Guest Post: Donal O’Mahony on NAMA

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.

57 thoughts on “Guest Post: Donal O’Mahony on NAMA”

  1. Good to see some pro-NAMA economist contributing to the debate here.
    Fair play Donal!

    I think most of the “NAMA opponents” as you call them aren’t against an asset management agency but are opposed to the terms the taxpayer is getting.

    For NAMA to work the following assumptions have to be met and in my opinion they will not be.

    1. LTV of 77% is very optimistic.

    2. NAMA will be cashflow neutral
    This assumes that as interest rates increase the interest NAMA will receive will match the interest in pays.
    But as interest rates increase defaults will follow, even on the currently “good” loans, and the interest NAMA receives will decreases rather than increase.

    3. Yields & Prices
    Firstly, no allowance is made for a further fall in rents.
    With the commercial vacancy rates at all time high of 25% I think this is very likely. Would you disagree?
    Yields returning to “normal” levels could be achieved through falling rents rather than increasing prices in my opinion.
    The high yields you have quoted have more to do with expectation of future falls in rents than anything else.

    The yields given my NAMA were for Dublin commercial properties only which probably represent less than 10% of the total loan portfolio.
    No analysis was done for the residential yields which are currently just over 3%.
    With rents continuing to fall dramatically it would appear that residential property still has significantly more to fall.

    4. Loans vs. Property Prices
    NAMA assumes that property prices have fallen by 47%
    It uses the €88bn estimated property value to come up with a current market value of the property of €47bn.
    And then goes on to say that the loans are worth €47bn. In my opinion if the security underlying the loans is worth €47bn then the loans would be worth less than this.
    So I think the government could also be accused of confusing loans value and property values.

    5. And the big one!
    The property market is at the bottom and will increase!

    Another very simple point I just cannot get my head around.

    What benefit does the taxpayer get from overpaying for the loans through NAMA rather than saving the money and recapitalizing directly?

    What international evidence is there that nationalized banks face higher funding costs than private banks?
    Surely the extra backing of the state would decrease funding costs.

  2. @ Donal,

    “NAMA is not a bail-out of developers, or bankers, but of a banking system and its host economy.”

    “host economy”?

    I wonder what the parasite looks like.

    😈

  3. “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”.

    Is there a suggestion here that the “loan assets” are more valuable than the underlying “property assets”.

  4. Not fair Donal, and I suspect you know it. Your host, Karl Whelan, has written a lot more than three paragraphs on an alternative version of NAMA – note, not alternatives to NAMA, but things, including Nationalisation.

    You wrote: “…..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.”

    This, may I suggest, is more than a touch discourteous. KW will be far too polite to reply in kind.

    Why, I wonder, have Davy stckbrokers consistently and relentlessly toed the government line on NAMA? From the Banks team, to the CEO and now the global strategist. Surely there can be no vested interests at work here? Surely there is no investment banking business to be had in the forthcoming restructuring of the Irish finncial landscape.

  5. @ Greg

    i swear to God i didnt give him that “real-world practicalities” line! Though great minds n all that…

    More seriously, i’m glad that there’s been a full and coherent explanation of what the pro-NAMA side feels and has tried to get across in venues such as this. There is a real fear that nationalisation followed by full-on insolvency proceedings would significantly impare the funding efforts of the State and its financial system. Certainly wiping out foreign debt holders and then immediately asking them for new funds seems unlikely to be successful. Equally, from an investors point of view, being willing to invest in a freshly announced insolvent financial system also seems unlikely to occur.

    While at a rational theorethical level, these events might take place, but markets are very often far from rational when faced with something as unprecedented as the full nationalisation and insolvency of an entire national financial system. The danger would be that foreign capital takes a large step back and waits for the dust to settle a year or two down the line. As an example of the bank that i work with, we still haven’t renewed credit lines with either Northern Rock or Anglo, but continue to have credit open to RBS, Lloyds, AIB and BoI. Reputational factors would also play a part in this.

    @ Simpleton

    in fairness to Donal, on this site i have on more than one occasion asked for an at least relatively detailed explanation of how much can be saved (debt wiped out) via a nationalisation & insolvency process (i’ve suggested a couple of billion tops), how this would interact with the govt guarantee and the broader economy, and what the assumed process would be for re-injecting capital, re-launching the banks, and eventually re-privatising the banks. Figures, time lines and basic working assumptions have been requested, and i’ve yet to see anything more than a 3-liner on this process. Indeed, i’d also want to see what the contingency plan for a funding freeze-up would be. At the moment, NAMA-as-is works in terms of funding, and has been accepted as satisfactory by the markets and the ECB. These are key attributes which the anti-NAMA side needs to take into account.

