What Will the Banks Do with NAMA’s Bonds?

There were some entertaining media reports last week about the appearence of AIB and Bank of Ireland executives before the Oireachtas Committee on Finance and the Public Sector. I decided at the time not to comment on these reports because the full transcripts of these meetings eventually get put online and these are a better way to judge what was said.

The transcript is now online here. The most insightful aspects of the committee meeting were the exchanges relating to what the banks were going to do with the NAMA bonds given to them by the Irish government.

Anyone following the NAMA debate over the past few months will have regularly seen and heard members of the government explain how NAMA was going to get credit flowing: NAMA would take ownership of the banks’ property loan portfolios in return for government bonds, which the banks would then use as collateral to get repo loans from the ECB and then these funds would be loaned out to Irish firms and households.

The statements made at the committee meeting by CEOs Richie Boucher of BOI and Eugene Sheehy of AIB did not at all conform with this story. Indeed, the general tone of their statements was that there would be very little swapping of NAMA bonds for ECB loans. Instead, as illustrated by Sheehy’s already infamous “trickle-down” comment, the only benefit to getting credit going in Ireland would be a lower cost of market funding for Irish banks which might get passed on to customers.

NAMA Bond Yield Formula Finally Revealed

Finally, and only after questioning prompted by Brian Lucey’s earlier appearance on Morning Ireland, the Minister for Finance decided it was appropriate to let us know exactly what type of bond he was issuing with €51.3 billion of our money. The regular NAMA bonds will be issued with a six-month rollover period with an interest rate set at a half percent above the ECB’s main refinancing rate. This ECB rate is now one percent but there is general agreement that it will rise over the next few years (click here for historical values).

It should be clear now that there is nothing especially good for the Irish taxpayer about the current low yield on these bonds. At a time of low short-interest rates, it can always appear as though one is saving money by borrowing short and rolling over this short-term debt. However, because bond market participants aren’t stupid, long-term rates are determined with reference to this short-term rollover strategy, so there is no “free lunch” from issuing short-dated rather than longer-dated bonds. (Here are my own teaching notes on this issue.)

Those who think that the NAMA bonds are an especially good deal for the taxpayer might also note that the government is currently able to borrow at a six month duration at a rate of 0.5 percent—the yield on the latest six-month NTMA Treasury Bill auction. The extra amount being paid on the NAMA bonds can be justified as reflecting the higher sovereign default risk associated with longer dated debt.

I would note also that, given the relatively unremarkable nature of these bonds, any claims that their current low rate reflects some sort of special deal with the ECB—claims I never understood—need to be retired from circulation.

In relation to NAMA “washing its face” (it was washing its hands on Morning Ireland earlier—perhaps because of swine flu) there is no reason to expect the coming ECB interest rate hikes to generate corresponding increases in income from the 40% of NAMA assets that are generating income, so claims NAMA will always break even on an income basis appear to have little basis in reality.

Of course, we still don’t know anything yet about the maturity of these bonds. Or about the yield on the €2.7 billion in subordinated bonds. Or about the exact conditions under which the subordinated bonds will fail to pay off—though statements that they will pay off as long as property prices bounce back by 15% suggests that, as I had feared, the definition of “NAMA making a profit” will exclude interest costs.

But hey, Pat McCardle still reckons it’s all a secret EU conspiracy, so who am I to disagree? Perhaps Pat might enlighten us as to what changes the ECB have made to their current operational procedures to accomodate NAMA. Perhaps not.