Following the approval of NAMA by the European Commission, the Department of Finance has published revised guidelines in relation to NAMA’s pricing of assets. This is a revised version of these regulations released before Christmas. Based on a quick read, there are appear to be a couple of changes, both of which show that the Commission is pushing the government towards paying lower prices.
The first relates to the discount rate used to value cash flows when coming up with long-term economic value. These had provided for an adjustment of 0.8 percent above the relevant government bond rate. This adjustment is now 1.7 percent. This change will lower the value of the assets.
Government bond rates are, of course, lower now than they were last September. This is probably what the Minister was referring to when he said “There will, however, be a reduction in the interest rates used for loan discounting purposes” a comment widely (and now it seems incorrectly) reported as being related to the Commission’s recommendations. We see now that the Commission’s recommendations, taken on their own, will imply lower prices paid.
The other change I can spot relates to the (to me) mysterious “Standard Discount Rate”. The regulations for this used to be as follows.
The standard discount rate that NAMA shall apply in the calculation of the long-term economic value of all bank assets shall be 2.75 per cent to provide for enforcement costs, and 0.25 per cent to provide for due diligence costs.
The 2.75 percent is now 5.25 percent. From previous discussions, the prize for best answer as to what the standard discount rate was went to Frank Galton: NAMA LTEV = LTEV*(1-Standard Discount Rate). Assuming that’s correct, then this latest change would also imply lower prices. Anyone who understands the standard discount rate (or can see any other interesting changes) feel free to explain it to us.
75 replies on “New Guidelines for NAMA Pricing”
What does this section mean
“Long-term economic value of property other than land.
3. The long term economic value of property other than land shall for all
purposes be its market value at a date specified by NAMA.”
Is the reference to other property non property related assets such as shares, bonds or derivatives?
Please delete the above post – I need to tidy it up.
Take your time …………. you are ‘on the ball’ – as usual. D.
Irrespective as to the EU’s role, I agree that the model should be placed in the public domain for information and review. Failure to do so should be construed as evidence of a conspiracy. As you may recall, I raised questions about the treatment of rolled up interest in Nama’s draft business plan as a consewquence of a failure of Nama to publish even the most basic proforma projections.
At the NAMA Legal Conference in the Westbury on Saturday it was stated by Garret Simons SC that the discount applied to loan valuations to represent due diligence and enforcement expenses was to be increased from 2.75% to 5.25% at the behest of the Commission.
It was stated that the standard discount rate is applied across the board to reduce all LTEV valuations.
Padraig O’Riordan of Arthur Cox confirmed this was the case.
It was not clear if the Standard Discount Rate (SDR) is a percentage of the Market Value (MV) (i.e., Discounted LTEV = LTEV – MV*SDR) or of the LTEV pre application (i.e., Discounted LTEV = LTEV*(1-SDR)). It was also not applied if it was to be applied to the aggregate LTEV of all assets (Portf_LTEV) after the cap of 20% uplift on a portfolio was implemented (i.e., Discounted Portf_LTEV = Portf_LTEV(1=SDR)).
The impression I got was that the cap across aggregate assets was 20% uplift from market value (i.e. Pre-Discount Portf_LTEV = 20%).
To my mind, there are two ways that (i) the LTEV cap for individual loans (Indiv_Cap), (ii) the LTEV cap for portfolios (Portf_Cap) and (iii) the Standard Discount Rate (SDR) can all be of effect:
1. SDR is applied to Indiv_MV in calculating Indiv_LTEV, with Indiv_LTEV capped at 25% after the application of SDR. Thereafter Portf_LTEV should be capped at 20%.
2. SDR is applied to Portf_LTEV with Portf_LTEV capped at 120% of Portf_MV prior to the application of SDR.
The idea is still allowed to persist there are significant differences between the values of loans and the values of underlying securities without any explanation of how this is assessed.
I think it is the case that the model to calculate LTEV of loans has been approved by the Commission. If I am correct then it is scandalous that the model has not been notified to the Oireachtas so it can be scrutinised.
[My best guess is that the application of SDR, having had a conducted a quick word search in the masterfully vague regulations and Act, may work as follows:
1. Market Value of individual Loan (Indiv_MV) is assessed.
2. Pre-discount LTEV of Loan individual Loan (Indiv_LTEV) is then calculated applying adjustment factors according to a model (I suspect there is a finalised model as per my post on the regulation thread). Pre-discount LTEV is capped at 25% uplift (i.e., Pre-discount Indiv_LTEV <= Indiv_MV * 125%).
