Haircuts

Here are the estimates from Davy Research for the different types of property loans held by Irish banks. (Access, however, limited to customers of Davy.)

Their summary:  “Gauging the appropriate haircut is a function not just of the asset value; rather, it also hinges on the original loan to value, the vintage of the loan and the provisions made. Our analysis suggests a range of mark to market haircuts: from as low as 5% for loans backed by UK commercial investment property to 44% in the case of loans backed solely by Irish development land.”

Bottom line in terms of state ownership:   The base case delivers ownership by the state of 78 percent for AIB and 69 percent for Bank of Ireland.

Sarah Carey on NAMA and Nationalisation

Sarah Carey’s article in today’s Irish Times is worth reading because it is perhaps the most articulate version yet of the key argument that tends to convince people that nationalisation is a bad idea and that NAMA and limited state ownership is the way to go.  The government has made a series of arguments against nationalisation but it’s hard for them to bluntly say “we don’t want to own the banks because we’re scared we’ll make a mess of them.”  But an opinion columnist can and this is the essence of Carey’s argument.

I think Sarah is too pessimistic about the long-term performance of semi-state bodies in Ireland and that, in any case, there’s little point in applying these analogies to businesses for which state ownership is an explicitly temporary measure. 

Beyond that, at the risk of making Sarah’s head hurt a bit more, let me put the case for why she should trust her instincts and support the college boys.

Continue reading “Sarah Carey on NAMA and Nationalisation”

NAMA Website

There may not be any legislation yet but NAMA has a website.  It provides an example of how NAMA will buy loans from the banks using a “purely illustrative” example of a 25% discount.  It has been widely reported that AIB would be selling €30 billion in loans to NAMA.  A writedown of €7.5 billion would wipe out essentially all core Tier 1 (shareholder) capital, so this is an interesting illustrative example.

Update: Patrick correctly points out that the illustration is of a €25 million writedown of a €65 million loan for a property originally worth €100 million.  So indeed it’s a 38.5% discount. I know it’s just an example but it’s interesting all the same.

IMF on Costs of Financial Stabilisation

The Irish Times lead story cites the IMF’s Global Financial Stability report as having the following sentence: “The United States, United Kingdom and Ireland face some of the largest potential costs of financial stabilisation (12 to 13 per cent of GDP) given the scale of mortgage defaults.” It turns out, however, that the IT was a little behind on a (fairly silly) controversy about this sentence.

It turns out that the IMF’s cost estimates are not new at all but actually first appeared on page 17 of this report released on March 6, which was written as a companion to this report on the outlook for public finances around the world.  The March 6 paper reports a cost figure of 13.9 percent of Irish GDP, which amounts to €24 billion.  Table 4 also reports the cost for the UK at 9.1 percent of GDP.

For this reason, there was a bit of a flap over this when the BBC reported the 12-13 percent figure, with the UK Treasury pointing out correctly that the sentence and its accompanying table were wrong.  The version of the report on the website no long contains the parenthetical “(12 to 13 per cent of GDP)” that the Irish Times had quoted and the table has been altered—I think Ireland may have been listed in the original Table 1.8 but we are not now.  In any case, you can find the original source of the calculations from the above link.

So, not the IMF’s finest hour.  However, beyond the silliness, it is clear that the IMF’s assessment of the likely costs of financial sector support measures to the Irish taxpayer does not fit well with the government’s current stance that “under extreme stress scenarios” BOI only need €3.5 billion in additional capital, while AIB only need €5 billion.

AIB Re-Cap Announcements

So where does the substance of the AIB announcement leave us?  As has often been the case with the government’s approach to the banking crisis, this pushes us one step closer to some kind of resolution, while still maintaining lots of uncertainty as to what that resolution will look like. 

Continue reading “AIB Re-Cap Announcements”

A NAMA for Germany?

