Tag: NAMA

Do NAMA Critics Know About LTVs?

The single strangest turn that the NAMA debate has taken is the sudden emergence of the claim that those who are critical of NAMA don’t know that it is purchasing loans rather than property assets. Take this quote from Damien Kiberd in the Sunday Times:

Are the agency’s critics aware that if we allow the European Central Bank (ECB) to fund the €60 billion or so that NAMA will pay for loans, we will be getting control of properties originally valued at €120 billion and not the €90 billion that is continuously cited?

Leaving aside the incorrect claim that the ECB are “funding NAMA” (the bonds issued will be debts that the Irish taxpayer will have to pay back), the answer to the question is, Yes, we are perfectly aware that not all loans have 100% loan-to-value ratios (though whether €120 billion is indeed the correct figure is uncertain).

I suppose it is possible there are many regular folk out there who don’t understand the distinction between loans and collateral but that can’t be who Kiberd is taking about.  All I can say is that no economist that I have communicated with on this issue has failed to understand this distinction.

And here‘s the Minister for Finance, quoted in the Irish Times:

The crucial point about the €90 billion, which has not been reported, is that when you take into account average loan-to-value ratios, the property secured had a peak book value of about €120 billion. When people talk about reductions, they are ignoring that issue completely.

Really, who is this “they”?

One explanation for the sudden focus on loan-to-value ratios is that perhaps the government are confused by the fact that NAMA critics have focused extensively on property valuations. There is, of course, a very good reason for this focus. If a developer cannot pay his loan back, then the bank will have to end up seizing the collateral and the value of this collateral will be all the bank has to show for the money lent out.  So, in most cases, the value of collateral will be the value of the loans.

Another explanation for this new talking point is that, rather than engage in a substantive argument, the government has decided that it may be an effective debating tactic to claim that forty six professional economists are unware of even the most elementary aspect of banking. Decide for yourself.

NAMA and Best Practice

From an article by then-ivory-tower economist Alan Ahearne in the Sunday Independent on July 27, 2008:

However, if the borrower is unlikely to repay the loan, the best strategy is often for the bank to sell the loan to a special company created to handle bad debts. This allows the banks to concentrate on what banks do best – making new loans.

In some countries that have had severe property busts, these asset management companies have been state-owned agencies. In this country, one could imagine an agency like the National Treasury Management Agency buying nonperforming loans from the banks and then managing and disposing of the properties that are collateral for these loans. These distressed properties could be disposed of gradually, thereby avoiding fire-sale liquidations.

A key question would be what price the agency should pay the banks for the loans? Buying the assets at inflated prices would amount to a back-door recapitalisation of the banks. Similarly, many of the proposals currently doing the rounds to reignite the housing market using government subsidies to first-time buyers involve disguised bail outs of banks and developers.

Best practice is for the banks to recognise the losses on these loans up front and sell the assets at fair market value. If banks do not have sufficient capital to take the hit, then they should raise new capital to plug the hole. Dealing with impaired assets properly will be critical for our economic recovery.

Discuss.

Loan to Value Ratios

In interpreting the write down on loans that NAMA is intending to announce in mid-September, an important element will be the loan to value ratios. A commonly cited figure has been that original loan-to-value ratios on development loans were about 75%.

For example, this ratio would be consistent with a property purchased for €100 million with a loan of €75 million. If for instance, this property had fallen in value by 50% and the developer had insufficient cash flow to repay the loan, then bank would only recoup €50 billion, for a one-third loss on the original loan. A 70% decline in property value, as Anglo Irish noted for Irish property development land back in March, would imply a 60% loss.

So far, so simple. However, the real world is not so simple. Here are two complications that seem likely to have pushed loan to value ratios above 75%.

First, there is the fact that many (most?) development loans allowed developers to roll up the interest from day one. This then gets incorporated into the principal that they owe. So, to take the example above, three years of rolled-up interest at a six percent rate will have left the developer owing €88.5 million, leaving an LTV of only 88.5%.

Second, it’s my understanding that the average loan-to-value ratios generally quoted include a quite different form of loan to the one outlined in the fictional example above. For instance, a developer may have borrowed 100% of the money for the project. However, in addition, they have put up additional collateral in the form of another property they own. If this additional property was worth one-third of the value of the new property being purchased, then this would count as an LTV of 75%.

