Fallout from Zoe collapse poses problems for Nama

BUSINESS OPINION:AND SO it begins. The unthinkable has happened. A significant part of the empire of one of the States's biggest property developers has collapsed into insolvency. It was suitably dramatic, with lawyers rushing into the High Court late on Friday to seek protection from creditors pending the appointment of an examiner.

And the reason? It’s not that the Zoe Group – as this collection of six Liam Carroll companies is called – is insolvent all of a sudden. It has probably been insolvent for months if not years, but was kept on life support by its banks who have rolled up interest and not sought capital repayments on bank loans totalling €1.1 billion.

What brought things to a head was the decision of ACCBank – which is owned by Rabobank in the Netherlands – to pull the plug. It was threatening to seek to have the Zoe Group liquidated or placed in receivership on foot of its debt to ACC of €131 million.

There has obviously been a game of poker being played out over the last month or two, with the other banks in the consortium, led by AIB which is owed €489 million, hoping that in the end ACC would roll along with them on the basis that it had more to lose by collapsing the company now than by working with the other banks to try and salvage the situation over time.

ACC, or more specifically Rabobank, thought differently. It’s pretty clear now that it wants to call a halt to a disastrous foray into Irish lending and get out.

As one of the few AAA-rated financial institutions left standing, it simply doesn’t need it. There will be no happy ending to the Irish property bubble and if you are not in too deep, it’s long past time to cut and run.

It raises some very interesting questions for our banks and more pertinently the directors of Allied Irish Banks (AIB) and Bank of Ireland. Given that their counterparts at Rabobank are better bankers than they are – having retained their triple-A status – why are they not doing what it is doing and liquidating Zoe and the other troubled developers?

The reason is obvious.

Applying for court protection Zoe said that if the group of six companies, which have total debts of €1.2 billion, was liquidated, they would have a deficit of €900 million. Based on this writedown value, properties on which it has borrowed €1.1 billion from eight banks would fetch €275 million if they went on sale this morning.

That means a 75 per cent writedown for the banks. For ACC it means a loss of about €100 million, which is more than manageable for Rabobank. For AIB it is proportionally larger €367 million. For Bank of Ireland, which is owed €113 million, it is €84 million. But when you apply it across the rest of the distressed part of its commercial property book, which would be the consequence of liquidating the other insolvent property companies, you really are looking into the abyss.

Absorbing losses of that magnitude is simply not possible. Both banks would be destroyed and nationalised overnight.

It is in order to avoid just this that the Government has gone down the road of setting up the National Asset Management Agency (Nama) which in practice should allow the banks to absorb these losses over time. This should in theory also allow Nama to achieve better prices for the underlying assets and thus avoid the 75 per cent writedown scenario.

Nama has yet to decide what writedown will be applied to the property loans that will be transferred starting this autumn.

There seems to be a consensus though that it will be in the region of 20 per cent to 30 per cent, depending on the loans in question. It will be based on “through-the-cycle” values – a guess as to what the property will be worth in the longer term – rather than the price you would get today if you put it up for sale, or “mark to market” to use the jargon.

The figures given by Zoe Group in its application for examinership are as close as we have come to a mark-to-market event in the Irish market for some years. Even allowing for a bit of exaggeration to make a point, there is quite a difference between 75 per cent and 30 per cent.

This gap is particularly relevant because the presumption at this stage is that in a effort to keep the “through the cycle” valuations used in the Nama process “honest”, they will be periodically checked against the mark-to- market data. It will have to be one hell of a cycle to bridge that gap.

This brings us to what is the real problem for the Irish banks. It’s not whether they should be following the same hard-nosed strategy as ACC or Rabobank. The real problem for them is what the fallout from the Zoe Group examinership is going to say about the logic and viability of the Nama process as currently envisioned.

Once AIB and Bank of Ireland start swearing affidavits supporting the Zoe Group examinership predicated on the sort of 75 per cent loan writedowns mentioned on Friday, it starts to get very serious indeed.

If the banks and their boards cannot convincingly reconcile the Zoe Group writedowns with the decision to start transferring similar properties and situations into Nama in three months time with writedowns of 30 per cent, then they have no business even thinking about raising money from shareholders. The way out?

Get a move on. Recall the Dáil, establish Nama and short circuit the Zoe examinership.