From today’s Eurointelligence

There is some movement in the debate on bank resolution policies in Germany. FT Deutschland has the details, according to which the government is currently favouring a model proposed by investment bank Lazard. According to one variant of this model, the government takes the toxic assets from the banks, in return for government debt obligtation, which carry ultra-low interest rates, and which the banks promise to keep on their books for a long time. The idea is that such a construction prevents spillovers into the general bond market. Another construction is a bad bank, which holds the bad assets, and which issues government-guranteed debt obligations to the good bank.

Lessons from Sweden

I linked last weekend to former Swedish Finance Minister’s Bo Lundgren’s appearance on the Marian Finucane show.

Lundgren also appeared recently before the TARP Congressional Oversight Committee, chaired by Harvard Law Professor Elizabeth Warren and his written testimony was the basis for the section on Sweden in the committee’s latest report. Here’s a webpage containing the written testimony of Lundgren and three other experts on other banking crises (Great Depression, 1980s S&L and 1990’s Japan) who all appeared before the committee at the same time.

The webpage also has full video of this meeting. The experts delivered short verbal testimony (Lundgren’s starts about 14 minutes in) and about 40 minutes in there is a question and answer session. Prof. Warren’s opening line of questioning about arguments against nationalisation was of particular interest to yours truly but the whole session is really useful.

Continue reading “Lessons from Sweden”

Arguments Against Nationalisation, Part 5: Lack of Government Expertise

[Last in Series …. For Now]

Speaking with Myles Dungan on RTE radio on Thursday, Minister Eamon Ryan put forward the following argument against nationalisation:

You have to run the whole bank, the system, from Merrion Street … And there’s no ability, I believe, in the Department of Finance to run six banks at the one time … They [the Department of Finance] recognise that you don’t just suddenly start running six banks. And you can’t do it in a very transparent way.

I think the Minister raises a fair concern here, so I thought I’d throw this one out there as my final (for now) post on this.

Continue reading “Arguments Against Nationalisation, Part 5: Lack of Government Expertise”

Arguments Against Nationalisation, Part 4: Continuous Stock Market Listing

Peter Bacon’s final argument against nationalisation in his Morning Ireland interview was the following:

Also, if you nationalise the bank, it’s gone. If the bank remains there, even if it comes to pass that in some cases there is majority ownership by the government, by the taxpayer, there will be a quotation on the Irish and London stock exchanges. There will be a price every day that bank shares will trade at and that will provide taxpayers with an exit mechanism out of their ownership of the banks in due course.

Continue reading “Arguments Against Nationalisation, Part 4: Continuous Stock Market Listing”

Arguments Against Nationalisation, Part 3: Transparency

Peter Bacon outlined two other arguments against nationalisation in his Morning Ireland interview. The first related to the question of transparency:

You nationalise it and then you would still have to deal with it. You would be dealing with it behind closed doors. People have screamed “let’s have transparency with this”. The only place you will find transparency is if you do this in the open market.

Given the amount of public money at stake, I couldn’t agree more with Dr. Bacon that transparency is essential. However, I disagree with him regarding the levels of transparency that would prevail under nationalisation relative to his NAMA plan.

Continue reading “Arguments Against Nationalisation, Part 3: Transparency”

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).

Arguments Against Nationalisation, Part 2: Baconian Equivalence

Probably the most common argument I have heard from influential Irish commentators when they argue against nationalisation is to quickly dismiss it on the grounds that it simply does not help in “solving the problem” or reducing the cost of the banking crisis for the taxpayer.  Yesterday’s Irish Times article by Scott Rankin provides one example of this argument.  Let me provide three other examples.  Here are two examples from Prime Time on March 19.

Continue reading “Arguments Against Nationalisation, Part 2: Baconian Equivalence”

Arguments Against Nationalisation, Part 1: Politicisation of the Banks

Let’s start with what I see as the single best argument against nationalisation. The vast majority of economists get very worried when public ownership of banks is brought up because, as Frank Barry discussed yesterday, nationalised banks are particularly likely to be subject to abuse by politicians and their crony capitalist mates.