  6. Donal,

    To conflate NAMA with Lisbon is dangerous ground. I know, I know, Fianna Fail are doing it. That doesn’t make it a safe tactic. It risks alienating and confusing the electorate regarding the choice they must make about the future direction of the European Union.

    I, like you, am dispirited by half-truths.

    Can you clear up a half-truth?

    Does the Irish State have a 25% equity stake in Allied Irish Bank or Bank Of Ireland?

    For clarity, I don’t consider Redeemable Preference Shares as “equity”. From various interviews on radio and television the man in the street could easily be left with the opinion that the State “owns” 25% of AIB & BOI.

    As you say half-truths are not helpful.

    What say you? Truth or half-truth?

  7. Eoin Says:
    September 22nd, 2009 at 9:25 pm

    @ Greg

    “i swear to God i didnt give him that “real-world practicalities” line! Though great minds n all that…”

    😆

    Eoin,

    Didn’t see that. Still deconstructing the language.

    You’ve got me worried now. Possibly Group Think?

  8. “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. ”

    Is the figure of 47 per cent incorrect? Even if one takes the assumed peak value of 88 billion for the underlying property (rather than the 77 billion loan book), an acquistion price of 54 billion does not consistute a 47% discount. Moreover, is DO’M not guilty of doing the very thing he complains off, i.e. confusing the acquisition of loans with the acquisition of property?

  9. “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…”

    Tellingly, actually, I would have seen three of the main one-eyed kings as being Willie O’Dea, Eamonn O’Cuiv and Frank Fahey, all three of whom have sown confusion and misinformation – I’ll spare them the accusation of rank deception – in their explanatory defences of NAMA on the airwaves.

  10. @ Donal,

    “It feels like déjà vu all over again”

    I know. I feel your pain.

    We have had the greatest misallocation of capital in the (short) history of the State and now we’re going to see it all over again.

  11. @ Donal,

    “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.”

    While your words have a seductive bird-woman quality I am inclined not to follow.

    The overlooked point that has been brushed (or is that hushed) under the carpet is that Ireland has long needed a Financial Regulator that was not captured by the industry regulated.

  12. @ Donal,

    “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.”

    Donal,

    Apart from the fact that what you say is true, and without engaging in the causal case, can you not see that what you say is self defeating?

    “enforced downsizing” by definition means that there will be no “recovery”.

    The excess credit must be removed. Creating yet more credit to overcome the failure to repay credit already advance will compound the problem.

    It is liquidation that is required. Not just in Ireland, but globally.

    Debt destruction is essential. The real (local or global) economy cannot recover until excess debt has been eliminated and price discovery is not influenced by the creditor.

    Shifting the debt burden from the private to the public solves nothing. The economy still has excess debt.

    Of course the private (the creditor) is quite happy to shift their bad debt problem to the public purse.

    Why would they not be?

  13. @ Donal,

    “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.”

    Donal,

    Hallelujah

    “…with private investment capital increasingly supplanting government capital…”

    Do you have a time frame on when that will happen in Ireland?

    It seems we are going in the opposite direction.

  14. I think the article contains a lot of good stuff but I think the condescending languange and speculation about and condemning of other people’s intentions and thoughts dim the message.

    ————

    Donal O’Mahony says:
    “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.”

    I think Donal O’Mahony should understand that the disquiet and debate over the haircuts was largely inspired by “analysts” published “assessment” that the Govt would skew values to avoid >50% nationalisation.

    More telling by far, nowhere in Donal O’Mahony’s article does he expand on the risks of a lower haircut or give any cogent justification for the amount of the hair-cut as is.

    —————–

    Donal O’Mahony also condemns people for confusing and interchanging property asset values and loan asset values… and then goes on to do the exact same thing…:

    “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” ”

    “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”

    According to the documentation published on 16 Sept 2009, the E47bn refers to loan values, as does the E54bn. Neither valuation refers to property assets. It is a pity Mr. O’Mahony couldn’t explain to us how loan values relate to market values. At least then he might have helped clear up the confusion which so reviles him.

    ——————–

    I also think the following statement should have been left out after a night in the desk drawer:

    “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.”

    It is just not smart for people in glass houses to throw stones. I think there are a lot of people who would laugh to hear financial advisers and analysts refer to others as “one-eyed kings”. I think there are many more who have no laughter left at all. Some of us fear that those in glass houses think they are in country house gazebos.

