The maths of NAMA-type valuations

And it’s not just NAMA.  From Boston to Berlin, valuation of distressed assets is a hot topic these days.  Jacco Thijssen‘s new Irish Economy NoteValuing Distressed Assets Using Optimal Stopping Theory” looks at some of the underlying maths that could be used.

Anglo Irish bank: dealing with risk investors

Anglo Irish Bank has announced losses that bring its measured shareholders’ funds down to about 0.1 per cent of total assets — effectively zero.  It has also announced a further €3.4 billion in expected loan losses, little of which would be offset by operating income over the next year or so.

From a strict contractual point of view, the next in line for absorbing these losses are the subordinated debt holders.  There has already been some discussion on this site of the issues involved here.

Now we are at a crunch point because a recapitalization of Anglo cannot be long-delayed. Indeed, to continue trading, the bank presumably needed the assurance that was provided by the Government today that needed capital would be forthcoming.

There is €2.8 billion of unguaranteed sub-debt on Anglo’s books.  I am assuming that part of the Strategic Plan promised by the bank this morning will have to involve risk-sharing by sub-debt holders.  This could take the form of of a deeply-discounted buy-back (as indeed is already suggested in the Government’s statement). It could also take the form of a debt-equity swap. (This would parallel current discussions in the US around debt-equity swaps to recapitalize some of the larger US banks following their stress-tests).

Obviously none of this is easy, and these bondholders may want to play chicken.  In a liquidation they would be wiped out, but — absent modern bank insolvency legislation here — a messy liquidation could also inflict severe taxpayer and economic costs.

I admit that I am not sure of the most effective way of accomplishing it. There are some obvious options. Perhaps readers will have some further ideas. I am sure that officials are pondering these issues.

But difficult does not mean impossible.  The stakes here are evidently high. 

Urgent work to modernize bank insolvency procedures (as recently enacted in the UK post Northern Rock) could strengthen the Government’s hand. 

It might be argued that losses incurred even by sub-debt holders of a bank could damage the credit of the Irish government.  I disagree. 

First, it is really immaterial that the bank is Government-owned: eveyone knows that situation has only arisen as a result of the disastrous performance of the bank. No new subordinated debt has been issued since the nationalization. Besides, in his statement in the Dail on January 20, during the debate on the nationalization bill, the Minister removed any doubt about whether nationalization entailed an expansion of the guarantee.

More generally, even though there might be an immediate knee-jerk reaction in market prices of debt, mature reflection by the financial markets would recognize that a country honouring its debts and guarantees to the letter–and not beyond–was more creditworthy than one which handed over money lightly to unguaranteed risk investors.

Crisis Policy Conference programme, 20th May

Trinity College Dublin
(Department of Economics and IIIS)
and the
Dublin Economics Workshop



J.M. Synge Lecture Theatre (Room 2039), Arts Building,
Trinity College Dublin
Wednesday 20th May, 2009


Session 1: 1.30-3.30

Chair: Jim O’Brien, Second Secretary General, Department of Finance

John Fitz Gerald (ESRI) on Competitiveness
Karl Whelan (UCD) on Potential Output
Brian Nolan (UCD) on Inequality

Session 2: 4:00-6:00

Chair: John McHale, Queens University, Canada & NUIG

Colm McCarthy (UCD) on Pensions
Philip R. Lane (Trinity College Dublin) on Fiscal Policy
Patrick Honohan (Trinity College Dublin) on Banks

Shifting ownership of Irish banks

Given the current interest in ownership of the Irish banks, I thought readers might be interested to read about the size distribution of shareholders.

AIB provides the most interesting data, reported in their recently published Annual Report and relating to end-December 2008.

There have been some interesting shifts in the past year.  First of all, shareholders in the Republic (including pension funds etc.) now hold 41 per cent of the shares, up from 37 per cent last year.

Second, in the face of dramatic declines in price and increase in volatility, the number of AIB shareholders has increased by over 10 per cent or 10,000 persons.  Almost all of the increase relates to the Republic, and almost all hold less than 5000 shares.  (Today, the shares closed at €0.81).  This confirms what was known anecdotally, namely that lots of middle income people thought it worth taking a flutter on bank shares given the novelty that they were only worth cents.  They have bought these shares from foreign institutions.

For, although there over 90,000 AIB shareholders in total, of whom 76,000 in the Republic, fewer than 5000 shareholders hold more than 10,000 shares, and just 384 hold more than 100,000 shares.

Bank of Ireland had about 80,000 shareholders when it last reported the number, about a year ago.  (We’ll likely see a similar pattern to the changes when the March 2009 figures are published.)

A look at Irish Life and Permanent‘s reports (giving shareholders at end March 2009) shows a similar, though smaller trend: they now have over 135,000 shareholders up about 1%.  All but 10,000 of them have fewer than 1000 shares each, but most of the newcomers seem to have between 1000 and 10000).

Anglo Irish Bank had far fewer shareholders — fewer than 20,000; just over 100 of them held 85% of the total shares between them.

Scope of NAMA

Much has been written about the pricing of the NAMA loan purchases and the consequences for shareholders (including by myself in tomorrow’s Sunday Business Post), but less on the scale and scope of the proposed purchases.

The announced plan is that

“The eligible land and development loans of each bank involved will be transferred – that is the eligible loans secured on development land and property under development. In addition, the largest property-backed exposures of all the banks in the scheme will be transferred.”

Ignoring, for a moment the undefined word “eligible” — which allows an attractive degree of flexibility — what about the two other distinctive features of this proposed scope of purchase:

First, it is not limited to non-performing or impaired or problem loans. Second, it excludes a large swathe of property-related and other loans, including problem loans.

Inclusion of performing loans
I can see that it is an attractive simplification for NAMA’s management to sweep in all of a clearly-defined category of loans, not least because that way you are sure of covering even those loans that have not gone bad yet.

I am less impressed by the argument that including performing loans is good for the taxpayer because they will be serviced. The inclusion of performing loans increases the gross scale of the NAMA operation, and with it the size of the National Debt. It may also, I suppose, complicate the operation inasmuch as both the banks and their non-delinquent borrowers may be very unhappy to be separated.

Exclusion of non-development-property loans
If the goal is to end up with unquestionably clean bank portfolio, should one not also be considering inclusion of other non-performing loans, given the deterioration in the overall economic prospects?

At this stage, I am not sure what to conclude, except that the scope of the purchased assets is an important issue. Clearly, that word “eligible” could come in very handy as the scheme moves towards statutory definition.

Meanwhile, another question worth considering is whether NAMA needs to wait until it has identified all of the loans to be purchased. Here the answer seems clear: best to go ahead with an initial purchase of the most problematic loans as soon as the agency is up and running (assuming, of course, all of the pricing & financial restructuring,  governance and transparency issues also sorted).