More Secrets from the NAMA Temple

The EU Commission has released the full text of its decision to approve NAMA announced on February 26. Emmet Oliver discusses the statement in today’s Independent. Thanks to Jagdip Singh for the hat tip. What I find frustrating about this process is why we get a minimal “EU approves NAMA” statement in February and a slightly-censored version of the full approval six weeks later. It would be far preferable for the full text to be released at the same time as the announcement of the decision.

Thanks also to Jagdip for getting us more information on the “NAMA total consideration” mystery. As outlined in his comment, Jagdip wrote to NAMA:

Dear Sirs,

I have studied your four publications from Tuesday 30th March 2010 with respect to the transfer of the first tranche of loans to NAMA. I write to ask if you could make publicly available the overall methodology to derive the Long Term Economic Value (LEV), Current Market Value (CMV) and consideration paid with respect to the first tranche of €16bn of gross loans.

In summary the gross loans of the first tranche are estimated at €16.03bn, the LEV is shown as €10.51bn, the CMV as €9.44bn and the consideration paid is €8.51bn. Could you explain in general terms how the LEV and CMV were calculated and why the consideration paid is different to the LEV.

Also the press have widely reported the estimated haircut on the first tranche at 47%. Would it be more accurate to quantify the haircut as 34% (1 – LEV/Loan Value or 1 – 10.51/16.03)?

I have read the Act and the LEV Regulations before writing to you and I can still not resolve the figures produced for the first tranche. I propose publishing any response from NAMA to the above questions on the irisheconomy.ie blog.

Jagdip received a reply (Garbo speaks!):

Thank you for your email.

Please see below a brief guide to how NAMA obtains these calculations:

1. The €16.03bn is the nominal value of the loan balances transferring to NAMA.

2. The property CMV represents the current market value of the property as at 30 November 2009.

3. An LEV uplift factor is applied to the property CMV to arrive at the property LEV which is one of many inputs to the valuation methodology to arrive at the consideration NAMA will pay for any of the transferring loans. In addition to the LEV of the property, the loan valuation is determined by reference the discount rates per the valuation regulations taking account of enforcement costs and the legal due diligence levy, and the potential for legal haircuts regarding defects in security and title amongst other inputs which influences the consideration paid by NAMA for the loans. The average LEV uplifts per participating institution are available on our website.

4. The discount applied can therefore be calculated as: (1- (Consideration paid/Loan balances at transfer)).

Some additional information is available on our website http://www.nama.ie.

As Jagdip notes, “defects in security and title” are likely to be the principal explanation for why the “total consideration paid” for the first tranche was below the “current” (i.e. November 2009) market value of the underlying assets. I think this means that the signed copy of the 46 guy letter is on its way to an anonymous NAMA official, who I’m sure will treasure it.

Between this reply and Brian O’Neill of NAMA’s letter to the Irish Times commenting on Brian Lucey’s criticisms of their ingenious linked-to-Euribor strategy (Brian’s original article here and reply to NAMA here) there is some sign of NAMA becoming a somewhat less secretive organisation. This is a welcome development though I suspect those who ask tough questions may find limits to this transparency.

21 replies on “More Secrets from the NAMA Temple”

I don’t think the reply from the NAMA official adds much beyond what is visible from the legislation and regulations. I previously posted as follows:

“2. LTEV of each Indiv_Prop is calculated in accordance with the mysterious and secret LTEV_Indiv_Prop model.
…
7. Each LTEV_Indiv_Prop is then fed into the mysterious and secret LTEV_Loan model.
7.1. The appropriate CFDR [Para 7 of the Regs; Sections 79(2)(b)(v), 79(2)(c)(v), and 79(2)(c)(v) of the Act] is also fed in to the model.
7.2 The SDR is also fed in [79(2)(c)(vi) of the Act].”

The official has told us that the LTEV Loan model includes “and the potential for legal haircuts regarding defects in security and title amongst other inputs which influences the consideration paid by NAMA for the loans”.

Well and good, but how do we know how much this is? What is a “legal haircut” and how can it be quantified in circumstances where NAMA has extensive statutory powers to rectify any defects in security and title?

Also, the NAMA official has not resolved the main conundrums of:

1. What is the typical uplift from LEV of property to LEV loan in the absence of legal problems?

2. Does the consideration paid for the transfer of the loans in the First Tranche represent the aggregate of the “loan valuations” for the First Tranche or does it also include estimated due diligence and enforcement costs which will affect loans in future transfers. The “Key Tranche 1 Data” document on the NAMA website reads as follows:

“NAMA – upfront recovery of costs on total portfolio
€m
Total costs recovered from participating institutions€2,788
Recovery of due diligence costs 133
Recovery of enforcement costs 2,655”

I am sceptical of any suggestion that defects in legal security has caused the additional haircut.