    ——————–

    I also have a problem with the commentators who advocate nationalisation being villified, viz:

    “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.”

    The IMF has said nationalisation must be countenanced as have other reputable people. Indeed, even the Minister has said it may be necessary. However, very few financial analysts or commentators have given any detail of the problems involved and only the Minister for Finance has expanded on the possible costs.

    I fear nationalisation but one gets the feeling that those who are aware of the good arguments against it are withholding them from the public for fear of lending credibility to an opposing point of view. Such an approach, if it exists, would be contemptuous of the democratic process and the sovereignty of the Irish people. (We can all wrap ourselves in a flag when we wish).

  15. I probably went a bit over the top there – I might be suffering from Stockholm Sydrome 🙂

    I thought the article was generally a good piece even if I did feel it could be criticised in part.

  16. @Gadge
    “Moreover, is DO’M not guilty of doing the very thing he complains off, i.e. confusing the acquisition of loans with the acquisition of property?”

    The taxpayer is acquiring loans (toxic). These are easily valued on the international debt market.
    DO’M -“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.

    It is the price that is the problem. We have seen reports of Gov refusal to consider offers for Anglo US loans.

    The market price of the loans in all jurisdictions would expose the true extent of the horrors.

  17. “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.”

    I am intrigued by the often repeated line that NAMA is cost-free to the taxpayer. Of course anyone can cook up some favourable scenario where this is the case. But no-one can truthfully claim that NAMA is risk-free for the taxpayer (as it is for banks).

    In fact risks for taxpayers are heavily skewed to the downside – e.g. NAMA starts in a 7Bn+ hole, we are at bottom of interest rate cycle, depth and duration of property collapse etc.

    The taxpayer is being told to ignore a lot of nasty real-world tail risk.

    How ironic that the financial industry blew itself up doing precisely that.

  18. €54bn including the €7bn uplift includes an amount to be paid for Anlgo Irish Bank and INBS loans not counting additional equity for Anglo. (Rump INBS will probably be merged into EBS)

    If anyone is promoting Nama’s positives then surely the fact that none of these two banks will be capable of lending into the productive economy should be considered.

    Just how much of ECB liquidity will be passed through in the form of bank credit to productive viable enterprise remains to be seen. Pat Farrell (IBF) was quite certain his members were meeting demand and were advancing sufficient funds at this time- they have an “independent” report that says so.

  19. @ Donal,

    “Alas, deleveraging is a far more intractable problem for the Irish banks…”

    Damn, I knew it was too good to be true.

    Do I understand you correctly here Donal. On an International scale the Irish banks & Fianna Fail have made such a bags of it that we are the outliers on the curve?

    Jeeze Donal,

    Now you are scaring the horses.

    😯

  20. @Simpleton

    You do not need to be so coy, we know why Davy are loya supporters of all forms of NAMA -its a four letter word called “fees”.
    However, could you outline your position. Are you in favour of nationalisation or NAMA?

  21. @property Gal
    Seeing as you asked……simplifying the positions of the two camps, as I see them:
    First, the (sensible) nationalisers, such as KW. Contrary to the the ad hominem attacks that they have faced, they are pro-NAMA. But they are against loading all the risk on to the taxpayer. Note the use of the word ‘all’. They have always accepted that the taxpayer has to take a hit. It’s just the size of that hit. They, unlike Davy’s Global Strategist, have emphasised that we do not, and cannot, know how this is going to play out. Risk must therefore be shared between all the various players. It is a simple maater of fairness and efficiency. Hence, they, and the IMF, advocate temporary nationalisation in the context of NAMA.
    The (sensible?) anti nationalisers start by defending the interests of the senior bond holders (some even fret about the subbies). They then talk about liquidity crises post-nationalisation (the deposit base walks). They fret about the funding problems it will throw up for the state. They worry that the government couldn’t run a bath, let alone a banking system. They describe an apocalyptic vision of state directe lending by this mob of quasi-corrupt etc etc.
    I find much of the anti-nationalisation rhetoric bogus. It is argumet by assertion rather than evidence based. And it fails to think through the logic. For example, the arguments about debt holders leaves us with the assumption that senior debt, at least, always and everywhere carries a government guarantee. I’m not sure anyone ever told the taxpayer. Maybe it is, but it needs to be priced differently going forward (the taxpayer needs his cut). Also, if the government is too corrupt/inefficient/incomptetnt to run a bank (quite a simple business actually) what hope is there for eduaction, health or the police?
    Anyway, I would have taken a very pragmatic position and reversed engineered a haircut that implied the state taking a 60% stake in BOI and 85% in AIB. Arbitrary numbers, admitedly, one that refelects a very subjective assessment of the respective loan books. That level of state ownership gives the taxpayer a fairish share of upside and leaves the existing shareholder with some skin in the game. The two entities are still listed with all of the regulatory and market disciplines 🙂 that go with that.