3. LTEV of loans is reduced by 5.25% of Market Value of individual Loan. (i.e, Discounted Indiv_LTEV = Indiv_LTEV – Indiv_MV*SDR)
4. Discounted LTEVs are aggregated across a portfolio. If they exceed 20% of aggregate market value then they are reduced to 20%. However, this cannot arise as all Pre-discounted Indiv_LTEVs are capped at a max of 25% of Indiv_MV.
Of course that interpretation does not tally with the impression I took from the conference. That impression was that LTEV would be capped at 114.75% of the Market Value of the loan after the cap of 20% was imposed and the standard discount of 5.25% rate was then applied. However, I cannot back that up with the legislation and regulations.]
AAAGH – still plenty of typos! You’ll have to figure it out yourself! I weep for all the unborn edit functions.
Thanks for this effort. Take the public interest award for March.
5.25% discount rate = 0.25% due dilegence + 5% enforcement rate
Could be mad coincidence but…
“So how does the southern part of Ireland rank according to the World Bank in Contract Enforcement…..Costs stated as a % of total claim value….Enforcement = 5.8%”
So i dunno, is 5% the average enforcement cost in this country or something like that?
Quick question, just to clarify something.
Section 7 deals with the long term economic value of bank assets backed by property.
sub section (c) is not unlike (a) and (b) when it says “where the bank asset is a bank asset for which the security is land for which the adjustment factor is more than 15 percent of the land’s value but less than or equal to 25 per cent of that value, NAMA shall take into account the projected cash flows of the bank asset over a period of 8 years using the NAMA 8-year discount rate,”
If the individual asset has an adjustment factor of 25% (the maximum allowed) how does NAMA have any scope to ‘take account’ of the projected cash flows? Or am I missing something?
“If I am correct [that the LTEV model has been approved by the Commission] then it is scandalous that the model has not been notified to the Oireachtas so it can be scrutinised.”
And what do you think this would achieve? Even if there were a division on any aspect, the Government would be able to marshal the required lobby fodder.
The fact we are debating the intricacies of the LTEV calculations is testament to the ability of the government spin machine to deflect the eye from the ball.
The very concept of a “LTEV” should continue to be loudly and vociferously exposed as the sham it is.
@CM – you are spot on. The whole purpose of PR (spin) is to get you looking in the wrong place and thinking about something else.
Maintaining focus on the real issue is what I earlier described as ‘Keeping your eye on the donut and not on the hole’.
Is this the calculation used to go from market value/LTEV of the underlying property assets to the market value/LTEV of the loans?
“The standard discount rate that NAMA shall apply in the calculation of the long-term economic value of all bank assets shall be 2.75 per cent to provide for enforcement costs, and 0.25 per cent to provide for due diligence costs.”
“And what do you think this would achieve? Even if there were a division on any aspect, the Government would be able to marshal the required lobby fodder.”
Politicians are all ultimately accountable at election time. If the information is in the open and there is a debate then at least everybody has to answer for it. The fourth estate through the more capable commentators such as Carswell and Ihle should also be allowed to get their teeth into it. On top of that, it is important that the citizenry get the full story, as previously noted by Colm McCarthy and Patrick Honohan.
We have agreed to pay LTEV to lure the banks into NAMA voluntarily. LTEV should be no higher than necessary after that imho.
There is no convincing evidence to suggest that NAMA debt will have less effect on our credit rating and spread than treasury bills. Therefore, we whould not want to put more fundoing through NAMA than is necessary. Furthermore, the more robust and achievable LTEV is, the more of a chance we have of NAMA debt been seen as less of a strain on the national finances.
I agree that it is unclear whether the 5.25 % standard discount under Article 8 of the 2010 Regs is to be applied before or after the “cap” of 25% on LTEV under Article 9. Thus it is unclear as to whether the effective cap is, in fact, 19.75% over market value for individual parcels of land / 14.75% average across the books of each institution. This problem stems from the fact that the term “standard discount” does not appear at all in the NAMA Act, 2009. Another drafting problem.
For what its worth, my read of the Regs is that the 5.25% applies to the loans, the 20% to the lands. Presumably in valuing a loan, one of the first things to do is to work out the LTEV of the land given as security. The LTEV cannot be more than 125% of the current market value. The value of the land is then taken into account in valuing the loan. As the standard discount applies to the loan, it seems that the final figure is to be reduced by 5.25. As you correctly point out this effectively removes some of the 25% uplift applied to the lands.
