THERE HAS been speculation about how the State’s “bad bank”, the National Asset Management Agency (Nama), will operate in the six weeks since the Government announced plans to establish the agency.

Little information has been made public by the Government – either through the Department of Finance or the National Treasury Management Agency (NTMA), under whose auspices it will function – on how it will work.

Asked at the Dáil Committee of Public Accounts (PAC) last week what kind of “animal” Nama would be, Dr Michael Somers, NTMA chief executive, said: “I know very little, apart from what has appeared in the newspapers.”

Somers said last week he was “aghast” at the scale of the development loans advanced by the Irish financial institutions and that the Government is facing an “appalling dilemma” in resolving the problem loans at the banks.

His warnings are thought to have been an attempt to state publicly that much of the detail on Nama has yet to be devised and that the task ahead for the NTMA is of gargantuan proportions.

The scale of the challenge facing the agency is vast. It involves creating a company with a balance sheet of €60 billion in property development loans – some of which are being repaid and some of which are not – together with related assets of between €20 billion and €30 billion in collateral.

These assets will most likely comprise commercial investment properties such as offices, shops and other occupied buildings on which, for the most part, rents are being paid and other loans are being serviced with repayments.

Transferring loans of between €80 billion and €90 billion – about 22 per cent of the loans across the domestic banking sector – from the guaranteed institutions to the State’s balance sheet will be no easy exercise.

The challenge is made all the more difficult by the fact that many of the developers are “multi-banked”, meaning that their borrowings are spread across several financial institutions, including foreign-owned banks falling outside the Government guarantee.

The task is also complicated by the fact many of the loans are “bespoke” in that they were tailored for individual developers.

The Government has set a lifespan of 10 to 15 years for Nama to “work out” the loans and the NTMA is keen to deal with the loans on a phased basis given that no organisation, and in particular a newly created State entity, could absorb such assets all at once.

The confusion surrounding Nama relates primarily to the fact that the Government was forced to announce a major initiative as part of its emergency Budget last month to remove troubled loans from the banks in a bid to kick-start their lending as part of its attempt to show the international market that it was dealing with the most severe economic crisis to have hit this country in its history.

The scale of the problems within the financial sector meant that the Government had to outline any measures to address the ballooning deficit in the public finances simultaneously with any further plans to fix the banks.

However, after announcing the hugely ambitious plan, the Government has had to work backwards and devise the more intricate and far more complex detail of how the scheme will work.

Very little information has so far been disclosed publicly since the Budget about how Nama will operate on a day-to-day basis, what loans it will take over in the first instance, the discounted price to be paid for all the loans and, ultimately, the possible capital hole that will be left on the banks’ balance sheets in addition to the consequent equity stake in the banks that may have to be taken by the State to fill that hole.

A steering committee comprising the NTMA, the Department of Finance and staff from the Attorney General’s office has been working over the past three weeks to devise the legislation establishing Nama as well as a framework on how it will operate.

Senior NTMA staff – Brendan McDonagh, who has been appointed interim managing director of Nama by Minister for Finance Brian Lenihan; John Corrigan; and deputy NTMA director Seán Ó Faoláin – have been working hard in the background to construct Nama around the plan devised by the scheme’s architect, economist Dr Peter Bacon.

The committee is planning to push for the legislation establishing Nama to be published by the end of July before the summer break, though the heads of the Bill may be published next month.

The aim is to recall the Oireachtas in early September to debate and pass the legislation.

Much has been made of the potential legal challenges facing Nama. Somers warned last week that the agency could lead to court actions and a “bonanza” for lawyers over possible disputes.

The Attorney General, Paul Gallagher SC, is understood to be poring over the potential legal scenarios facing Nama in an attempt to fire-proof the legislation against possible challenges. In some instances, the banks are assisting the NTMA in this regard.

Once the legislation is passed, President Mary McAleese could refer the legislation to the Supreme Court immediately, given the likely effect it will have on property rights in the State.

A prompt decision by the court could protect the legislation at the outset, expediting the entire plan.

Bank of Ireland, which has held talks with the NTMA on the plan, has signalled that it could transfer its €12.2 billion in development loans and associated borrowings, estimated to be about €8 billion, into Nama within eight weeks.

