Not too long ago, the Green Party announced with great fanfare that they were getting the NAMA plan amended to feature “equal risk sharing” between the government and the banks (though not between the government and bank shareholders as proposed by Patrick Honohan). Even as it was announced, there were strong rumours that this risk sharing element would represent a tiny change to the original plan. This has now been confirmed.
First, there is the issue of the interest rate on NAMA’s subordinated bonds. I had noted more than a month ago that no information on this had been released. Now, continuing in the drip-drip manner in which it is releasing information about how NAMA will actually operate, the Minister has told the Oireachtas Commitee meeting on the bill that the bonds will pay an interest between 5% and 7%. No information has been released to suggest that these payments depend on the perfomance of NAMA. If these are unconditional coupon payments at say, six percent over ten years, then this will mean that the banks will recover sixty percent of the €2.7 billion in subordinated bonds no matter how badly NAMA’s loans perform. So much for risk sharing.
Second, there is the question of why the payment of subordinated bonds is being capped at five percent of the total. Today’s Irish Times reported the Minister as saying that there was “an accounting issue” relating to going above 5 percent. The transcript records the Minister as later clarifying this issue as follows:
The general rule when valuing equity investments, for example a straight-forward ordinary share, is to value it on a mark to market basis. It is valued as it is in the market because the share is traded in the market. With an ordinary share, market valuation takes place on whatever it is quoted in the Stock Exchange. However, in the case of the six-month treasury bills which are the nature of the bonds which we will issue as consideration for the assets, it is not mark to market and carries the full-face value as an asset of the bank. In accountancy practice, if subordinated debt is well in excess of 5% of the total consideration it is mark to market and treated as an ordinary share. Therefore, its hazardous character means it can be traded on the market and marked to a substantially reduced price. That would mean it would not amount to compensation for the banks and one would still have to pay the additional money depending on the appropriate level of compensation for the assets that one acquires. There are powerful technical reasons that one cannot exceed this 5% limit in the case of subordinated debt and that is the clear accountancy advice which the Government received on this matter.
In other words, the Minister is worried that if the banks receive too many subordinated bonds, they will have to be marked to market and that their “hazardous nature” will see them sold at a large discount. I’m not a financial accountant so I don’t know what the rules are under which banks have to mark assets to market rather than record them on a “hold to maturity” basis but I’d be surprised if five percent of the bank’s sales to NAMA featured in these rules. Still, I’d be interested to hear from those who know more about this.
Of course, the hazardous nature of these bonds relates to the probability of NAMA breaking even. In stating that the market will sell these bonds at a discount, the Minister is effectively admitting that the financial markets do not believe that NAMA can break even.
Update: It’s possible that the Minister is referring to the International Financial Report Standards on “derecognition” of financial assets — link here. These guidelines suggest that assets can only be “derecognised” from the balance sheet as long as the bank has not “retained substantially all risk and rewards”. A five percent payment in the form of contingent bonds seems to fall a long way short of creating the problem of the banks being unable to derecognise the assets.