The other change in the 2010 to the “discount rate” presumably is for the purposes of calculating NPV. The various 3yr 5yr and 8 yr rates all seem to be based on the 5 yr government bond yield. Surely the NAMA loan book is a lot more risky the sovereign debt and a higher discount should apply?
From the Act:
79.—(1) The Minister may make regulations relating to the determination by NAMA of the long-term economic value, or the market value, of a bank asset or a class of bank asset or a property or a class
of property, including the matters that NAMA shall or may derive, use, apply or take into account for those purposes.
(2) In making regulations for the purposes of subsection (1), the Minister shall have regard to the laws of the European Communities governing State aid and any relevant guidance issued by the Commission of the European Communities, and may have regard, and may include such provisions relating, to such of the following as he or she thinks appropriate:
(c) such other matters that he or she considers relevant to the long-term economic value or market value of property or bank assets including—
(vi) the specification, for the purposes of attribution and application across all bank assets, or all bank assets of a particular class, of a standard discount rate, to be attributed to or applied in the calculation of each bank asset, or each bank asset of the particular class, as the case may be, acquired by NAMA, which in the opinion of the Minister is necessary or appropriate to provide for enforcement costs, due diligence costs and other relevant costs incurred or likely to be incurred by NAMA over its lifetime in the discharge of its functions;
I suspect one cannot know how the SDR will be applied without sight of the model to be applied in calculating LTEV.
Perhaps an FoI request would bear fruit.
I stand corrected, “standard discount rate” does appear in the Act.
I had that quote ready before I saw your post. I only posted it to show how little clarity it adds.
“Surely the NAMA loan book is a lot more risky the sovereign debt and a higher discount should apply?”
Yes, much higher. I would have though about 10% for “dead certs” and 20%+ for highest risk. Although not strictly comparable, venture capitalists look for returns of 5 times in five years from individual investments in order to achieve portfolio returns of 20%+. I wonder would a company such as CRH ever make risky investments offering sub 10% returns. If it did, I doubt that would survive for very long.
Many thanks. You’re focusing, quite rightly, on the mechanics and I’m pulling you off-topic wrt to the scrutiny that will be applied and the likely effectiveness of this scrutiny. But, on your own admission, the mechanics have not been revealed and what has been published is opaque.
Your desire to see an effective working out of the current system of governance, scrutiny and accountability wrt to NAMA is noted, but, in my view, that’s not how it happens in practice – and this view seems to be shared by the Ombudsman:
This is becoming very convulated indeed. In the absence of the EU Decision whose publication is deferred for confidentiality reasons, does anyone have a model spreadsheet to bring us from asset value to loan/rolled-up interest to haircut, LTEV, LTEV premium, actual asset price and that deals with the passing on of due diligence costs?
And given that 80% of the loans will be repaid in full, are future cash flows from the assets of any great significance?
Are we really going to acquire €16-17bn of gross loans with such question marks over the mechanics? Wasn’t it the fact that the experts didn’t understand the true nature of CDs and the like that got us into this mess in the beginning?
What on earth does this sentence mean, though?
“3. The long term economic value of property other than land shall for all
purposes be its market value at a date specified by NAMA.”
I’m certainly delighted that they spend so much time on how to price land, given that it’s the largest chunk of NAMA’s loan book, but I would have thought the 20% or so of the loan book in commercial and residential developments in Ireland deserves a little more than just this sentence! Date specified – in the past, or present… or future?! The latter in particular throws up a game theorist’s delight!
Also, when oh when are we going to get a clue as to what’s in this “associated loans” category which is as big as the land category? Are these going to be priced by the original asset perhaps? In which case the €30bn or so in associated loans gets divvied up across land and developments and we’re left with even more of the loan book that gets one line.
And judging from the scant yield analysis presented in September, I wouldn’t be convinced that they’re on top of the whole yield thing.
“And judging from the scant yield analysis presented in September, I wouldn’t be convinced that they’re on top of the whole yield thing.”
To be honest I don’t think they are on top of anything in relation to NAMA.
How are they going to factor in the number of empties and a commercial vacancy rate of 25% into the calculations of LTEV?
IMO LTEV is significantly below current market value.
“IMO LTEV is significantly below current market value.” – so we should pay the banks even less than the assets are presently “worth” (and pass on to the banks the costs of due diligence)?
The banks are no doubt punch-drunk with the hits they’ve taken from all sides and some have no real choice in jumping through whatever hoop the govt holds up, but even the banks might baulk at accepting less than the assets are presently “worth”.
Are we not playing out the zero-sum game that Hirsch envisaged back in the mid 70s ?