This means that the agency could be dealing with the first problem development loans by the first half of November, if the legislation is passed on schedule.

The NTMA has been advised by officials who have worked on similar bad banks in Sweden and the United States, though the size of the problem loans to be acquired by Nama make the Irish plan unprecedented on a global scale.

Sources familiar with the committee’s work say that Nama will initially try to deal with the top 50 to 75 borrowers as they represent a large proportion of development loans. In one institution falling under the Nama plan, the top 100 borrowers account for 60 per cent of its development loans.

Under the proposals being considered for Nama, financial institutions will be asked to establish new subsidiary companies, or special purpose vehicles (SPVs), and move the staff currently managing the loans to be transferred to Nama to these companies.

While all the development and associated loans will eventually be transferred to the State’s balance sheet through Nama, the agency is expected to use the SPV to administer the loans on a day-to-day basis, while the management decisions on the loans – for example, whether a developer should be liquidated – will be transferred to the State agency.

This will maintain within the financial institutions the estimated 3,000 to 5,000 staff who currently manage the loans.

The plan also tallies with comments by Somers last week.

Such management of a large volume of toxic loans has worked in the past. When French bank Crédit Lyonnais (now part of Crédit Agricole) created a “bad bank” to clean up impaired loans of between €40 billion and €50 billion from 1995, the new company operated with a staff of up to 200, and used new and reconstituted lending teams from the bank to manage loans. That plan cost considerably less than the €15 billion estimate but took double the time, lasting a decade.

Under the Nama plan, the banks can charge an administration fee through their SPVs. In turn, Nama can also offer the banks an incentive fee of up to 10 per cent of loans recovered in an effort to encourage the financial institutions to recoup the money from the developers.

Bank of Ireland looks set to be the first financial institution to move its loans into Nama. The bank has already begun the process of establishing its own SPV to manage the toxic loans.

Nama is also expected to deal with Allied Irish Banks and EBS building society in the first wave of toxic loans subsumed into Nama. Then Irish Nationwide Building Society and Irish Life Permanent (ILP) will be assessed.

ILP has no development loans, though it may have loans to developers on commercial investment properties, which could be moved into Nama as collateral for other development and landbank loans.

It is not yet clear whether the Government will include the nationalised Anglo Irish Bank in the Nama scheme. The Minister for Finance is expected to make a decision on this shortly and to appoint an advisory committee to provide advice on the establishment and operation of the new agency, as well as on the valuation of loans.

The NTMA has held meetings with with Construction Industry Federation and prominent property developers. The NTMA has stressed it is willing to work with developers over the life of Nama to ensure properties are managed and the best value is obtained by the taxpayer. However, it has also been made clear that Nama will foreclose on delinquent developers, which could lead to liquidations and receiverships of the most indebted borrowers.

Developers are concerned about the prospect of performing development loans and the associated collateralised investment properties, on which they are making repayments and earning rents, being moved into Nama alongside non-performing loans.

Clearly, not all development loans are bad. However, the aim of the Nama plan, according to Bacon, is to take out not only the entire infected class of loans – namely toxic development loans on which the banks are posting a large share of their losses – to remove any uncertainty, but to acquire performing loans and the assets securing those loans, so repayments on those borrowings cover the cost of the bad loans.

Any properties repossessed from delinquent developers will be packaged and sold to pension funds, investors and private equity firms – all of which have made tentative approaches to the NTMA to see what could become available.

The price that the State pays for the loans remains the main crunch issue and will determine whether the taxpayer, rather than the banks, will shoulder more of the losses on the loans up front.

The difficulty on pricing the loans is how do you assign a market value to property assets when there is no market?

Brian Lenihan told investors on his tour of European financial centres earlier this week that the loan assets would be valued and transferred in line with EU guidance on the treatment of impaired assets.

The European Commission has set parameters for what it describes as “economic value” or “through-the-cycle” values, which means that values do not necessarily need to be assigned to properties at highly distressed levels but can be set at estimated average values over Nama’s life.

The banks are due to report their largest borrower exposures to the NTMA next week. That should give an idea of the scale of Nama’s initial work, though removing these loans and selling properties securing bad loans will be another challenge entirely.

While much of the detail on how Nama will work has yet to be confirmed, planning is well under way for what is one of the biggest challenges facing the State.