cowen gets good marks, Kenny is considered weak, and Bruton is generally considered good but seemed slightly below par yesterday.”

Huh? Nobody who matters in the bond market or any market gives a hoot about how anybody performs in the Dail.

spreads came in because its 54Bn not 60Bn or higher. that’s all.

@ Zhou

i read that, didnt really understand the logic? I can understand it from a control issue, ie €1bn only gets u 30% now as opposed to 50% last month, but thats the same for any investor who owns some shares but wants to own more. It also didnt seem to look at the idea that it would decrease our required capital injection. I say this on the basis that the likelihood of AIB attracting private capital increases in line with their share price. If AIB still cant raise private capital at say €4/share, it doesn’t mean that thats where we have to pay for it.

@ John Looby
You say “NAMA is the likely ECB sanctioned (possibly even designed) response to this situation”.

No.
The ECB on the whole would be in favour of responsible policies, as outlined in most detail by the IMF. The European Commission has made clear it wants an open playing field between banks across Europe.
And as KW says,
the ECB have not made a “decision” to “support the NAMA plan” by accepting the NAMA bonds as eligible collateral. Rather they are sticking with their existing operational procedures.

@Ciaran O’Hagan

“The ECB on the whole would be in favour of responsible policies”

There can be no argument with the above statement.

But, do you really believe that a Euro-Zone State could issue new Bonds to its own Banks to the tune of almost its entire existing stock of outstanding debt; that said bonds could then be exchanged for cash and subsequently rolled over on an indefinete basis at the ECB, and that such a mechanism could be reasonably described (in spirit if not in letter) as the ECB “sticking with their existing operational procedures.”?

@Conor
The problem if interest rates go up is that the companies that are currently paying on their loans may not be able to pay any more – the default/impaired/downright criticised level of loans will rise. So NAMA’s income could be less even though it should be more.

I have heard euribor + 0.5%, refi + 0.5%, six month maturity, six month rollover, six month reset. I am none the wiser as to what these bonds are and what the risks are as a result (although I am aware of the risks of each of them).

I am beginning to suspect that even with the current level of overpayment the numbers don’t add up for the banks or the government –
long duration = lower repo (higher haircut),
short duration = rollover risks;
refi + 0.5% = risk of severe haircut when ECB liquidity window closes;
euribor + 0.5% = reset risks.

There have been two severe credit crunches in the last ten years, the current one and the 9/11 one (that I am aware of). In the ten years before that, there was the Asian debt crisis and the Russian default. What chance of going another ten years without one?

@Derek
While it would make sense to have varying start dates to not have a single big rollover/reset event, how likely do you see that as being? The loans can hardly be transferred to NAMA piecemeal, so they will probably be transferred in a single chunk from each bank…

@John Looby

I have seen nothing from the ECB to suggest that “said bonds could then be exchanged for cash and subsequently rolled over on an indefinite basis at the ECB”. They may well stop infinite liquidity operations before NAMA is done. Most likely will considering NAMA is going to last 10 odd years.

@ yoganmahew

i was under the impression that they would be transferred piecemeal, and BoI stated that this is what they believed to be the case today as well (they said they’ll take each writeoff in the financial period that they are transferred). However, that said, they also seemed to suggest that the biggest loans will go at the start, so quite likely in one big chunk or very close together.

@Eoin

My understanding is as follows:
– A fully recapitalised detoxified bank will have a total share value of €x in, say, two years’ time.
– €x does not vary according to when capital is injected.
– The amount the state can recover for its investment is y% of €x, where y = the state’s percentage shareholding in the bank
– y is inversely proportionate to the bank share price [should this be share capital?] at the time of recapitalisation.
Therefore, the greater the bank’s share price the less bang the state will get for its buck in a recapitalisation.

Now, it is always open to the state to make a low-ball offer for recapitalisation BUT the banks can call the state’s bluff by recapitalising to a smaller degree privately and then proceeding as zombies.

By decoupling NAMA from recapitalisation and by announcing the estimates first we are eroding our future negotiating position with the banks. If NAMA and nationalisation (partial or otherise) are the two sides of the one coin then they should be linked, i.e. the banks should not be allowed to sign up to NAMA unless they sign up to a formula to govern any future recapitalisation as part of the same deal.

Recap will come, late and small, from the NPRF. It will be to a level that combined with the banks existing capital will bring them to 5-7% ratio, which while adequate for regulatory purposes is below market norms. We will have slightly fresher, semi-liquid, zombies.
Hooray. Not

@ Zhou

ok, i see where you’re coming from, but i still find it unlikely they’d deliberately under-capitalise themselves. As i said, it makes sense that as more private capital pushes the share price higher, it should be far easier to convince private capital to inject fresh new capital into the bank itself. There’s nothing in a zombie bank for private shareholders to gain from.

However, please note that if they were to deliberately do this i will be leading the pack to nationalise them straight away.

The gain from private shareholders in semi-zombies is that they have a larger share of some cashflow versus a much much smaller share of a larger cashflow in recapped banks. Status quo bias tells us they will stay with being zemi-sombies….

