Category: Banking Crisis

Lenihan: Current Share Prices Prove Banks Can’t Be Nationalised!

Yesterday’s Oireachtas Committee meeting left me more certain than ever that the NAMA “stockbrocking scenario” of something like a 20% discount is going to happen and that long-term economic value will be adjusted to deliver it. The transcript provides the strongest evidence yet.

The following exchange between Richard Bruton and Minister Lenihan shows that the NAMA pricing process has effectively already been decided. First, Bruton makes a point that I have emphasised on this blog many many times (for instance, here and here) which is that the Minister has effectively set a lower limit on the average NAMA haircut with his public statements:

If NAMA decides a €50 billion write-down is to be applied to the loans that are being transferred, and the shareholders’ funds are, for example, €20 billion, while the subordinated bondholders hold another €10 billion, it seems that the write-down will wipe out the shareholders and the bondholders. The legislation which purports to allow NAMA be independent in setting its prices has not shown us what will happen if NAMA, acting independently, wipes out the shareholders and the bondholders and is then left further below the water. That is a crucial issue.

On the one hand the Minister is saying that NAMA will be independent and that whatever happens with the valuation the cards will fall where they will and the State may have to put in more money. However, at the same time he is saying the banks will remain in private hands. He cannot pretend these two positions are consistent. To be honest, one cannot pretend that those the Minister engages as valuers – who are supposedly independent – will be immune from the knowledge that the Minister is saying every day of the week that at the end of this process the bank shareholders must be left intact. That may not be a written directive but it is certainly directive in its implications to those who are setting values. People who set values are fairly flexible in the way they work.

Lenihan’s answer is priceless. Read the following carefully. Referring to AIB and BOI he says:

Why would I outline the fact that there may be a residual or substantial shareholder interest left in these institutions if valuations established that their entire shareholder value was wiped out? The reason is on the basis of the information that I have at my disposal. This is not information that only I have at my disposal because markets have assessed that information in the context of their current share prices and rating agencies have used it in their assessment of these institutions. Were these institutions in the condition which Deputy Bruton suggests they would not have these positive market ratings and they would not have the degree of shareholder value they do. That is why in my public statements I do not envisage a complete wipeout of all shareholder interests in those—

Deputy Richard Bruton: What valuation of the loan book transferred to NAMA underpins those views?

Deputy Brian Lenihan: Bear with me for a moment. With regard to those two institutions, the current market assessment is based on their entire balance sheets which include the assets to be transferred to NAMA. Even on that basis the current market analysis is that they are viable trading entities based on their share price and rating assessments. That is why I speak as I do. I have to maintain confidence in a system in which world markets have confidence. When one speaks of the total wipeout of shareholder value it is unlikely to materialise on the basis of the information I have to hand and that will be the basis of my Estimates in the middle of September.

Now sit back for a moment and take this in.

Lenihan is saying that he knows the assets have a high enough value that the underlying losses won’t wipe out shareholder value. And he says that he knows this because the stock market says the banks currently have positive value! When he says “Why would I outline the fact that there may be a residual or substantial shareholder interest left in these institutions if valuations established that their entire shareholder value was wiped out? The reason is on the basis of the information that I have at my disposal” —it certainly appears to me that he is saying that even if NAMA came back and told him that the their asset purchases would render the banks insolvent, he would over-rule them, based on current share price valuations.

But anybody who has every studied financial economics knows that the stock market is valuing these banks based not on what the assets are truly worth but based on what NAMA is expected to pay. Bruton’s interjection is an attempt to explain this to the Minister. However, the Minister ignores it, ploughs on and essentially repeats the same point.

So there we have it. NAMA is a self-fulfilling prophecy. The markets expect something like a 20 percent discount. That’s built into the current share price. And the Minister will use the current share price to decide the discount.

It would be funny if it was happening somewhere else. To actually be living through this is very depressing.

A Chartered Surveyor’s View on Valuation

Today’s Irish Times carries an interesting article by Eoin McDermott, a chartered surveyor, on the issues relating to valuing property assets.

Garrett FitzGerald and the Budget Deficit

On Morning Ireland today, Garrett Fitzgerald again criticised the opinion article signed by the 46 economists. However, rather than focus on the article’s principle arguments about the government’s banking policy, Dr. Fitzgerald concentrated on what was essentially a parenthetical comment about the budget deficit. Among other things, he said:

Moreover, the statement made that we’re moving towards a deficit of €30 billion was quite irresponsible and that destroyed my confidence in the 46 economists.

Even leaving aside that the fact that the size of this year’s deficit is nowhere near the key issue in the 46 economists piece, is it indeed the case that this figure was irresponsible? One way to check is to look at the forecasts of that highly responsible body, the Economic and Social Research Institute. Their most recent Quarterly Economic Commentary, based on data available through July 9th, predicts an exchequer deficit of €25.7 billion.

Since then we have had the publication of the July exchequer returns (Irish Times story here) which saw tax revenues falling behind the targets set in the April budget. It would certainly not be extreme to add another billion or so to the projected deficit forecast on the basis of these figures, putting it at about €27 billion. To the extent that these shortfalls relate to unanticipated weakness in the economy, it is likely that social welfare payments will also come in ahead of target, perhaps pushing the projected deficit up to €28 billion.

Even ignoring the fact that deficit forecasts have been coming in too low now for some time, it seems to me that this is already enough evidence to justify the statement in the 46 economist piece that

We now look to be on course for a Government deficit of close to €30 billion.

Note incidentally, the sentence is projecting a deficit “close to” not “equal to” €30 billion.

I’m afraid here that, as with Dr. Fitzgerald’s claim that the piece failed to distinguish between different classes of bank debt, this criticism seems to be largely unwarranted.

The pity, of course, is that far more people read the Irish Times and listen to Morning Ireland than will ever read this blog. So, unfortunately, the damage to professional reputations done by being branded “irresponsible” and “destabilising” by a respected public figure will not be easy to undo.

ECB Opinion on NAMA

During today’s Oireachtas Committee meeting, the Minister for Finance referred to a formal ECB opinion document on NAMA and that it was being published this afternoon. Well, lo and behold, here it is.

I haven’t had a proper chance to read this but two sections jumped out. First, on valuation of assets being transferred:

Although the measures contemplated by the draft law should restore confidence in the Irish banking system, the ECB considers it important, in line with previous opinions that the pricing of acquired assets is mostly risk-based and determined by market conditions. The preference expressed in the draft law for the long-term economic value of assets, rather than current market values, requires careful consideration in this context. In particular, it should be ensured that the assumptions to determine the long-term economic value of bank assets will not involve undue premium payments to the participating financial institutions to avoid creating inappropriate incentives from their side as regards the use of the scheme.

And on nationalisation:

the ECB notes that the Irish Government shares the guiding principle that the preservation of private ownership is preferable to nationalisation. If the NAMA scheme will be successful in this respect, this strategy should help to avoid, in the short-term, the high costs involved in nationalisations and, in the medium-term, the risk of banks’ objectives being diverted from profit maximisation to alternative goals that might distort the market structure and jeopardise the level playing field.  

The opinion is silent on what should happen when their preference for pricing that is “mostly risk-based and determined by market conditions” comes into conflict with their preference for preserving private ownership.

Guest Post: International Credibility Does Not Need NAMA; It Needs Determination

Here is a guest post from Ciarán O’Hagan (fixed income strategy, Société Générale, Paris). Ciarán had submitted some of this material as a comment on an earlier post but we thought they were worth giving their own dedicated thread. Text below the fold.

Continue reading “Guest Post: International Credibility Does Not Need NAMA; It Needs Determination”