Ronan L: Well, my read on this, ‘other assets’ refers to the ‘associated loans’ category to a great degree. Could be loans for cranes, plant, building equipment, stock, intellectual property, anything. There is nothing wrong with this valuation per se. The thing about the date is very open to interpretation – does NAMA choose one date for all the non-land valuations, or does it choose a date for each asset as it comes to it?
I’d guess the reason for this arising is that NAMA is taking out all loans of particular persons, rather than just property loans.
LTEV is a metaphysical concept, meaning it has no scientific meaning, thus the arithmetic and calculations serve merely to obfuscate.
I thought I’d put this up already, apologies if I am repeating myself.
What if LTEV is below current value?
All the analysis that I’ve seen, by Mr. Lyons, Mr. Kelly, Mr. Justice Kelly, Mr. 2Pack, Mr. ragingbear, Mr. Dreaded_Estate, Mr. anyoneelsewithashredofcredibility, indicates that current price and rent levels are beyond the capacity of the economy to sustain at current economic levels given the debt overhang; that current economic levels are not unreasonable given the debt overhang; that growth is likely to be muted in the near future given the debt overhang…
… er .. ‘metaphysical’ – ‘metaphysical’ is far too grand a descrivtive for this particular LTEV – brings ‘mental reservation’ into disrepute: more accurately – it is a purely political heuristic, of highly dubious ideological provenance, with potentially devastating nagative consequences for a generation of the Irish citizenry – hence the necessity of ruthlessly deconstructing it and challenging it. We owe Zhou more than a bit of gratitude here for getting stuck into it – and Karl for bringing it up here again – and all who contribute to bringing some ‘reality’ into such pseudo-science ………… 30 seconds to melt-down!
I’m not an economist and have to admit I am finding some of the analysis above difficult.
I suspect though that we are talking our eye of the ball if we focus on the LTEV and the ‘hair cut’. To me that is not too important because if we don’t overpay we will end up putting more money into the banks in the form of recapitalisation, admittedly we will at least be getting more equity. I am not even against nama if it was to act as John Gormley said, as a debt collection agency.
The real threat that we need to keep focused on is that nama will act as a giant cartel to maintain high property values. This will hurt the rest of the economy as it will not bebefit from the competitive advantage of having dirt cheap housing.
What indications are there that this is how it will operate?
Why are performing property loans entering nama?
Will there be transparency when other depts lease/purchase from nama developers (such as for social housing).
Will Nama push (in the normal way) insolvent developments into liquidation before sitting on the property, or will they keep the developers solvent by favourable repayment schemes?
As I said the principal of nama is fine but I fear its implementation.
Sorry if this is off topic, I know for experts its better to go through each issue such as LTEV in great detail.
Trying to work out something in relation to NAMA:
* Bank has non-performing developer loan, initially worth $10.
* Bank has lien on developer’s assets, which was worth $10 but is now worth $2.
* Government buys loan for $7 (30% ‘discount’), and takes lien on assets, which are worth $2.
* Government pays the Bank for this loan with a Bond. Bond is worth $7 and pays $1 interest each year for 10 years.
Is this last step correct? After say 10 years, will the Bank return the Bond to the Government?
I can’t work out this important bit of this document 🙁
“Section 7 (page 5) Determination of long term economic value of bank assets” is the source of my confusion. It’s a little unfortunate, afterall NAMA is buying bank assets.
“shall take into account” – very good, any chance of an example of how you would do this and how it is applied to LTEV of the land?
Section 9 might be relevant. Depending on definitions, Section 7 may suggest that a (separate) LTEV adjustment exists for the bank asset and doesn’t fall under the caps below which relate to land. Any thoughts?
“Prescribed fractions for the purposes of section 76(2) of the Act.
9. (1) For the purposes of section 76(2)(a) of the Act, the fraction by which
the long-term economic value determined by NAMA for a parcel of land shall
not exceed its market value is one-quarter.
(2) For the purposes of section 76(2)(b) of the Act, the fraction by which the
aggregate of the long term economic value of all land valued in connection
with the acquired portfolio of each participating institution shall not exceed the
aggregate of the market values of that land is one-fifth.”
Can someone explain the above two rates in relation to the much-touted 30% discount rate please?
The LTEV is calculated havbing regard to a number of factors.
The cost of funds discount rate is inversely proportionate to LTEV uplift. Similarly the enforcement and due diligence discount rate is inversely proportionate to the LTEV uplift.
Therefore the higher these two rates are the lower LTEV is. The lower LTEV is the greater the “haircut” (Haircut = book values of loans – LTEV of loans).