For BoI, AIB and EBS, by apply the 1.7% premium for an average of 5 years I can more or less get to the consideration paid. However for INBS and Anglo they are way off and these are the two organisations which reputedly have huges issues with the quality of security and paperwork. So for me it makes sense that a haircut for potential issues with title and security would particularly affect Anglo and INBS.

BTW, for Karl’s journalistic integrity the actual email exchange (which has an unanswered follow-up) is on the namawinelake blog.

Interestingly the Commission sought undertakings from Ireland as to the use by NAMA of certain of its statutory powers in respect of security. The Commission was concerned that such powers are specific to NAMA and not available to other market operators, and thus are “potential sources of competition distortions”. Thus the risk of a “legal haircut” exists.

The statutory powers at issue include a power to compulsorily acquire lands: although cast in wide terms, it seems that this power is directed principally to ransom strips. One of the anomalies of the legislation is the compensation paid for compulsory acquistion is assessed by reference to current market value. The landowner does not get any uplift to reflect the fact that the current market value might be less the long-term economic value. If one follows the logic underlying the legislation to its conclusion however, and accepts the notion that the current market value is artificially low, then compensation should be measured by LTV. If an adjustment is necessary when valuing property in the context of working out the value of banks loans, surely a similar adjustment is required in the case of a person who has been deprived of land compulsorily?

@Jagdip

It woudl be great if you could set out your calculations for BoI, AIB and EBS to show how you have applied the discount rate.

It appears that the decline in asset values is not much worse than was predicted in September 2010. As I posted on the original discussion:

“It is interesting to refer back to the “Supplementary Documentation” of 16 September 2009. At that stage NAMA estimated an average 11.7% interest roll-up. It also estimated a average 47% decline in property values (in Ireland and abroad).

Using the Tranche 1 figures, and assuming 12% interest roll-up and an original LTV of 77%, one comes up with an approximate decline in property values of 49%.

Note that in September 2009 a circa 30% haircut was predicted for a 47% decline in property values! Also, given that more interest has rolled up we are probably closer to the 47% decline.

If these calculations are right (i.e. if the loan balances include rolled up interest) then it is hard to see where the big shock was that makes things so much worse!”

It is not inconceivable that poor quality security is the issue. However, it is not clear that this is the case. No details whatsoever has been provided as to the nature or degree of problems with security or how it has impacted the haircut. Surely some potential for security problems were included in the Sept 2009 estimates. The mystery remains unsolved as far as I can see.

If it turns out that I am correct that the enforcement and due diligence have been frontloaded to exaggerate the Haircut for Tranche 1 then NAMA will legitimately be able to say that they were upfront about this in the documentation published.

@ zhou_enlai

I have approached this in a very, very simple way. I assume that the LEV already has accounted for SDR etc.

In terms of BoI, AIB and EBS, I calculated that NAMA deducted from the LEVs the NAMA remuneration for providing asset relief and calculated that at 1.7% of LEV for an average of 5 years, akin to how the EU calculated it in para 71 of their Decision. Take off 5 * 1.7% off the LEV and you more or less get the considerations for BoI, AIB and EBS for the first tranche.

I’m assuming you are misdirected by the due diligence and enforcement costs and I’m assuming they are not offset from what is paid in respect of the tranches. I’m assuming they are separate.

I agree with you that unless we get a better breakdown from NAMA (as I requested in a follow-up email but I am assuming I won’t get a response) there could be lots of other explanations but given that we have rumours in particular about the security and title documentation held by INBS and Anglo it seems likely to me that legal haircuts are the reason why their consideration is so much worse in % terms than the other three.

If you read the EU Decision you will see they have what appears to be a financial overview in Jan or Feb 2010 where assets were valued at origination at €94.2bn and were worth an estimated €47bn which is just over 50% off the values at origination. Ireland didn’t provide what the EU refer to as a “vintage breakdown” of the loans but they are not all peak values and I understand an exchange in the Dail in November to mean peak values were around €120bn – even if that’s a misinterpretation the peak values will be more than the values at origination so even in Jan the govt was pointing to a drop from peak of over 50%.

Tightlipped Quinner responds to criticism of secrecy in desperate attempt to save empire… oh, sorry, wrong thread!

@Jagdip

Thanks for the reply. I had a long post done but lost it.

Basically, I think the Act and the Regulations and the reply you got from NAMA make it implausible that the standard discount for enforcement costs and due diligence has already been factored into the property LEVs published in the Key T1 data.

(NAMA Official: “In addition to the LEV of the property, the loan valuation is determined by reference the discount rates per the valuation regulations taking account of enforcement costs and the legal due diligence levy, and the potential for legal haircuts regarding defects in security and title amongst other inputs which influences the consideration paid by NAMA for the loans.”).