  22. @ Simpleton

    “For example, the arguments about debt holders leaves us with the assumption that senior debt, at least, always and everywhere carries a government guarantee. I’m not sure anyone ever told the taxpayer”.

    I agree that no one ever explicitly told the taxpayer, but this doesn’t make the assertion on a government guarantee false or bogus. When you have systematic solvency and liquidity problems occurring across an entire nation’s banking industry, many foreign investors and decision makers start to see the problem as a sovereign one, or at least a quasi-soveriegn problem, and it is no longer individual bank risk that is in question. How else can an entire financial sector get into trouble if there was not some sort of incompetence at a sovereign regulatory and policy level? I know i’m going to be criticised for mentioning the dreaded ICE word now, but this is exactly why international investors are putting the sovereign Iceland state on the hook for the excesses and losses of its banking industry.

    If we were not in the fiscal and credit straight jacket that we currently find ourselves in, we could probably attempt to test the market’s stance in this regard, but i think the dangers of a real funding crisis as a result have been underappreciated.

    As regards the taxpayer getting his cut off this implicit government g’tee, i would argue that this has previously arrived in the form of a cheaper cost of capital than there would otherwise have been, but i think a more honest and transperent pricing tool would be better all round going forward. However, this would also probably see an increase in the cost of lending to customers as the banks factored this cost into their margins. The net effect would at least be that only those that use credit are forced to pay for it.

  23. Interesting to note that Goldman Sach’s chief European economist, Erik Nielsen, has praised NAMA in a client note as “the latest in a series of impressive steps” by the Irish Government to clean up the mess in our banking system.

    He also warmly praised the appointment of Prof Honohan.

  24. The fatal flaw in this pro-NAMA argument is that it fails to acknowledge that the government plans to overpay by 10 billion euro. This is hidden in the 15% forecast abnormal return to acquired property, and the over-valuation of assets in terms of current market values. The government is in a quandary since if it pays fair value, the banks are insolvent. If the government admits that it is subsidizing the banks and their shareholders and other security claimants with an extra 10 billion euros, there would be a public outcry. So it claims that it is not over-paying by 10 billion euro, while clearly doing so if one looks dispassionately at the numbers and likely values. These are essentially property loans on repossessed properties, and true values are a fraction of initial book values. The 10 billion hidden subsidy is the fatal flaw in the plan.

  25. @Eoin
    Your point about it being different for an entire system, rather than just one bank is, of course, absolutely right. The consequences of a force majeure, 100% overnight nationalisation of the system are almsot certainly too awful to contemplate.
    But I am not sure that was what KW and co. were ever advocating. I think, without wishing to put words in there mouths, they were suggesting something along the lines of my scheme, outlined above, Which, amongst other things, would protect bond holders.

  26. @ Concubhar

    slightly off subject, but related, in another of his weekly comments a few weeks back, Erik Nielsen noted with some worry that there appeared to be a turn towards the No vote in the Lisbon Treaty debate here (i think it was probably more due to some headline-grabbing marketing from Paddy Power than a real change in the trend!):

    “And finally, a not entirely trivial matter: Irish bookmakers said on Friday that they have cut the odds on a “No” vote in the Irish referendum on the Lisbon treaty on October 2.  The latest poll, which showed 54% in favour, is more than two months old, but sentiment could be changing.  The ratification of the Lisbon Treaty is critical for the functioning of the EU; it has been ratified by everyone apart from Ireland, Germany, Poland and the Czech Republic.  Ireland needs the referendum to go the right way.”

  27. @ Simpleton

    i’m fairly sure KW et al were arguing for complete (though ‘temporary’) Nationalisation of all the banks (possibly ex Irish L&P) per the IMF reasoning, on the basis that paying the ‘real’ MV on the loans would result in all capital being wiped out?

  28. @ Donal

    “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. ”

    Ireland’s property market can boast the following shocking vacancy rates; 20%+ in retail; 20%+ in commercial and perhaps 15%+ in residential. Add to this a falling population and mix in at least two contractionary budgets and I cannot for the life of me see anything but further downside for all types of property prices in Ireland.