Consequently the increases in these rates should cause the estimated 30% haircut to increase where such estimate was based on a lower cost of funds discount and a lower enforcement and due diligence discount.
Thank you very much for that zhou.
I at least understand how the rates increase can actually be a good thing in terms of the taxpayer actually paying less for the loans overall.
I still don’t fully understand “why” the two rates changed enjoy an inverse relationship to the LTEV but perhaps someone could link me to an explnation if it is too annoying to explain
Sorry if it has been mentioned already, but did this evade the main stream media over the last couple of days? I have not seen it anywhere (even struggling to find it on the DOF site without the link above).
If the citizen is confused, and there are serious implications for the citizen, then I, for one, would like an opinion on the validity/CONSTITUTIONALITY of this cute-heuristic LTEV from one of the few Irish Institutions that I retain trust in – THE IRISH SUPREME COURT.
think about it like this:
The LTEV is designed to compensate the banks for getting rid of their assets at the bottom of the economic cycle (allegedly) and at a time of acute banking distress
The Standard Discount Rate is designed to compensate the government for the fact that they are somewhat forced buyers of these assets, many of which are distressed and in need of major repair and attention. Therefore, the higher the SDR, the lower the overall LTEV is for the banks.
Eg: ‘REAL’ LTEV minus SDR = OFFICIAL LTEV
The Funding Discount Rate is the rate at which it is essentially costing us to buy these distressed bank assets. Think of it like ur mortgage rate – the higher it goes, the more expensive it is to own the house, and therefore, ceterus paribus, the lower the value of the house (LTEV) should be.
Good explanation, not entirely sure why a high mortage (interest?) rate would affect the value of the house though. Simply that, the cost of accessing the fund to purchase your house is higher so you are going to have to sell the house at a lower price to me if you want to make a sale?
If thats it then great.
well think about the maths we’re basing all this off.
If you thought the value of an asset, which you are buying today, will be worth 25% more in 5yrs time when you sell it, then you want to make sure that the cost of buying it, plus the interest on the funds you have borrowed, is less than or equal to the price you get in Yr 5.
ie if value of asset is 100 today, and funding rate is 6%, then in 5yrs time if you only get back 125, you will have made a loss. If the rate was only 2% though, well then you would have made a profit (this is a very very basic example).
So, if the funding discount rate is higher, including a credit margin for the risk from being forced to buy the asset (as it may turn out to be worthless), this increases the overall cost by the time you go to sell it in Yr 5.
Ahhhh I got you. Thanks again.
Last question before I get kicked off for annoying people, is the “official LTEV” (which we will all be working off) the inflated value of the loan or somewhere in between the inflated value and current market value?
@ fellow anoraks,
AIB’s latest SEC filing splits the 23bn of NAMA bound loans by maturity. A whooping 19bn falls due in the next year. ( page 90 of Form 20F http://www.aib.ie/servlet/ContentServer?pagename=AIB_Investor_Relations/Miscellaneous/ir_article_printer&c=AIB_Article&cid=1096576948103&channel=IRFP ). This will provide an early guide to Mr Lenihan’s tough on developers stance.
Besides the high level interpretations, do you understand the details of the Government’s LTEV document?
@ Ahura Mazda
absolutely not. My time is better spent, and more likely to be successful, in trying to decode the third secret of Fatima.
More honestly, it appears to be a statutory document to deal with a statutory instrument, and only likely to be understood by people well versed in such legalese type stuff. If there’s a smoking gun in there, which i doubt, im sure some independent scholar, the EU or the ECB will unearth it.
Fair enough. Though its risky to underestimate the value of understanding the detail.
IIRC the 3rd secret of Fatima was revealed some years back.
“IIRC the 3rd secret of Fatima was revealed some years back.”
Pah, thats what they want you to think…
The 3rd secret is still a secret although I have heard rumours to the effect that if the banks are nationalised, permanent darkness decends and if senior debt is haircut a plague of locusts will arrive with frogs in tow.
So the bottom line is that the NAMA haircut may be bigger than the 19% leaked by sell side analysts at Christmas, than the 25% impled after the Sept biz plan and the 30% announce by NAMA at the start of Jan.
Therefore the capital requirements will be greater and the state probably end up with super majority stakes in the banks. These get bigger if the Regulator hints that banks will go to 8% equity T1 immediately.
Will the two major banks reopen for business if they end up with i) industry leading capital levels due to state ownership & ii) smaller, less risky and more liquid balance sheets as a result of NAMA. If they do will it put a floor under asset markets?