If we take AIB as an example and work from the Property LEVs we get the following:
LEV of properties – 2.04
cost of funds discount – 0.1734 = [2.04*1.7%*5]
standard discount for enf and DD – 0.1071 [2.04 * 5.25%]
Net value – 1.7595

This is more than EU200m less than the consideration paid for the loans. It also does not include any potential legal haircut. Therefore, the LEV of a loan is significantly greater than the LEV of the underlying asset. (This applies whether or not the upfront Enf & DD costs have been charge separately and are not included in the T1 haircut.) Until we know how much greater the LEV of a loan can be as compared to the LEV of the underlying asset we do not know the most important fact about how loans are valued. We also do not have the benefit of any “cap” in the legislation.

In summary,
LEV loan (pre-application of dicounts) > LEV Underlying Property
AND
We do not know the relationship between LEV Loan and LEV underlying property
THEREFORE
The protection provided by caps on LEV property in the legislation are largely illusory.

@Jagdip

It is possible there is no vintage on the valuations because properties may have been continually revalued for each renewal of a facility. Therefore, even if the initial loan to acquire a property was low the bank gave the borrower the benefit of the higher value on renewal of the facility. Therefore, all values might represent peak values as “origination” might mean the date of renewal of the facility. Maybe Eoin or somebody else could clarify that.

The latest estimate of the Haircut given to the Commission was 35%.

The amount of loans to be transferred had been increased from the Sept 2009 estimates from €77bn to €82.5bn and the rolled up interest had increased from €9bn to €10bn.

The amount which we would be paying for the loans remained static at €54bn.

The estimated haircut had therefore increased to 35.00%.

It is not clear what information was available to NAMA at the time of its latest estimates to the EU Commission which was not available on Sept 2009.

It is further not clear what information, if any, was not available to NAMA then which has since materialised to increase the severity of the haircut, if indeed the haircut will be more severe than 35%.

That’s not a bad article form Brendan Keenan.

I think he is misjudging the politics of the situation though. A NAMA which makes serious losses could have devastating effects for Fianna Fail in the long-term. Furthermore, whilst people may be disgusted at the amounts being paid to the banks, it does illustrate clearly the true magnitude of the problem. That in turn should help in garnering acceptance of the necessary reforms and measures.

I also think Brendan Keenan is neglecting the international aspect to this. Brian Lenihan said the loan transfers to NAMA would be credible. This is because they have to be credible to inspire confidence in our national debt levels. Overly generous prices could fatally undermine the notion that the NAMA debt should be viewed as separate from the national debt because it is backed by valuable assets. The idea that we could sneak less credible prices past them strikes me as a bit fanciful, though maybe the international financiers really are that thick.

Brendan Keenan rightly says that a solution which fixes the banks to a degree that enables them to assist in the economic recovery is the minimum which must be done now. I think it is incompatible to suggest that keeping the capital requirements low and over-paying for the loans would have been enough to position the banks so they can assist in the recovery. As Colm McCarthy has repeatedly pointed out, the losses have already occured. Not recognizing them will not cure the problem. As Alan Ahearne has pointed out, banks failing to recognise their losses and therefore not properly recapitalising has been a disaster in Japan (although some would say Japan may have done as well as could be hoped for).

@ Zhou

between facility renewal, equity withdrawal (which im sure was rampant) and a very competitive banking market which saw borrowers switching from one bank to another (oh, the stories of dodged bullets are incredible…), i think it’d be very difficult to get a real feel for initial origination/”vintage”. As you suggest, for example, a property bought in 1990 for 100k was im sure later referred to as a loan granted against property valued in 2005 as 1mio, even though it was in essence the same facility constantly rolledover. If nothing else, i’d imagine cross-collateralisation would’ve required this sort of re-working of value referencing.

@Jagdip

“I’m assuming you are misdirected by the due diligence and enforcement costs and I’m assuming they are not offset from what is paid in respect of the tranches. I’m assuming they are separate.”

More circumstantial evidence of on the question of an upfront a deduction from the consideration paid:

Brian Lenihan in the Dail on 30 March 2010:
“There are a number of reasons the initial estimate was reduced massively in subsequent discounts. One was the over optimistic assumptions by the institutions about the loan to value ratios. A further factor was the bottom-up valuation process [?] and another factor was the securitisation and a degree of securitisation for particular loans. The revised uplift is the result of individual loan valuations following extensive due diligence and individual property valuations.”

However on page 92 (of 92) of the Minister’s statement on the NAMA website :
The cost of advisory services has been low to date. The very competitive and thorough public procurement process used by NAMA for valuation and legal due diligence services is in fact driving the cost of these services down. Furthermore, NAMA will recoup the cost of these services from the banks as the valuation regulations provide for recovery of initial due diligence and any subsequent enforcement costs (i.e. legal and other costs incurred in the process of taking over the underlying asset when a borrower defaults). These costs will be recouped through an upfront deduction of 5.25% from the price NAMA will pay the banks for the assets.
http://www.nama.ie/Publications/2010/FinanceMinisterStatementonBanbkingSupplementaryDoc30Mar2010.pdf

I have emailed NAMA on the point of the upfront deduction being included in the First Tranche discounts. I’ll let you know if they reply.

