ANALYSIS:The key detail – how much the State will pay – still remains unknown, writes SIMON CARSWELL.
THE GOVERNMENT has finally published the draft legislation for the National Asset Management Agency (Nama), but it is no clearer whether this “bad bank” plan aimed at unblocking the banks of their toxic assets and kick-starting new lending will work.
The main difficulty is that the key make-or- break detail still remains unknown – how much will the State pay for property-development and associated loans with a face value of €90 billion that are sitting on the books of the banks?
The draft legislation, which runs to 136 pages and 200 sections, outlines the biggest financial exposure assumed by the Government in the history of this State.
The scale of the task is gargantuan. Nama will hold more assets than any publicly quoted property company in the world, dwarfing giants such as GE Capital Real Estate and Morgan Stanley Real Estate, which own assets of $85 billion (€60 billion) and $70 billion (€48 billion) respectively.
The difficulty for taxpayers is that the Government is seeking approval to buy up to €90 billion in loans at an as-yet-undecided discount to be determined by as-yet-unknown valuation methods from now until June 2010.
On the cost of the scheme, all that is known so far is that the Government will pay “significantly” less than the loans’ book value.
The draft proposals primarily outline the mechanics of how Nama will operate. The toxic assets will be valued loan by loan through an assessment of when the loan was made and the percentage of the property’s value represented by the loan. Nama will then consider the asset’s current value based on the value of the property backing the loan.
Minister for Finance Brian Lenihan says some assets will be valued at their current market value or over this value, at “a long-term economic value”. This will be based on factors such as demographics, demand and supply, and future economic growth.
Lenihan says the value of some land backing loans will increase over time because there is no current market for certain property and these will be valued on the “long-term economic basis”.
This is essentially a hope value and follows EU guidelines on the valuation of toxic assets, giving the Government flexibility. It also avoids assigning a depressed, firesale price, which could lead to heavy capital injections into the banks to make up the shortfall caused by severe losses on loans.
Lenihan also says that other land will not move beyond current values due to “gross oversupply” in the market. The price paid for these loans will be valued accordingly. For example, loans on landbanks that have little or no prospect of development, even in the long term, will be priced at agricultural value.
In some cases, as a result of the dramatic collapse in the property market, these lands may have fallen in value by up to 90 per cent. However, that is not to say this will involve a 90 per cent writedown on the loan as a bank may have only originally provided a loan worth 60 per cent of the land’s value.
Lenihan says the banks provided on average loans worth 75 per cent of the value of the development land, so in many cases of development land, the borrower’s 25 per cent equity will be wiped out and the bank will also have to take a loss on its borrowing share.
The Minister has given a breakdown of the type of loans that the State will be buying. Some €30 billion of the €90 billion loans are backed by “pure land”. A further €30 billion relates to loans on work-in-progress projects, which could be everything from building sites where just the foundations have been laid, to developments that are almost complete.
The remaining €30 billion relates to loans provided on commercial investments such as office blocks and shopping centres that were provided as collateral to the banks for the development loans. More than half of all loans being acquired by Nama are performing, which means they are generating some interest payments; the remainder are bad.
The State will through Nama buy 10,000 loans in all across the banking sector.
All of the above figures relate to the face value of the loans on the books of the banks. Again, they don’t reflect the knock-down price that the State will pay for them.
Lenihan says each loan will be valued “separately and individually”.
The Minister will reveal on September 16th how much in Government-backed bonds will be issued to pay for the toxic bank loans – this will give an “indicative” estimate of the cost of the scheme. The thinking is that the Government could not seek the approval of formal legislation establishing a State enterprise of such a scale as Nama without revealing an estimate of the cost of the scheme.
At the same time, he will also publish the formula to determine how much Nama will pay for the loans. However, it will be June 2010, when all loans are moved to Nama, before the size of the discount will be known.
Once the “haircut” has been applied, Nama’s next challenge is to recover its money and make a profit over and above the purchase price paid. The difficulty for the taxpayer is that the State is taking all of the risk upfront on the Nama plan. The success of the plan depends on the lifespan of State agency and the working out and sale of bad property assets over a long period.
The draft legislation fails to outline the expected lifespan of the agency, though the proposals say that it will be reviewed after five years. Officials say it will take 10 years as values will not recover until life returns to the market. That seems some time away.
The first assets to be transferred to Nama will include the most toxic as they will relate to the top 50 biggest developers whose loans currently have an estimated book value of €30 billion. Such borrowers are the most exposed.
Clearly, if a long-term economic or “hope” value is being assigned to certain loans where properties are held by Nama, developed over time and then sold, it may take longer to make a profit on these assets.
In these circumstances, the State is likely to pay over the odds for some assets in the short term, leading to Nama incurring losses on the first assets it acquires, develops and sells in the agency’s early stages of operation.
Lenihan says if there is any shortfall at the end of the Nama’s life, then the Government will introduce a levy on the banks to make up the difference. However, he told reporters yesterday that he didn’t expect the State to lose any money on Nama.
The agency will also take on some of borrowings of its own. Nama will have powers to borrow up to €10 billion to complete developments in an effort to increase values.
Officials say the transfer of both good and bad assets to Nama will mean that the cost of the new government bonds used to buy the loans will be more than covered by interest payments on good loans. This will also cover the cost of running the agency.
Interest is currently being paid on more than 50 per cent of the loans being transferred to Nama, according to its interim managing director, Brendan McDonagh.
There is also a question mark over how much cash the banks will be able to draw from the European Central Bank by swapping the State bonds used to buy loans. It is not clear how much liquidity the bonds will inject into the system to generate funds for new lending.
One source close to the Nama plan says that determining whether the plan was a good or bad idea depends on a consideration at a particular point in time.
With the property market currently valuing assets at firesale prices, Nama now seems like a bad idea as the taxpayer is bearing all of the risk, he says, but as the market recovers over time, Nama may end up being a good idea.
This will be of little comfort to taxpayers on whose behalf the Government plans to assume a massive risk without yet being able to tell them either the cost of the gamble or how long they face such a risk.
It will be some time before one can say whether Nama will work. That is the difficulty with the option chosen by the Government to repair our broken-down banks.
Simon Carswell is Finance Correspondent of The Irish Times