Reviewing the SI the first part is about a statistical exercise that will establish relationships between prices and various variables? This should give some backbone to any arguements re reality of achieving price levels.
The output from this will be used to project forward price levels based on an economic forecast that is being prepared?
It then looks as though they are applying the principle of giving the most impaired assets as much time as possible to recover value? It is likely that interest rates will rise and this is reflected in the increasing discounts that they propose.
If a loan is performing as per contract it is akin to a standard loan refinancing by a new institution?
The discount rates used are to be applied in the normal discounted cash flow (DCF) calculation manner to the cashflows generated using prices generated by the economic model prepared to generate the value (V). The overall discount rate (r) that will be applied to the cashflows (C) is a combination of the 3/5/8 year rate (to cover funding and risk) plus the 5.25% standard rate (to cover enforcement and due diligence) i.e. 9.76%, 10.82% or 11.41%. Thus V = C / (1+r).
The main legislation pointed to this SI as the place where the discount rates to be used would be published.
I think that it is straightforward enough?
“Will the two major banks reopen for business if they end up with i) industry leading capital levels due to state ownership & ii) smaller, less risky and more liquid balance sheets as a result of NAMA. If they do will it put a floor under asset markets?”
Judging by the latest accounts, Irish banks were open to buying bonds last year. With a special weakness for Irish gov debt. I’d expect this circular relationship to continue, though sooner or later external players will get uncomfortable with this.
Re putting a floor on (irish property) assets: personally I wouldn’t invest.
I agree with you. Unless banks are able to lend to private sector activity in the doemstic economy then debt deflation persists.
@ Barry T
It may be simple to you but I’m still a wee bit confused.
So you reckon that the “standard discount rate” is added to the “NAMA discount rate” to come up with the final rate used to discount cash flows.
Fair enough but where does it say that? The first mention of the standard discount rate is on page 6 and it doesn’t describe at as an amount to be added to the existing discount rates. It seems a little bit more like something lopped off the top of all the LTEV valuations, which is how everyone else has been interpeting it.
Appointment of portfolio asset manager at the National Asset Management Agency announced.
Re: yogan & dreaded
In the NAMA context you effecticely cannot own an asset and have today’s LTEV being below the market price. If you could sell the asset today for 100 then the LTEV today is at least 100.
Now you may decide to be foolish and decide to hold the asset in an attempt to realise more than 100 only to discover that the asset’s value falls….but in the initial condition the asset’s LTEV is at least the market price to anyone selling the asset.
As for the discount rate – a higher rate will depress today’s value, but the trickiest part is still the estimation of future cash flows. If there are reasonably calculable flows then you can use DCF to give today’s PV and the rate will play a role, but the issue will still be dominated by estimates of the cash flows, particularly the terminal values. Estimating these will be akin to estimating the amount of rain to fall on the 2nd Tuesday in June 2011. Whether I use 2.75 or 5.75 will be largely beside the point.
“It may be simple to you but I’m still a wee bit confused.”
You’re a better person that I am, because I am utterly confused though some of the posts on here have assisted in some of the mechanics. If someone can stick their heads above the parapet and provide a worked example of an asset valuation and the operation of the loan in NAMA’s books until repayment/liquidation then that might help dispel the notion that no-one knows how this is operating. So to begin (this is completely hypothetical by the way):
I’m a developer who bought a site in 2002 for €88m and got a loan from Anglo of €68m (a Loan to Value of 77%) and my contract was a roll-up and I now owe an additional €9m interest. NAMA are acquiring my loan now showing at €77m in Anglo’s books.
Right what are the next steps and how does the valuation and operation of the loan in NAMA work.
“If there are reasonably calculable flows then you can use DCF to give today’s PV and the rate will play a role, but the issue will still be dominated by estimates of the cash flows, particularly the terminal values. Estimating these will be akin to estimating the amount of rain to fall on the 2nd Tuesday in June 2011.”
Yes, terminal values are the key variable and virtually impossible to predict with any accuracy for six months ahead, never mind six years. The use of DCF is fine for toll roads, Government bonds etc. but cannot be relied on in this case. Its use might make the methodology look respectible and give some semblance of professionalism to the projected values. Maybe, that is why it is being used. If Nama was a commercial body working in the best interests of its shareholders (us!), it would create best and worst case valuations/scenarios and aim to do better than the worst case (as per thoughts of the Commercial Court). Instead, I fear that it is pursuing best case valuations dressed up with DCFs, a classic case of fur coat and knickers.
