Risk Sharing and Accounting Issues

Not too long ago, the Green Party announced with great fanfare that they were getting the NAMA plan amended to feature “equal risk sharing” between the government and the banks (though not between the government and bank shareholders as proposed by Patrick Honohan). Even as it was announced, there were strong rumours that this risk sharing element would represent a tiny change to the original plan. This has now been confirmed.

Subordinated NAMA Bonds = Equal Sharing of Risks?

So, as signalled on this website over the past week, the government’s nod towards protecting the taxpayer consists of NAMA paying for some of the assets it acquires via subordinated bonds whose payoffs will depend in some way on the performance of NAMA assets.

I’d make two points. First, it is generally understood that the payment of these subordinated bonds will only account for a small minority of the overall payment. As such, Eamon Ryan’s claims that this mechanism “will deliver an equal sharing of the risk between NAMA and the banks”—a characterisation directly taken up by RTE’s 9 O’Clock News last night—does not appear to be justified.

For example, suppose we pay €70 billion for NAMA assets, €5 billion of which is in subordinated NAMA bonds. If the assets turn out to be worth €50 billion, then the taxpayer loses €15 billion and the banks lose €5 billion. Perhaps Minister Ryan would characterise this as “equal risk sharing.”  If so, I think the taxpayer is shouldering “the bigger half” of the risk.

Second, the legislation does not make it at all clear what these subordinated bonds really are and, if the government’s track record is anything to go by, they won’t be explaining what the bonds are next week either. The legislation does not even actually say that the bonds will be linked to NAMA’s profits just that “to the extent” that they is linked to NAMA’s performance, the link will be to the totality of NAMA’s performance (e.g. there won’t be a special AIB sub debt issuance linked just to how AIB’s bad assets.)  And certainly there is nothing in the legislation linking the payments to the total cost of NAMA including interest payments.

Beyond the reasons I have already outlined as to why I think this approach is inferior in design to Patrick Honohan’s original plan (and will almost certainly be grossly inferior in terms of the scale of risk sharing) I find the lack of necessary detail disappointing. Relevant section below

47.—(1) NAMA or a NAMA group entity may, whenever and so often as it thinks fit, create and issue subordinated debt securities of such class or type as it specifies—

(a) bearing interest at such rate as it thinks fit, or no interest,

(b) for such cash or non-cash consideration or deferred consideration as it thinks fit, and

(c) subject to such terms and conditions as to repayment, sub-ordination, repurchase, cancellation or redemption or any other matter as it thinks fit.

(2) Subordinated debt securities issued under this section shall be used only for the purpose of providing part of the consideration for the acquisition of bank assets in accordance with section 89.

(3) To the extent that the terms and conditions of the subordinated debt securities (including the terms of subordination) are referenced to or based on a measure of financial performance, the
measure shall be the financial performance of NAMA in totality and not any part or parts of the acquired portfolio.

(4) Subordinated debt securities may be subject to different terms and conditions for different classes or types of those securities.

(5) The total amount of subordinated debt securities issued under this section shall not exceed a percentage of the aggregate total portfolio acquisition value specified by the Minister by order. Such securities will be issued to the participating institutions pro rata.

(6) Where the Minister proposes to make an order under subsection

(a) he or she shall cause a draft of the proposed order to be laid before Dail Eireann, and

(b) he or she shall not make the order unless and until a resolution approving of the draft has been passed by Dail Eireann.

Lenihan on Two-Part Payments

Quoted in the Sunday Tribune, Minister Lenihan discusses two part payments:

A levy on bank profits is still planned if NAMA leaves the taxpayer with a shortfall, and there is the idea of paying for the banks’ loans in a two-stage process—possibly 80% up front and the remainder later on, depending on how the loans perform.

But Lenihan has a warning about all these ideas. “There comes a point where you leave so much contingency and risk in the banks that there is no confidence in them. There is a balance you are trying to strike,”

It is becoming increasingly clear that the government is engaging in its own two-stage process in relation to Patrick Honohan’s risk sharing plan. Stage One involves re-interpreting the original plan, which makes a lot of sense, as something completely different which is very flawed—giving the contingent second payment to the banks instead of the bank shareholders as Patrick proposed. Stage Two is to then point out that this reinterpreted plan is flawed and can only be implemeted in a very limited form.

This statement is also the best indication yet that the government’s commitment to its levy idea is, at best, half-hearted.

Government Adopting Honohan Plan?

Since the announcement of Patrick Honohan’s appointment as Governor of the Central Bank, there has been a series of media stories implying that the government are going to amend NAMA to feature some version of Patrick’s risk-sharing proposals. The most concrete report is at the bottom of this article in today’s Irish Times: 

Government sources yesterday said Ministers have been looking very closely at the issue of risk-sharing and the two-tier model that has been suggested by Patrick Honohan, the incoming governor of the Central Bank.

One of the options given serious consideration, said the sources, was the creation of two classes of bond. This approach provides for one class of bonds to be issued immediately and the other to be deferred and paid at a future date if it were shown the scheme was working. However, it is understood that discussions have not yet moved to the question of what percentage would be made available immediately.

I have also heard this story from a number of sources who rather than describe it in terms of the second class of bond payment being deferred describe it as immediate issuance of  two classes of bonds, the second of which is a “subordinated” NAMA bond, which may not pay off under certain conditions.

I think it is important to emphasize that these proposals do not at all correspond to the essentials of Patrick’s plan.