I think the government may have made a tactical error. By overpaying for the assets by at least 15% they have engineered a back door recapitalisation of the banking system. This has allowed the market to drive up the shares to a new plateau closer to a higher level of valuation. The banks have thus emerged with more capital courtesy of overpayment so consequently they need less capital to reach regulatory minima. With more capital, the absence of nationalisation and more funding from the ECB the risk premium on their private sector funding goes down.

This presents a far better investable proposition for private capital to flow in. Consequently, we are likely to see rights issues of more limited size at higher prices than two or three months ago. In short less dilution for existing shareholders. If the govt underwrites them, it may end up not getting much of a share.

Consequently, we will probably emerge as taxpayers with all the downside risk abut none of the upside potential. The banks are already going down this route, in talking down their capital requirements.

@JL
I cant reconcile these two statements
“I think the government may have made a tactical error”
and
“Consequently, we will probably emerge as taxpayers with all the downside risk abut none of the upside potential. ”

I have all along suggested that the objective was to avoid nationalisation/massive dilution at almost all costs. And lo….So how can achieving your aims be an error? The banks and the govt have what they wanted. Game over.

@jl
I think the problem is not that the banks have more capital (movements in the share price don’t translate to changes in share capital), but that the percentage shareholding a certain amount of capital would buy is diminished. Before the NAMA details were announced yesterday, a 2 bn equity recapitalisation would have bought 50% of each of the big banks. Now it is heading towards only 25%. This is a major loss to the taxpayer.

@ Brian Lucey,

I was giving the govt the benefit of the doubt in assuming a pragmatic outcome where they would overpay a little and take an appropriate stake (short of nationalisation) at an attractive valuation in the banks.

Unlike some here, I am uncomfortable with nationalisation on many fronts, ranging from i) politicised lending-the Anglo HQ ii) the plain inability to fund-deposit flight & iii) the inability to attract talent to run them iv) taint on the sovereign-wait til market consolidates AIB balnace sheet on to ours

The banks got what they wanted which was to minimise govt involvement but I am not sure what the govt has got. It has overpaid, got no commitments on lending, got no risk sharing, got no upside. Still as long as we have that rock solid commitment of ECB funding at 2% below market rates that Willie promised us. He must have slipped out of Cabinet at that point.

@ Yogan,

agree-sloppy drafting. I meant that the banks have more capital than the might have had if Lenihan had not overpaid so much. You are quite right as well. Share prices have risen due to overpayment resulting in less of a stake for our money-if any at all.

Minister Willie O’Dea, on Primetime last night, appears to disagree with the Minister for Finance. After R. Bruton pointed out the cash-flow implications for NAMA should (when) short-term rates increase in the future Min. O’Dea replied that “…the arrangement with the ECB is that we will be paying a rate of interest that is about 2% below their average rate of interest.”

A few questions spring to mind.
– What is the “ECB’s average rate of interest”
– Why haven’t we been told about this fantastic arrangement with the ECB?
– Why is the Min for Defence announcing huge changes to NAMA that the Min for Finance doesn’t appear to be aware of?

Or is Min O’Dea completely confused about the operation of NAMA because he has heard that NAMA’s raising 6 month money “about 2% cheaper” than the NTMA is raising longer dated money.

Amazingly Bruton didn’t pick up on this obvious gaff/misrepresentation and allowed Min O’Dea to dodge the interest rate risk issue entirely.

@roundabout
Both Bruton & Little picked up on it – Little moved it on as Wee Willie was filibustering.

@Garo

“I have seen nothing from the ECB to suggest that “said bonds could then be exchanged for cash and subsequently rolled over on an indefinite basis at the ECB”.

Expecting an explicit statment along these lines from the ECB is unarguably pointless.

Equally, the lack of such a statement in no way suggests that the practical operation of the NAMA mechanism won’t be effectively along such lines.

In the current information vacuum we are left grappling to make reasoned conclusions – only time will tell on this one, and maybe we can agree to disagree on it for now?

Might be worth pondering however why Simon Carswell in the paper of record today (P.15) is so categoric in stating:

“the NAMA plan, under which the government is borrowing Euro 54 billion at a very favourable rate of about 1.5 per cent under the blessing of the European Central Bank (ECB)” … “NAMA is a complex plan to repair the banks, secure cheap European money from ECB headquarters..”

Where is he getting such ideas?

[…] these are not ten year loans – Lenihan amitted that they are 6m loans. So everyy 6m we go lookin for the principal to be borrowed to repay the outstanding amount. the rate is not 1.5% over anything, it is 1.5%. And this is paid for from NAMA income or the state if that is not enough. A long disucssion on this at The Irish Economy Blog Archive NAMA Bond Yield Formula Finally Revealed […]

What’s really interesting is the controversy over the regular NAMA bonds which will be issued with a six-month rollover period with an interest rate set at a half percent above the ECB’s main refinancing rate. Are these really short term or are they long term?

Karl whelan’s theoretical persepective is correct “because bond market participants aren’t stupid, long-term rates are determined with reference to this short-term rollover strategy, so there is no “free lunch” from issuing short-dated rather than longer-dated bonds.”