“So you reckon that the “standard discount rate” is added to the “NAMA discount rate” to come up with the final rate used to discount cash flows.”
You correctly note that this is not said at all in the SI. My hypothesis is that an overall discount rate is being constructed to take into account recovery of 1) funding costs, 2) risk margin, 3) enforcement costs for duration of NAMA 4) due diligence costs. And used to calculate the PV of the loan. The language is not clear at all
Considering the hypothetical “€88” million site (paid 68M Debt, 20M Equity). Assume planning for 600 units of average net size 70 sqm. Construction cost in 2002 of €1,500 per sq m. (For this analysis ignore the construction finance and consider only the initial loan) On a per unit basis:
At the time of site purchase the developer assumed a sales price of €4,743 per sq m
Site: 147K + Build: 124K + D Costs: 19K + Dev profit: 43K = Appt Sale price: 332K (€4,743 per sq m)
Current analysis indicates sales price at €3,000 per sq m in 2010 which gives:
Appt Sale Price: €210K = Site (value): 77K + Build: 115K + D Costs: 17K + Dev profit: 0K
i.e. Land value now 600 x 77K = €46.2M i.e. current market value. This would be the cash available to repay the loan now – highly distressed.
Based on the economic models produced (as indicated in the SI) it is forecast that prices in 2017 will have risen to €3,500 per sq m which gives:
Appt Sale Price: €245K = Site (value): 103K + Build: 123K + D Costs: 19K + Dev profit: 0K
i.e. Land value now 600 x 103K = €61.7M i.e. long term economic value.
This is then discounted at 6.16% (risk and funding cost over 8 years) + 5% enforcement + 0.25% due diligence = 11.41% i.e. €61.7 / (1+0.1141) = €55.4 M i.e. the transfer value of the asset to NAMA taking into account costs that NAMA will incur moving forward. (There may be guarantees etc. that will bring this value up but they are ignored in this analysis)
The developer still owes €68M + €9M interest = €77M to NAMA.
Thanks very much Barry that’s the first time I’ve seen this type of working for NAMA.
Just to make sure I’m not missing anything you mean the Build costs in 2002 to be €105k, not €124k (70 * 1500)? Development is what – fees to Local Authority, architect?
Why did you reduce Build and Develpment costs in 2010 per unit?
How exactly did you get from €3000 per property value per metre in 2010 to €3500 per metre in 2017? And why did you select 2017?
Interesting. I’m totally confused about the discount rates. Are these annual or multiyear? Excluding the 1.7% risk margin, the rates for 3, 5 and 8 years are 2.84%, 3.87% and 4.46% respectively. If multiyear, then the 8-year rate is less than double the 3-year rate! Also, the rates look extraordinarily low bearing in mind all the risk. Please help!!
Numbers are as indicated.
1. to build a nett 70 sq unit you need to build 70/0.85 = 82.4 sq m gross. Construction costs are per gross sq m (was not clear so hope clarifies). Development is design fees, contributions, la fees etc usually around 15%
2. Construction tender prices have now gone down to c 2000 levels so a lower value used. They will be up from current levels in 2017
3. The value per sq m of €3,000 is a gut feel number of where we are today. 2.5% per annum price increase over 7 years brings us to c €3,500. 2017 is used as this is the window used in the legislation.
The implied site value is what is left to repay the loan.
Barry, again thanks very much – I didn’t realise you were putting so much detail into the numbers.
Last detailed question from me I think, where did you get the 2.5% compund annual increase from – is that anything that was published? The number I generally heard bandied around was 1% per annum (wasn’t sure if that was flat rate or compound rate).
I assume that they are annual discount rates and that they expect the base interest rates to rise – these are straight from the published Legislation (SI)
I pulled the post together as to get someone to say I was totally wrong in my reasoning. Its nearly a question posed as an answer!
Nothing published – just an assumption. Looking at the figures published by the DEOLG stripping out inflation and outlier years – house prices increase on average by 5% yoy (since they started the data collection in 1970). 2.5% is close enough to the medium term 2% inflation target of the ECB.
Thanks again Barry, and if I could summarise the workings for my original development site.
Actual value today 46.2m (presumably arrived at by the NAMA valuers using a methodology the same or similar to what you have outlined)
LTEV in 2017 61.7m (assuming 2.5% compound growth in property value and other assumptions with respect to labour costs)
Consideration to be paid to NAMA = 61.7 divided by (1 plus 5% enforcement cost plus 0.25% due diligence cost plus 6.16% risk and funding cost over 8 years) = 55.4m
the source of the 5% and 0.25% is the SDR under s8 of the LTEV regs
the source is rge 6.16% is s2 (2) (c) of the LTEV regs
“In the NAMA context you effecticely cannot own an asset and have today’s LTEV being below the market price. If you could sell the asset today for 100 then the LTEV today is at least 100.