For example, the developer may have borrowed €75 million to buy a property worth that value and then pledged €25 million in additional collateral. In this case, not only is the property that the loan financed declining in value but so is the additional collateral (the “equity” component.)  It is also widely reported that the same piece of property may have been put up multiple times as additional collateral in these types of loans.

From my ivory tower, I’m afraid I don’t know how much this stuff affects overall LTV rates but both practices seem to have been pretty prevalent and they both point towards higher ratios than 75%. I would really appreciate if those with more detailed knowledge of these issues could give us some estimates on the magnitudes at hand here.

Beyond that, I think it will be important that the mid-September announcement of NAMA’s intended purchase prices include information on true underlying loan-to-value ratios, including the amount of rolled-up interest and the valuation of additional collateral pledged.

Pro-NAMA Irish Times Article from Rory Gillen

The Irish Times has an article today by Rory Gillen of Merrion Capital. Gillen takes issue with arguments raised in a recent Irish Times article by Fintan O’Toole and also, to a lesser extent, with arguments in the 46 economist piece.

There is one argument in piece that I think is worth highlighting. It relates to subordinated bond holders. The 46 guys piece makes it clear that “certain classes of bondholders” should take a hit. Gillen presents this proposal as disastrous. He says that the

argument that bond holders should also be scalped is, in my view, a very short-sighted one. The cost of Ireland’s debt would most certainly increase, further hitting the majority of mortgage holders and businesses.

In the eyes of the international community, it would also link us to such bedfellows as Argentina, Russia and Iceland. I, and surely our descendents, would rather not be stuck with that particular stigma.

Raising the spectre of Argentina, Russia and Iceland here is unfair and, funnily enough given the title of Gillen’s article, alarmist. An Irish bank defaulting on its subordinated debt is not the same as our government defaulting on its debt (Argentina, Russia) or our banking system refusing to pay up on huge amounts of foreign liabilities (Iceland).  And as for the cost of “Ireland’s debt”, some highly respected sovereign bond analysts have repeatedly pointed out that a resolution of the banking crisis in a manner that eases the burden on the taxpayer will have a positive effect on market’s assessment of Irish sovereign debt.

There is the question of the guarantee. However, some of the subordinated debt is not guaranteed while the rest is only guaranteed up until September 2010. A signal that the guarantee will not be extended for this class of assets would in no way be similar to a sovereign default.

More generally, subordinated debt is, by definition, at the back of the debt queue in terms of being paid back when a business gets into trouble. Sometimes businesses default on their subordinated debt—that’s sort of the point—and this happens not just in the countries mentioned by Mr. Gillen but also in the US, the UK and every other capitalist country in the world. We will not automatically turn into Iceland if a few subordinated bond holders don’t get their money back.

Irish Times NAMA Piece Signed by 46 Economists

The Irish TImes has today published a letter signed by 46 economists (organised by Brian Lucey) warning against the dangers of the NAMA process. Forty six economists can’t possibly be wrong can they? 😉

On a more serious note, one of the issues that will inevitably be raised about this is the position being taken by those economists who were offered the opportunity that didn’t sign. I suspect some will argue that they must all be in favour of NAMA.

My sense, however, is that there is no alternative groundswell of support from (non-stockbroking) economists for the govenment’s approach. Rather, many people are instinctively not petition signers, preferring to express their own views in exactly their own fashion, stressing whichever nuances they think are most important.  Also, it is worth emphasising that most economists are not experts in banking and finance and some simply don’t feel comfortable signing something relating to an area outside their research specialisation.

Still, if such an alternative groundswell of support did exist, I would strong suggest that they should put forward their own piece. I know that Alan Ahearne has been pressed into action but Alan is in a difficult position because publicly disagreeing with the Minister for Finance is outside his job description. I genuinely think that a high profile alternative letter, followed up by an intensive debate about the issues raised, would be very useful.

As a final note, I’d add that the headline for the article, as always, is written by the Irish Times subeditors. As far as I can see, the article says nothing about shifting wealth to developers.