Higher discounts see more loans being bought for less money

ANALYSIS:Nama protects taxpayers in three ways – loan discounts, risk-sharing and a possible bank levy, writes PAT McARDLE

DESPITE CLAIMS to the contrary, Nama is very transparent. Compare it, for example, with the UK or German equivalents about which we know little or nothing. This is one reason why I expect this week’s announcement to be favourably received by the markets.

The Nama terms are also much more onerous, with the discount or haircut at about 50 per cent.

The UK insurance scheme costs about 10 per cent, while the initial haircut on the German one was also 10 per cent though this is to be revisited. In effect, Nama was a test case for the EU, which is presumably why it took so long.

My theory is that we had to make Nama transparent to keep markets happy. Whatever the reason, we now differ from the others in that we will shortly have detailed information on the individual bank loans. These loans and their associated security will, moreover, have been valued by a comprehensive process independent of the banks involved.

This has given rise to considerable angst. The initial information supplied by the banks proved to be well wide of the mark. Left to their own devices, do you think the banks would own up to the true state of their books? That is why we have Nama and similar schemes in other countries.

Take the discount on loans transferred. On the first tranche, it came to 50 per cent. Here I include an additional €1 billion whose transfer was postponed because the banks did not have adequate documentation and which Nama proposes to purchase for zero consideration. This gives €17 billion transferred for €8.5 billion or 50 per cent. The discount includes the 5.25 per cent deducted upfront in respect of Nama costs at the behest of the EU.

If we apply a similar discount to future tranches, Nama will pay €40.5 billion for €81 billion loans, with 5 per cent, €2 billion, held back for risk-sharing. Compare this with the infamous €54 billion that was supposed to be paid for €77 billion of loans. More loans are being bought for less money.

The taxpayer is protected in three ways – sizeable discounts, 5 per cent risk-sharing and legal provision to recover any eventual Nama loss by means of a levy on the banks. No other country has such protection, though some are considering options.

Of course, there are downsides to this approach as the cost of recapitalising the banks is higher. However, I have yet to see any of those who claimed that the State would overpay for the loans admit that their guesses were wrong.

Now the attention has transferred to Anglo Irish Bank. This was handled poorly. We had been prepared for a capital injection in the €8-€10 billion region but to have this topped up by a potential €10 billion is little short of a disaster. Moreover, different estimates are floating around for the cost of the various options, viz transformation into a smaller bank, an orderly wind-down or abrupt closure. I suspect that the EU will be the ultimate arbiter.

Many people cannot understand why Anglo was not closed down in 2008. I have some sympathy with them as the occasional bank failure is a good thing. However, in the immediate aftermath of the Lehman collapse, it would be a brave, or a foolish, person who would have let Anglo go under. On balance, and given the limited information available, I think it was of systemic importance in the context of the circumstances of the time or at least was a risk not worth taking.

Once the guarantee was applied, the opportunity was gone. It is shocking that we are still discussing this more than a year later. It is even more shocking that Fine Gael, who supported the guarantee, now speaks of reneging on bond commitments and appears to believe its own rhetoric.

Subordinated bonds are defined as debt that is either unsecured or has a lower priority. Such bondholders who lent to Anglo have already taken a hit as their bonds were bought back below face value. Anglo’s stock of these bonds is now only €2 billion, not enough to make a big difference.

Senior bank debt, on the other hand, is generally sacrosanct. It includes Certificates of Deposit and Commercial Paper, typically placed by blue-chip investors such as pension funds, credit unions etc.

Senior bonds are not part of a bank’s risk capital – they are normal funding in the same way deposits are. Generally, they rank equally with ordinary deposits in a wind-up situation. Defaulting on these would put us beyond the Pale. It would, as far as I know, be the first time that this was contemplated by a euro-zone country.