    Moreover, NAMA is more likely than not too add to our oversupply of property. A fequent poster on the propertypin (yoganmahew) has highlighted this fact on numerous occasions. Essentially, NAMA might allow insolvent developers to finish projects for which there is no demand, and as I have already pointed out we have enough property of all types as it is. If the opposite occurs and all these half-finished developments dotting Ireland are scrapped then the taxpayer will be stuck with the losses on these projects as well. Heads I loose and tails you win.

    By the way, if I recall correctly, Anglo Irish was on Davy’s stock ‘focus’ list until the bitter end (as were AIB & BOI). Forgive me for taking the forecasts of any Irish stockbroker with a wee pinch of salt.

  29. “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.”

    This sentence struck me, among many in this vested-interest piece, as emblematic of the almost lyrical nature which the Nama debate has assumed.

    “But revive it will” has almost a spiritual ring to it. It is a hope-filled exclamation, a battle-cry to rally troops around a cause.

    What it is not is a reasoned argument in favour of reconstituting the Irish banking sector through the current approach.

    Donal and others who seek to mask their real motivations behind economicsy verse like this are simply not able to provide the solid reassurances that this plan will work, because they do not have them.

    Otherwise, the diatribe against the opponents of Nama contains nothing new – baseless character assassinations of ant-Nama economists in the form of accusations that they do not understand the difference between loans and securities of loans; the much abused Only Game in Town line dressed up in the specious “Look, we have a Ministry that can write 200 pages of pro-Nama legislation. Where are your 200 pages of pro-Nationalisation stuff? Ha! You haven’t got it! Ha!”

    I give up.

  30. @ Graham

    i haven’t asked for a 200-pager on the nationalisation/insolvency/debt wipeout/re-capitalisation/re-launch/re-privitisation process. I’ve simply asked for something longer than a few lines, with some solid expectations of how much can be gained from this, and what underlying assumptions and tools will be used in order to (a) make it a success and (b) be used if runs into difficulties. Given that NAMA-as-is appears to be accepted by the markets and appear to be workable, i think its important any alternative plan is able to check these boxes as well.

  31. There are many obvious areas of contention in Donals reasoning, valuations being one (i dont believe them and i dont believe you should pay up for distressed assets), NAMA’s income stream being another (no information on it’s source, it’s stability or if it has been stress tested or not).

    My biggest problem is with his conclusion – “NAMA is a bail out of a banking system.” The Irish banking system is history. The wholesale funded banking model is obsolete. NAMA does not address this. The capital required to get the loan to deposit ratios of the Irish banks back to 100% is just too big. NAMAs €54bn gamble only gets them to 130%, that’s zombie bank levels, leaving them still to deleverage. We need a new system not a continuation of an obsolete one. We need to start again.

  32. Re nationalisation : my point (half blind , misconcieved, disingenious and facile though I apparently am, as opposed to the visionary, lucid, dispassionate and realistic views of Donal) is exactly that of Eoin – its consequential to loss realisation. Labour (of whom I am not a member, nor is I suspect KW or Gregory connor, or Constantin…..) have siezed on that as support for preemptive nationalisation which is a quadruped of a different hue. But hey, lets not let facts get in the way of a good backanded insult!

  33. So let’s talk about loans rather than assets.

    There’s 9 bn of rolled up interest and 60% of the loans are non-performing.
    77 bn loans.
    60% non-performing.
    9 bn rolled-up interest.
    From the Zoe case, it appears that the liquidation value of non-performing loans is 25%.
    77-9=68 – ‘real’ loan value
    68 – (68*0.6) = 27.2 – value of performing loans
    (68*0.6) = 40.8 * 0.25 = 10.2 – liquidation value of non-performing loans

    Assuming none of the performing loans go bad, can be liquidated at 100%, and are at market price, total asset value = 37.4 bn

    Loss of 25+ bn coming up…

  34. @MM
    Very good article which confirms earlier comments on the bond market and illuminates the comments of Dr. Somers at PAC on the Gov bond market.
    “Both Government and banks benefited from this arrangement. For Government, funding costs were reduced. Having domestic buyers for over 25 per cent of total issuance limited the premium which Irish bonds had to yield over similar German bonds, at a time when this spread was rising. Banks, at the same time, obtained assets yielding around 5 per cent, which they funded by borrowing from the ECB at 1 per cent!”

    Free lunch at the ECB for bankers.

    @BG
    “In fact risks for taxpayers are heavily skewed to the downside – e.g. NAMA starts in a 7Bn+ hole, we are at bottom of interest rate cycle, depth and duration of property collapse etc.The taxpayer is being told to ignore a lot of nasty real-world tail risk.
    How ironic that the financial industry blew itself up doing precisely that.”

