'Least worst' option Nama is the only game in town

Thu, Sep 17, 2009, 01:00

ANALYSIS:I am convinced the price of EU support was Nama. The Government cannot change such basic ground rules

IT IS only in the past few weeks that a proper debate on the National Asset Management Agency and (non-polarised) alternatives began to emerge. The most interesting suggestion put forward was that by Brendan Dowling and Dermot Desmond – that another guarantee be provided, this time on bank loans instead of deposits. Unfortunately, it is now much too late in the day for radical change, and it is a pity that these suggestions were not put forward much earlier.

The debate has been useful in that it has laid a few hares to rest. It is now clear that the vast bulk of commentators regard nationalisation as a very poor last option. How such an option ever gained any traction is a mystery, given our experiences with State-run enterprises over the past 50 years. I realise that Nama will be a State-run enterprise, but it will be under the aegis of the National Treasury Management Agency (NTMA), the most successful State body we have.

The guarantee proposal is attractive in a theoretical sense but likely to be unworkable in practice, and it does not deal with the issue of liquidity. To understand why, you have to cast your mind back to last February when the original guarantee had clearly failed and neither the State nor the banks could borrow abroad. The banks were totally out of the market and the Government could only raise short-term funds, much of them ironically being subscribed by the Irish banks. We were effectively bankrupt, with bond spreads spiralling alarmingly. If the market would not accept the first bank guarantee, why would it give a rosier reception to a second?

The price we had to pay to get out of the hole we were in was twofold. First, the budget deficit had to be corrected, ie we got fiscal tightening instead of the easing that many economists recommended and other countries practised. Second, the rescue package had to be transparent. The Nama scheme is the toughest of all. Both the market price and the (higher) long-term economic value have to be determined and the results published. In this way, the world can see what’s going on.

Contrast this with the UK scheme, which is totally opaque. Nama has been criticised over the long delays, but it seems to me that the problems attaching to the UK scheme are at least as great. However, the UK and the US can get away with things that we cannot because they have the ability to print money to bail out their banks. We cannot print money; instead, we must rely on the ECB as our lender of last resort. I am convinced that the price of EU support was Nama and fiscal correction. The current Government, or any other one for that matter, cannot change these basic ground rules.

That is what I meant when I wrote a few weeks ago that Nama is the “least worst” option. The Government cannot go back to either the other member states or the markets at this stage, at least not without triggering a run on the banks and a probability that the guarantee would be called upon.

In a very real sense, Nama is the only game in town. How then, does it stack up, now that we have a better idea of how it will work?

One’s first impression is that significant safeguards have been built in by comparison with the earlier outline. First, the amount of debt to be transferred, €77 billion, is below the bottom of the €80 to €90 billion range given last April because loans of less than €5 million have been excluded. Based on a 77 per cent loan to value (LTV) ratio, and ignoring €9 billion of rolled up interest, this means the original value of the projects funded was €88 billion, again well below expectations.

Second, the haircut was 30 per cent to book value, as leaked, but this was well above the more conservative estimates of some brokers and the fears of many critics. The current market value of the €88 billion of original projects is €46 billion, which equates to a 47 per cent average fall in prices from peak to trough. This average covers multiple loan categories and countries and includes good and bad loans. Without detailed information, it is impossible to pass judgment on it, though the Minister did note that Irish property prices had fallen by 50 per cent.

The long-term estimated value (LTEV), ie the price to be paid for the assets transferred, is €54 billion, which is €7 billion more than their estimated current market value, but €2.7 billion of this will be held back and only paid if Nama is a success. This means that property prices need increase by only 10 per cent from their low point for Nama to break even. This does not seem like a great deal, and was probably the figure that attracted most attention last evening. (It is, of course, predicated on a LTV of 77 per cent – and more on this anon). Interestingly, the Minister stitched into the record the fact that both the outgoing and incoming Central Bank governors felt this was reasonable.

The most surprising omission was the absence of the scale of the likely recapitalisation of the banks, probably because this was regarded as too sensitive. However, given the higher-than-expected discount and the risk-sharing, it is clear that, in the absence of fresh private sector capital, State ownership of the main banks would range from 50 per cent to 75 per cent, with Anglo already at 100 per cent. Intensive efforts to raise private capital are now likely.

This, of course, provides further protection for the taxpayer. If, for example, the Minister owns half of the banks’ share capital, then half of any excess LTEV payment is being paid to himself. All in all, the taxpayer is better protected than we might have guessed or feared, albeit that major risks still abound.

The LTV issue is likely to remain contentious, as the Minister did not conclusively kill off the notion put forward by Nama critics that the real LTV might be 100 per cent instead of 77 per cent which implies the additional LTEV subsidy paid is €23 billion instead of €7 billion. It appears he is relying on the word of the banks for this, and the actual situation will not be known until the detailed audits are done. It would be foolish for the banks to deliberately mislead the Minister on this. Equally, it is extremely unlikely that all builders borrowed everything.

The implications for credit availability are another hot topic. Nama is a necessary but not a sufficient condition to get credit flowing freely again. At present, there is not much demand for credit so it is not a big issue, but it could become one next year or the year after. In the final analysis, each loan decision is an interaction between a borrower and a lender, and rules and regulations could easily be counterproductive. Regular monitoring as in the recent Mazars report on SME lending will help but, ultimately, it will be up to the bank boards to determine policy. The Minister will have a chance to influence this via his current and prospective bank director nominations.

Finally, as the debate on Nama has so far been conducted almost exclusively in domestic terms, it is interesting to see how it stacks up against the seven EU guiding principles for bank asset support systems issued last February.

First, participation should be voluntary – banks must apply to participate in Nama, and the Minister announced an extension of the time period allowed.

Second, the definition of assets eligible for support should be relatively broad – it is, thought smaller loans have been excluded.

Third, transparency of valuation is key – the Irish scheme is most transparent.

Fourth, there should be an adequate degree of risk-sharing – this was introduced following a call by the incoming Central Bank governor, Patrick Honohan.

Fifth, the duration of the scheme should be sufficiently long – Nama looks like being with us for at least a decade.

Sixth, the banks should continue to be run according to business principles – continued (partial) private ownership offers the best prospect of this.

Seventh, there should be measurable yardsticks such as commitments to continue providing credit on commercial criteria, but this should not be applied in a mechanical manner and the situation should be monitored. It is highly likely that this will be the case, and the Minister said he was open to further suggestions in this regard.

Pat McArdle is an economist