Continue reading “Arguments Against Nationalisation, Part 1: Politicisation of the Banks”

Bacon on Pricing Assets and Nationalisation

I was somewhat heartened by the overall tone of Peter Bacon’s comments about NAMA on Morning Ireland yesterday. He talked pretty tough about the need for NAMA to pay market prices for loans and correctly argued that indexes for property prices showed that one could put market valuations on these assets that would involve steep write-downs.

That said, I’m still not encouraged to think the plan will work out well for the taxpayer. Bacon himself won’t set the valuations for the loan portfolios—I’m guessing this will be done by a major accountancy firm. And I am concerned the accountants hired will value the portfolio according to conservative rules so that currently impaired loans are written down but all other property loans are valued at book value.

For me, however, what was more interesting than the tough talk on valuations was Bacon’s detailed explanation of why he did not favour nationalisation (starts at about 6.50 in). I think it is important that a full debate is had about nationalisation. To help with this, I’m going to write a few separate posts over the next few days to discuss the arguments made by Bacon and some others and to put forward a defence of nationalisation. Doing these as separate posts will facilitate interaction with our readers on specific issues and I’d be happy to take suggestions on which issues to discuss.

And before any our more excitable commenters start getting too worked up, I would like to emphasise from the outset that I view myself as politically moderate: A brief perusal of my research scribblings will uncover lots of boring arcane technicalities and no track record of radical left wingery. So, it is only with reluctance that I am advising this approach.

Without further ado, the first nationalisation post is just above this one.

IT Head to Head on NAMA Plan

Today’s Irish Times contains a head-to-head set of articles from me and Scott Rankin of Davy’s about the NAMA plan.

As is often the case, the articles are accompanied by a weirdly misleading headline—“Will NAMA aid the ailing banks?”.    I am listed in the “No” column because I don’t like the NAMA plan.  But my problem with this plan is not that it won’t “aid” the ailing banks.

The problem with the banks is under-capitalisation.  Of course, any plan that injects enough money can solve this problem by re-capitalising the banks.  The relevant question is how is this done and at what cost to the taxpayer—my concern is that this plan may “aid” bank shareholders considerably at the expense of taxpayers. More generally, I hope the Irish financial media will move on from their focus on “Will the plan work?” to examine the question of how it operates.

Scott Rankin’s final sentence is worth a short comment.  He writes:

One important point to understand is that if nationalisation is not an option, then the liability to the State from these assets does not necessarily diminish if a bigger haircut is agreed on transfer, that is, if it’s 35 per cent rather than 15 per cent. If Nama achieves a bigger haircut on day one (and hence saving for the taxpayer) this probably means more government capital required to recapitalise the banks.

This argument makes it sounds like the “haircut” (the discount over book value at which the state purchases the bad loans) simply doesn’t matter.  One way or another, we need to provide the funds to re-capitalise the banks.  But look carefully, folks, is it really the case that the composition of these funds doesn’t matter?

The bad loans will end up returning some concrete amount of money to the state and this amount will be completely independent of the haircut we apply now. The state gains nothing from reducing the haircut by a euro.  But it loses a euro of equity capital investment.

And contrary to Scott’s argument, this equity investment is not a “liability” for the state: It is an asset and can be cashed in for a return at a later date.  In calculating the long-run cost of this program for the taxpayer, the size of the haircut matters greatly.

Bacon Gives Bacon Plan Thumbs Up

Is it just me or is there something deeply odd about the way the media report things like yesterday’s NAMA report from Peter Bacon?   We are told that “the report by economic consultant Peter Bacon says the new agency has potential to bring a better economic solution to the banking crisis.”  Well, he would, wouldn’t he?  Why not report this as “Economist Peter Bacon, who drafted the proposals for a state asset management agency, released a summary of the report that he prepared for the government.”   Too boring, I guess, but why mislead the public by presenting an assessment of the plan by the person who wrote the plan as being, somehow, objective?