So long term rates will differ from short term rates because if an investor borrows long term they will fear the damage caused by increasing interest rates and this
outweighs any benefit they would get from falling rates. The liquidity preference theory states that lenders prefer
to lend short term and borrowers’ prefer to borrow long term. Borrowers pay a premium for long-term debt
because there is less exposure to the risk of having to repay the debt under adverse conditions. On the other hand
lenders demand a higher return on long-term debt because they are exposed to more interest rate risk. In other
words, lenders are assumed to have a liquidity preference for holding cash and therefore borrowers must offer
an interest rate high enough to induce lenders to abandon their preference for holding cash. Therefore because
lending long term means giving up more liquidity, long-term rates should be higher than short-term rates.

So is this1.5% “some blessing” or “conspiracy” by the ECB or is the ‘true cost’ of these bonds not made explicit?

Perhaps the Kelly and King research (www.KingResearch.ie) give us the answer? Here everybody is a winner: banks, government and taxpayers.
Because ECB cannot buy gov bonds directly it can do so indirectly via the banks borrowing short term, buying gove bonds and then refinancing at 1%. Is this not QE ECB style especially if the NAMA bonds are treated the same?

@thomas power

“Is this not QE ECB style especially if the NAMA bonds are treated the same?”

um .. no, this is not quantitative easing by ecb.

it is a normal repo market transaction, consistent with normal ecb rules.

NAMA bonds will end up in the interbank repo market. will we then hear that Morgan Stanley or Soc Gen are helping out with QE also?

you are right about one thing though. NAMA is a positive carry trade for the banks. they will earn 50bp (about 250m) from carry. however this is coming from the taxpayer not from ecb, as the taxpayer is paying the 1.5% coupon.

sadly, the only “free-money” here is free money from the irish taxpayer gifted to financial institutions.

Dermot Desmond’s article ‘financial institutions should be left to manage their own delinquent assets’ in the opinion section of the Irish times proposes a government insurance guarantee scheme that “would achieve exactly the same impact” as NAMA “without any additional risk”. He begins by opposing any valuations of the underlying properties of bank loans on the basis that it is not fair to taxpayers. But what he fails to understand is that it is not valuations per se but valuation methodologies that is unfair to taxpayers. Undoubtedly the valuation methodologies used by valuers have contributed to the asset and property bubbles and the toxic loans that go with them and this has indeed exposed taxpayers to risk. Nevertheless, any attempt at solving the problem comes down to an appropriate valuation of these toxic assets. The success or otherwise of any proposed solution (including Mr Desmond’s proposal) depends on how well the economy recovers going forward. This is why economic value is the appropriate measure.

Bearing this in mind, Mr Desmond seems to believe that banks can issue €60 billion of bonds (guaranteed by the taxpayer) without the underlying real estate being valued. It is, in his opinion, “a purely book-keeping exercise and could be done overnight”. I’m sorry but I don’t agree. Any investor who purchases these bonds will want to know what is the net value of the underlying asset and what cashflows these assets will generate and what risk is attached to those cashflows. Indeed apart from being a simple book keeping exercise property loans must have an up-to-date valuation in accordance with the RICS red book.

He goes on to say that the government can charge a “transparent fee” for this insurance. But it cannot be transparent if no sensible economic valuation is put on the properties. The way his proposal works is that the banks will buy insurance from the government to indemnify them (the banks) against any losses. Mr Desmond wants this insurance scheme to be fair to the taxpayer. But if it is to be fair to the taxpayer the insurance must be priced correctly to account for the risk the taxpayer takes on. This would involve a huge cash outflow from the banks thus delving the banks into further liquidity problems (which Mr Desmond rightly points out is the problem that banks face) and moving the end solution to nationalisation which Mr Desmond doesn’t want.

Furthermore, if NAMA is not involved in the valuation the banks will do the valuation themselves with the incentive to overvalue the properties to be included in the insurance scheme. This leaves the taxpayer picking the bill for the losses on the overvaluation.

Finally, while there is no ‘silver bullet’ solution to this mess, Mr Desmond’s insurance guarantee proposal is a case of “taking out insurance after you’ve crashed the car”.

Look, the proof of this pudding will be in the eating. Whether this is cheap or dear borrowing for the taxpayer will be assessed by the market value of these bonds. If they trade below par, and I very much suspect that they will, then the taxpayer has been able to exchange paper for its face value even though its market value is less.

@ Thomas Power

a lot of Dermot Desmond’s plan had striking similarities to the UK asset protection plan, and this was roundly noted by those who are supporting Desmond’s idea. However, as we’ve seen in the last few days, almost nobody has actually signed up in full to the UK asset protection plan yet, and both Lloyds and RBS are desperate to stay out of it, such is its structure. Now i’m not saying that this means it doesn’t have merits (the “whats bad for banks is good for society etc” debate), but its quite clearly been far less successful than some would have thought or indicated.

Furthermore, a cynic would argue that Desmond would prefer to be able to pick off some of these loans/property assets from desperate banks rather than trying to do the same against a long term and well funded NAMA vehicle (in any shape or form)…

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