After a somewhat unsatisfactory appearance together on Prime Time last week, in which we got to share fourteen minutes of airtime with a trade union leader and a property developer, I asked Donal O’Mahony (Global Strategist with Davy’s) if he was interested in writing a guest post on NAMA for this blog. Donal agreed and his post is below the fold.
NAMA: Misunderstood and misrepresented, but not misguided
The kids are back to school, and the evenings are closing in, but the silly season looks set to extend as the public debate over NAMA reaches its fever pitch. It feels like déjà vu all over again, that dispiriting mix of half-truths, misconceptions and disingenuities which blighted the 2008 Lisbon debate now making its reappearance on the NAMA stage. Reinforcing the prevarications of the NAMA debate is a darkened public mood, borne out of the economic misery of the past 18 months, and against which property developers, banks and government have constituted a rogues gallery in a vindictive blame game.
Public antipathy towards the NAMA project is therefore perfectly understandable in the current climate, not least in relation to that thorny issue of discounted purchase prices for the €77bn development loan book of the participating banks. However, perhaps the most overlooked point in the entire debate is that Ireland has long needed a NAMA construct, even if there wasn’t a solitary “toxic” asset to be found in the Irish banking book. The severe funding disruptions occasioned by the global credit crisis have exposed banks worldwide as dangerously over-lent, Irish banks included, and it is the enforced downsizing of the international financial system that continues to restrict much-needed flows of credit in both the global and domestic economies.
Stabilisation of bank balance sheets is being engineered through the joint forces of recapitalisation and asset disposals. Both developments are now gathering pace internationally, with private investment capital increasingly supplanting government capital, and marketable-asset sales being more readily achievable as investor appetites revive.
Alas, deleveraging is a far more intractable problem for the Irish banks, given the non-marketable nature of their bloated loan books, and with persistent solvency concerns impeding their access to longer-term capital. Solvency issues are also impacting on Irish banks’ access to the shorter-term funding markets and, with loan-to-deposit ratios for the two main banks in the 150-160% range, it has been left to the ECB to plug the funding shortfall in the Irish banking system to amounts in excess of €70bn at end-July.
It is towards this funding and credit log-jam that the NAMA project now takes direct aim. In replacing illiquid and impaired loan assets with debt eligible for refinancing at the ECB, the creation of NAMA has two immediate benefits, in simultaneously assuaging both solvency and liquidity concerns surrounding the Irish banks. By cleansing bank balance sheets of “toxic” loan assets, NAMA will dramatically transform the shorter-term funding prospects for Irish banks in both the deposit (wholesale/retail) and debt capital markets, whilst paving the way for longer-term capital raising in the domestic equity market. Most importantly, the combination of loan asset transference and enhanced funding flows will sharply reduce loan/deposit ratios at the Irish banks towards the 100% zone, thus providing the wherewithal for the resumption of prudent lending to corporates and households alike.
To be sure, domestic credit creation will be slow to revive in a recessed economy, but revive it will, the profit-maximisation motive a sufficient spur as lending margins rebuild. With economies rebounding internationally, and credit reviving domestically, Ireland can break free from its textbook debt-deflationary spiral of the past two years and embrace the recovery trail.
Thus far, all discussion on the potential economic benefits of NAMA has been trampled underfoot by a fixation on the “haircuts” to be applied to impaired loan assets at the transfer stage. It is here that many commentators have been at their most disingenuous, casually interchanging loan assets with property assets as though they were one and the same, and thereby misguiding public perceptions regarding NAMA “overpayment”. Such commentators have also falling victim to the fallacy of composition, failing to acknowledge key risk disparities in existence across the development loan books vis-à-vis regions (Ireland, UK, US), sectors (residential, commercial) and status (land-bank, work-in-progress, completions).
The fog was lifted somewhat on 16th Sep last, Finance Minister Lenihan providing key details regarding the scale of the NAMA asset swap (E77bn), the distribution of property assets across sectors and regions, the average embedded LTV (77%, pre interest rollups), the average loan haircut to be applied (30%), and estimates of both current market (E47bn) and “long-term economic” (E54bn) valuations for that once E88bn peak-valued pool of property assets. Through all the fuzz, NAMA’S effective price discount on its acquisition of impaired property assets is 47% (per “current market values”) or 39% (per “long-term economic values”). As a starting point for NAMA, such discounts represent a substantial alleviation of taxpayer risk, bearing in mind (a) the Agency’s cyclical starting point vis-à-vis both the Irish and (especially) UK property markets, and (b) the undoubted linkages between a revival in credit availability and that of the property valuations themselves.
NAMA is designed as a holding operation, pending longer-term realisation of “real economic value”. To be sure, the Irish property market may have further to fall, but signs of stabilisation are already apparent in UK commercial property, and current indicative yield levels suggest that Irish commercial property may not be too far from its trough. The recent Hilfiger deal on Grafton St reminds that the restoration of “positive carry” in any property downturn sows the seeds of incipient stabilisation/ recovery in asset valuations.
In the interim, NAMA is designed to be cash-flow neutral on an operational basis, with income from performing loans exceeding debt interest payments and administration costs. Accordingly, any prolonged holding operation (7-10yrs?) pending “long-term economic value” should constitute no further drain on Exchequer resources. As global recovery takes hold and ECB policy rates normalise, NAMA’s positive funding gap between its assets and liabilities will be maintained, and indeed may well improve further if the initial ratio of performing to non-performing loans picks-up as both real economy and asset cycles turn.
If NAMA is demonstrably seen to be acquiring property assets at a substantial discount (47%), if its daily operations impose no cash-flow hit on Exchequer funds and, crucially, if its asset transfer can be shown to dramatically transform the funding (and hence lending) prospects of the Irish banks, then any rational and dispassionate judgment must find in its favour.
Regrettably, the public debate on NAMA has been anything but rational and dispassionate. Confusion, misinformation and, at times, rank deception has run riot over the past several months, with a host of one-eyed kings regally bestriding the land of the blind. Tellingly, the brunt of discussion has majored on an anti-NAMA rant, with scant exposition of any credible alternatives. Nowhere is this more depressingly obvious than in relation to the nationalisation option, wherein protagonists have tended to confine their treatises to a short paragraph or three, and where the potentially ruinous funding consequences for both the banks and sovereign have been glossed-over by facile theoretical arguments far removed from real-world practicalities.
A more recent suggestion that the financial institutions be left to manage their own delinquent assets by directly issuing longer-dated (10yrs) government-guaranteed bonds to fund an internal good-bank/bad-bank carve-up appears well-meaning, but no less misguided. One obvious and considerable drawback is cost, given likely bank funding of 9%+ (mid-swaps +500bps plus govt fee) vs current ECB funding of 1%. More than this, however, the retention of impaired assets on bank balance sheets (however shadowy the corner they are parked in) would continue to cast a deep pall over perceived solvency risks in the Irish banking system, leaving this country still bereft of the necessary refinancing flows from which green shoots might grow.
When all is said and done, NAMA is not a bail-out of developers, or bankers, but of a banking system and its host economy. In that respect, it is a bail-out of ourselves.