    Are we to ignore the signal/warning from Jurgen Stark –

    “From a fiscal policy point of view, it should be noted that although the exit from monetary measures will be uniform across the euro area, it is likely to have asymmetric fiscal impacts given the current substantial heterogeneity of fiscal positions. A potential increase in market interest rates will have a much stronger impact on highly indebted countries, in particular those with outstanding government bonds with short maturities”

  35. Did anyone notice that on Pat Kenny’s new programe on Monday night, when minister Lenihan was asked what price NAMA would pay if the in depth valuation process came up with €40bn as CMV rather than €47bn, the minister said NAMA would in such a hypothesis pay €47bn.

    So €7bn would appear to be the key figure rather than any estimated recovery of asset value in the long run. How else explain why the LTEV premium would go from less than 15% (7bn/47bn) to 17.5% (7bn/40bn)?

  36. @Eoin

    “Given that NAMA-as-is appears to be accepted by the markets…”

    Just have to stop you right there: Nama-as-is created its own market for bank shares. You cannot allow markets to dictate policy choices.

    You don’t need a plan to see how nationalisation will work, you just need to do to AIB, BoI et al what was done to Anglo Irish. The deposits remain protected by the same deposit guarantee. The nationalised zombies will not be lending, but they are not lending now anyway, so no change.

    Then, you fire the clowns running the banks. Then run Nama as planned, with every memo, every dossier published on the website (hire a small secretarial scanning team and charge them with the task of PDFing every piece of paper in the office). Pay market values for bad loans. Keep paying until you restore any target liquidity ratio which the regulator sees fit.

    Hire in a cadre of provisional managers who sign in blood to respect a new code of ethics in lending. These new managers are given the cleaned banks, which are chartered under a new financial regulatory regime which is designed to minimise systemic risk and report every loan book to the government on a weekly basis, under criminal penalties of fraud if they do not comply fully.

    Then float the shares of the new banks on the stock market, to great fanfare and with little glittery hats on. Hope investors buy.

    If Bank of Maple Syrup buys a controlling share of new Bank of Ireland, so be it, ay. If Bank of Gouda Cheese buys a controlling share of new AIB, I say “groot stuff!”

    Meanwhile, flog off the loans as quickly as possible for market values, by way of regular Nama-auctions to get rid of the land bank. Read Ronan Lyons excellent reports as the Irish property market in Roscommon sinks another 40, 60, 75 per cent….all the way down to whatever makes us internationally competitive.

    And then we all live happily ever after.

  37. @ Graham

    vague and whitty. But again with no details.

    Are senior bondholders hit? How are the subordinated bondholders hit? What would the likely effect on the external credit lines of the banks be? How much can be gleaned from this process vs current options available? Declare AIB/BOI insolvent (court proceedings?), re-capitalise and re-fund – what is the timeline for this? When Anglo was nationalised it was the other Irish banks that helped keep it funded – who will step in to fill this gap when AIB/BOI are nationalised? What would be the effect on EBS, INBS and ILP in terms of their funding? How would this effect the already anaemic credit growth in the country? How would people’s existing credit facilities be affected, ie are overdrafts still open and available for use, could people still use their credit and ATM cards abroad, could they still deal in FX and MM prodcts? How would trade finance facilities be affected? Would insurance claims be delayed? Where will this cadre of professional managers come from to manage a multi-billion Euro banking industry employing over 40k people? Would the government be on the hook for the pension liabilities of these employees?

    There’s lots more questions i could add to that, but you see my point – Anglo was a far simpler business model to nationalise, with far less employees, branches and business scale and scope to deal with. It also had the rest of the Irish banking sector there to at least attempt to fill the gap. It didn’t provide even a fraction of the banking services that AIB and BoI do. Nationalisation of the banking industry should be the last step we take when all else has failed, given the uncertainties that would arrive alongside it. And if we are going to do it, i’d really really like to see some sort of detailed plan that can answer all of my questions above and show that its worthwhile.

  38. @ Eoin,

    Did you mean that I was “witty”? If so, thanks. But if you meant to construct an adverbial form of “whit”, as in “a slight and insignificant fragment”, then I take my thanks back! 🙂

    All of your questions are worth asking and deserve good answers. They do credit to your obvious professionalism in the field.

    If the taxpayer had a way of hiring guys like you (the same way the other side does!) it would be possible to answer them in a way that un-muddied the waters. Unfortunately, the guys the taxpayer is paying for have already been regulatorily captured by the other side.