[@mod – please disregard previous duplicate post]

@Jagdip

“I’m assuming you are misdirected by the due diligence and enforcement costs and I’m assuming they are not offset from what is paid in respect of the tranches. I’m assuming they are separate.”

More circumstantial evidence of on the question of an upfront a deduction from the consideration paid:

Brian Lenihan in the Dail on 30 March 2010:
“There are a number of reasons the initial estimate was reduced massively in subsequent discounts. One was the over optimistic assumptions by the institutions about the loan to value ratios. A further factor was the bottom-up valuation process and another factor was the securitisation and a degree of securitisation for particular loans. The revised uplift is the result of individual loan valuations following extensive due diligence and individual property valuations.”

However on page 92 (of 92) of the Minister’s statement on the NAMA website :
The cost of advisory services has been low to date. The very competitive and thorough public procurement process used by NAMA for valuation and legal due diligence services is in fact driving the cost of these services down. Furthermore, NAMA will recoup the cost of these services from the banks as the valuation regulations provide for recovery of initial due diligence and any subsequent enforcement costs (i.e. legal and other costs incurred in the process of taking over the underlying asset when a borrower defaults). These costs will be recouped through an upfront deduction of 5.25% from the price NAMA will pay the banks for the assets.
http://www.nama.ie/Publications/2010/FinanceMinisterStatementonBanbkingSupplementaryDoc30Mar2010.pdf

I have emailed NAMA on the point of the upfront deduction being included in the First Tranche discounts. I’ll let you know if they reply.

@Jagdip

I have looked at the Commission’s opinion properly. It is clear that the cost of funds discount is not 1.7% per year. See para 118 and footnote 44:

(118) Concerning the discount rate applied to the cash flows, the Irish authorities will discount the asset cash flows over 3 maturities (3, 5 and 8 years) depending on the recovery prospects (paragraph (64)) at a rate equal to the Irish government bond yield as of 21 December 2009 for the relevant maturity plus 170 basis points [44].

Fn 44. The Irish government bond yields as of 21 December 2009 with a 3, 5 or 8 year maturity are 2.844%, 3.900% and 4.462% respectively, resulting in a total discount rate of 4.544%, 5.600% and 6.162% for each maturity respectively.

Also, the discount rate appears to be applied to anticipated cashflows rather than to the overall LEV of the loan/property (paras. 51, 62, 63, 64 [fn 22], 65, 71, 102, 118 [fn 44], 119, 121 [fn 47]). It would be great to hear from somebody with valuation experience how this works, i.e. what the discount will be charged on.

Accordingly discounting the LEV Property by 5*1.7% to arrive at LEV Loan is not valid.

Also, I think it should be noted that four items are valued (para 53):
1. Property CMV
2. Property LEV
3. Bank Asset CMV
4. Bank Asset LEV

Isn’t it bizarre that we have only been furnished with the Property CMV and LEV when we are told it is the Bank Asset LEV that counts? There appears to be a deliberate policy of witholding crucial information from the public announcements. It is hard to figure out why.

I note the uplift from Loan CMV to Loan LEV is 15%. This is despite the 5.25% standard discount. Whither the protection of the cap of 20% uplift on aggregate property LEVs?

http://www.nama.ie/Publications/2010/NAMAChiefExecutiveStatementToJointOireachtasCommittee13Apr2010.pdf

NAMA Chief Executive Brendan McDonagh’s Opening Statement to Joint Committee on Finance and the Public Service, 13th April 2010 (http://www.nama.ie/Publications/2010/NAMAChiefExecutiveStatementToJointOireachtasCommittee13Apr2010.pdf):

Some commentators have expressed surprise that the discounts that have emerged for each of the institutions have been so high. Initial indications of an aggregate discount of 30% were based on information provided last year by the five participating financial institutions. However, our own detailed due diligence on a loan by loan examination has revealed a troubling picture of poor loan documentation, of assets not properly legally secured and of inadequate stress-testing of borrowers and loans – all born of a mindless scramble to funnel lending into one sector at considerable pace and of a reckless abandonment of basic principles of credit risk and prudent lending. As a consequence of a number of factors – the fall in property values, a detailed scrutiny of loan and security documentation and a sober assessment of the prospects for the underlying property which secures loans – the expected discount of 47% for the first tranche is higher than could originally have been expected. I should point out to those who predicted that NAMA would overpay for assets that the consideration of €8.5 billion is less than the estimated current market value of the underlying property (€9.4 billion) and is also less than its estimated long-term economic value of the property of €10.5 billion.

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