Now you may decide to be foolish and decide to hold the asset in an attempt to realise more than 100 only to discover that the asset’s value falls….but in the initial condition the asset’s LTEV is at least the market price to anyone selling the asset.”
Well I think this is where the whole LTEV argument falls down.
If the LTEV is below the market value, you think every rational seller would sell now rather than wait for the market to fall. Perfectly sensible hypothesis IMO.
But by the same token it the LTEV is above the market value, you would expect that every rational buyer to buying at the market value with the expectation of getting LTEV in the future. Equally sensible hypothesis IMO.
Why do you think the only rational investors are on the selling side of the transaction?
S.I. No. 88 of 2010 is a deliberate exercise in obfuscation.
It serves two purposes.
1. No sensible debate can take place in the Dáil or in the public media.
2. It provides cover for those involved in the case of future legal action or inquiry/tribunal.
That’s all it is. It is nothing else.
Barry, by the way if the present value is 46.2m for my site then according to 9. (1) of the LTEV regs “For the purposes of section 76(2)(a) of the Act, the fraction by which the long-term economic value determined by NAMA for a parcel of land shall not exceed its market value is one-quarter.” so presumably the LTEV would be capped at 1/4 of 46.2 (11.6) added to 46.2 = 57.8 and it is on the 57.8 LTEV that the “discount” (SDR + risk and cost of funding) would have to be applied? So NAMA could pay a max of 51.9m?
I think that the cap (as you have indicated) is correct and that the discount is then applied as you have indicated. i.e. wont pay more than 25% above market in this case. 51.9 on the original 77 (68 plus 9 rolled up)
This set of assumptions paints a pretty bad senario due to the assumption of what was paid per site in 2002 – it may be that the per site price was lower in 2002 (and more sites obtained for the original 88M); however, the principle still stands (if the logic of what outlined is correct).
Well Barry, as there’s an 80% chance that I’m going to repay the loan in full (the original €68m and the €9m rolled up PLUS any interest accruing from now until I pay off the loan) then NAMA is going to make a tidy profit on me!
Thanks again for your guidance. I hope to stick another scenario on the Ronan Lyons yield thread (I borrowed for a freehold building which is leased to a retailer in central Dublin) and see how they deal with discounted cash flows and terminal values.
NAMA is a distraction that will cost lives through lost payments to hospitals and ambulance services.
There are too many Gardai now but soon there will be too few and no hiring. Thanks to NAMA.
All the counting of angels will accomplish naught but to amuse the Gods! And the mad!
How will you repay €77m from assets that are only expected to be worth €46.2m?
Fortunately whilst some of my investments tanked, I did have some better investments in Romania, Poland, India, Turkey and China where markets have performed far better and as they are part of the same company, I will need to refinance based on increased values in these other markets. Although I did have to give a personal guarantee as well, in this scenario shouldn’t have to sell the Learjet just yet.
As you can see I was a pretty naive investor because my sharper colleagues were setting up separate SPV’s (oftentimes in Luxemburg for some reason) for each transaction whose liability was ringfenced and although some of them were asked for personal guarantees, being Ireland and everything, they succeeded in only giving nominal guarantees of perhaps €100k on a €100m loan. Apparently NAMA think that only 20% of them will in the end default – they’re obviously not considering my sharper colleagues.
By the way as I understand it, I owe Anglo €77m and will continue accruing interest until the loan is repaid but the deduction would be what NAMA paid Anglo, no? Which would be €51.9m so all I need come up with is €25.1m (77-51.9) plus of course any interest until the loan is repaid.
As far as I am aware you don’t get any reduction from NAMA.
So not only do I lose my asset but I am also liable for the full value of the loan? No that can’t be right. The usual practice would be to liquidate the asset (which is what I understand Anglo is doing with NAMA in my case for 51.9m and I am liable for the balance of the loan to NAMA 25.1).
@ Pat Donnelly
That would be an ecumenical matter. 😀
[…] economic value of these loans to be €10.5bn. This more than likely represents the impact of EU guidelines on discounting. How is unclear and not explained anywhere – particularly when the discount rate is seemingly […]
[…] economic value of these loans to be €10.5bn. This more than likely represents the impact of EU guidelines on discounting. How is unclear and not explained anywhere – particularly when the discount rate is seemingly […]