    But the basic point, I think, is that there is a mess to clean up. Cleaning up that mess requires a financial commitment from the government and ultimately liquidity support for our financial backers in Frankfurt.

    I fail to see why that cannot be achieved under nationalisation, if it can be achieved without nationalisation.

    The only difference, it seems to me, is the distribution of the losses and the control of the hiring and firing of the current managers.

  39. @ Donal

    On the off chance that you do read this, I think you deserve some credit for an erudite presentation on why NAMA is a least worst solution among all the proposals on the table. However there are some points many reaonsable people would take issue with.
    i) on the subject of valuation, we have no disclosure from the MOF as to how he arrived at his calculation. So therefore we have preciousl little context for judging the extent to which the taxpayer is assuming downside risk. Without further input, we cannot know whether LTEV is reasonable or make believe and without the market valuation spreadsheet we cannot judge how accurate the minister’s claims are
    ii)I would have liked some evidence from pro-NAMA ites on the degree of equity or first loss protection that the taxpayer has. the silence is deafening.
    iii) you say that NAMA is operationally cash flow positive at the current low level of rates-clearly it probably is. Your assumption is that in a global economic recovery where rates rise, the cash flow on the performing loans would also increase. I am assuming that you are claiming tht these loans are floating rate loans. However, again we have no disclosure. In addition there is no stress test provided to show what would happen to cash flows if ECB policy rates rose and the Irish economy lagged.
    iv) the purpose of NAMA as sold to the electorate is to bosst lending again, presuably by underpinning solvency and improving liquidity. Nowhere, is there a discussion of how giving about 50% of the ECB funding to institutions that are in run off is going to boost lending.
    v) what is completely missing from the MOF is a term sheet outlining how much capital the banks need and who will provide it in a post NAMa world.

  40. @ jl

    re (ii) i’m pro NAMA, or as you correctly describe, pro-the-least-worst-option, and i dont see why the subordinated element of the offering wasn’t, or shouldn’t be, increased to encompass the full 7bn overpayment in lieu of LTEV. I suppose it would possibly reduce down the available liquidity to the banks (on the basis that it couldn’t be repo-ed at the same level as the full nama bonds), but i wouldn’t have thought that this extra 4.3bn would be the material difference in the maths.

  41. @MM

    That was indeed an interesting article, though I thought it was odd that it didn’t mention that the amount of Irish govt bonds bought by the Irish banks (€7bn) is also the amount pumped into BoI/AIB in preference shares, adding another bit of circularity to the whole transaction.

    As to whether this is an argument against nationalisation…. Has not Anglo been heavily funded by the ECB post-nationalisation? (Could be wrong, genuine question.) Surely the collateral is the key thing for the ECB – the government could surely recapitalise nationalised banks with government bonds (which could in turn be used as collateral with the ECB) just as easily as with private banks?

    I doubt anyone who counts is likely to be fooled into thinking our deficit isn’t being partially and indirectly funded by Frankfurt by the private status of the banks acting as intermediaries. In any case, could nationalised and recapitalised banks not be immediately reprivatised via either an IPO or some per capita handout to the citizenry?

  42. @Eoin
    But most “anti-NAMA” people aren’t against NAMA in all forms they are against NAMA as it is currently designed.

    They are against overpaying the banks for loans and for taking on the bulk of the downside risk from bank shareholders and subordinated bondholders with very limited of the upside return.

    You mention that the amount of subordinated bonds should be increased to cover the full overpayment for LTEV but why shouldn’t it go even further?
    There is a real risk that property prices will fall further and not recover by 10% in the next 10 years. Why should the taxpayer accept all this risk from the shareholders of the banks?

  43. I’m not an economist, so please excuse my likely shaky grasp of the complexities;

    However, I can offer DOM/KW a perspective which might help them understand the scepticism of the great unwashed.

    We have had all these people in public office and at helm of industry tell us for years that prices would only ever go up, not to worry, to get on the ladder, there’d be a soft landing.

    Then we find that “the crazies” and the “nutters” and “marxists” were actually right all along: this was a wild orgy of overexhuberance that will/did end in tears.

    Now these same people unblushingly tell us that the fat cats, golden circles, ‘senior bondholders’ (unnamed) etc absolutely must have thier private wagers repaid, as they made all these hare-brained bets and somehow the taxpayer has to now reimburse them, at the cost of losing our public health and education systems (hospital closures, cancelled school building, increasing class sizes..)