NAMA, EU Guidelines and Pricing of Assets

My previous post discussed the price that our new National Asset Management Agency (NAMA) could pay for impaired loans from the perspective of how much of a loss relative to book value the banks could take under the assumption that the government didn’t invest more than its €7 billion planned re-capitalisation. The answer was that the discount from book value would have to pretty small relative to the figures being widely quoted for likely losses.

Admittedly, this was a bit of an around-the-houses way of warming up to the NAMA discussion and Patrick was completely correct in his comment that the key sentence in the speech was

If the crystallisation of losses at any institution requires additional capital the State will insist on participation by way of ordinary shares in the relevant institution.

Continue reading “NAMA, EU Guidelines and Pricing of Assets”

NAMA and Pricing the Bad Property Loans

I have examined the government’s banking proposals and will have more to say later about their substance. However, before discussing the details, I’d like to focus on some figures that will help shed light on a question that I’ve already heard many times today—how much will our National Asset Management Agency (NAMA) pay for the bad assets of our major banks? Continue reading “NAMA and Pricing the Bad Property Loans”

Getting the asset purchase scheme right

As we wait for today’s budget announcements, it is worth reflecting on the challenges of getting the right design and pricing for the asset purchase scheme now being trailed.

Some bloggers have made up their minds that the government will overpay for the assets. How can such an outcome be avoided? I have a slightly novel suggestion for this.

As in the United States, there will be a huge gap between what the banks claim the assets are worth and the value that the rest of the market would place on them.

Finding a mechanism that places a generally accepted price on the assets is as difficult here as it is in the US. Any asset purchase scheme will require a further detailed scrutiny and evaluation of the assets to be purchased.

It is to be hoped that the initial announcement of an asset purchase scheme will not lock the government into prematurely firm commitments on pricing and financial restructuring of the banks. The worst possible thing would be to crystallize the taxpayers’ costs at too high a level.

Buying the assets at inflated prices would surely be politically unacceptable. Indeed, Government sources have clearly trailed that they will not pay current book value for the assets.

Each country’s situation is slightly different. If we were to subtract now the present value of all prospective loan losses (taking recent analysts’ estimates), the main Irish banks would be severely undercapitalized. Removing the problem loans at anything close to the prices implied in the analysts’ estimates will require the banks to take immediate write-downs that have the same effect.

Therefore implementation of the asset purchase scheme at realistic asset prices will create the need for a further recapitalization of the banks.

Injection of more preference shares by the Government will not do the trick. If the banks are to move forward in a sound manner, and be accepted as financially self-sufficent, they must have sufficient equity capital. In quieter times there would be enthusiastic private sector buyers for equity in such cleaned-up banks. Failing that, the residual equity investor is likely to be the government. When you do the sums using the analysts’ estimated, this has to imply huge dilution of the existing shareholders. No wonder many commentators have concluded that full, albeit temporary, government ownership is on the cards.

Given this background, it might be better to do something just a little more complicated: let the asset management company pay even less than fair price for the bad loans, and in return give the existing shareholders of the banks an equity stake in the AMC. This has the advantage of making sure that the surviving bank really is clean, and neatly defuses shareholder objections that they are being expropriated. Of course they are even less likely to own much or any of the surviving bank, unless they choose to contribute to its recapitalization. Other existing risk capital providers, such as the holders of unguaranteed subordinated debt, could also be compensated for write-down by acquiring a stake in the AMC.

Let’s hope this week’s statements do not shut off possibilities such as this which can protect the taxpayer without destabilizing market confidence by allowing well-adapted financial contracts to bridge the gap between taxpayer and shareholder.

Although my idea may seem novel, specialists will recognize it as only an adaptation into our current circumstances of the most conventional form of bank resolution mechanism. It can work.