    They themselves were responsible for due diligence, having a clue, and reading the f’ing newspaper once in a while.

    The Irish National Casino : The House Always Loses. WTF?

    The taxpayer owes these people nothing.

    The argument for bailing them all out is because of the alternatives being “too awful to contemplate” and that “we need a functioning banking system” (for undefined values of ‘we’,’need’,’functioning’, and ‘banking’).

    I would really love to know what would happen if the banks were, as private enterprises, simply let go. Deposit and current accounts could be transferred to credit unions; MBS could be sold on the open market; tickets to watch the investors wail and gnash teeth could be sold for €50/head 8-hour show (i’d go twice a week). Businesses needing cash flow could approach all those still solvent, who, lacking a 20%/year ROI property play, could get 5% easy for punting a car mechanic, hairdresser, or pizza delivey play. Win-win.

    Risk is risk; Idiocy is not a defence; or if it is, I have a bridge to sell you. No; wait, somebody did that one already.

    What I would like to see people like DOM do is to offer a forfeit in case thier expectations of return to growth do not materialise.

    Given the oversupply of housing ;
    the <a href=”http://www.finfacts.ie/irishfinancenews/International_4/article_1017945_printer.shtml” overindebtedness of consumers;
    the prospect of falling wages;
    the still-deflating bubble ;
    the strong chance of interest rate rises;

    — would DOM be willing to, for example, donate his entire net worth to charity (SVDP/Barnardos/..) if any of the above risks negatively affects the taxpayers “skin in the game”?

    As is, if it all works out, he collects a big fee and retires on a fat pension.
    If not, … … … he collects a big fee and retires on a fat pension.

    Maybe he should instead offer to fall on his sword if he turns out to have been overexhuberantly optimistic.

    I can supply the sword, and assist with the ‘falling’.

    Fav Obama Quote – (to bankers) : “My administration is the only thing between you and the pitchforks”. Maybe out fearless leaders could try that line. Or “our administration is the only thing between you and default/russification/sinofication/etc”.

    Cheers to roubini, buiter, stetser, ilargi, mish.

    Now. I’m off to Q for 2 hours to get my dole.

  44. @Donal

    Credit for a timely, indeed overdue set of arguments in favour of the current NAMA proposal, in contrast to the worryingly threadbare offerings from so many of its proponents to date.

    In particular:

    1) Your emphasis on the International context is especially welcome – we are after all a Nation crucially dependent on the ongoing goodwill of International lenders.

    2) Your argument in favour of a NAMA mechanism:

    “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.”

    is, I think, the best summary of the necessity of such a mechanism that I’ve seen yet in this debate.

    However, the necessity to remain ever-cognisant of our International lending audience, and the need to accrue the benefits of a NAMA mechanism (as convincingly argued by you), fails to clinch the argument for the current NAMA proposal.

    Why can’t we assuage any concerns of International lenders, accrue all the benefits of a NAMA mechanism, and allow the taxpayer own a signiicantly larger share of the Banks (short of Nationalisation) than implied by the current proposal?

    Public happy / Job Done.

  45. @Eoin,
    Your working assumption is that the MOF estimate of market value is braodly correct. What if i is Mv was 40billion, would you issue 10-15billion in sub debt to the banks? At some point it kind of defeats the purpose of NAMA as AIB/BOI end up with sub paper which is heavily haircut by ECB-if accepted at all.
    @Dreaded,
    I notice the you have shifted your position. Are you now accepting that the senior debt should be left alone. BTW, if you are right and proerty prices fall further from here, the minister has indeed overpaid by a lot. He would also be a fool to throw even more money into re-capping the banking system as losses on SME, mortgage and the non NAMA book will take them down. Better to wait for NAMA II.

  46. James Conran says: “Surely the collateral is the key thing for the ECB – the government could surely recapitalise nationalised banks with government bonds (which could in turn be used as collateral with the ECB) just as easily as with private banks?”
    No it can’t do this. This is direct ECB monetary financing of budget deficits – specifically outlawed by ECB rules.

  47. Constantine says “I would start with subordinated debt holders at, ca 20-30cents on a euro equity swap. Put a gun to their heads and tell them ‘Guarantee will be over if you do not comply any way, so take it or leave it.’ Then you go senior debt holders and tell them the guarantee will expire and they have a chance to convert 25% of the entire debt holdings now at 110-125 cents of face value against market price of shares for an effective haircut of 2.5-6.25%. This is a shallow haircut and you get some equity out of it withour a default.”
    I might be faint hearted but this will result in a massive flight of capital. I for one do not want to take this risk.

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