Nama an arduous path - but the right one


OPINION:Sticking it to the bondholders would make matters far worse – Nama is the least worst solution to the crisis, writes DONAL O'MAHONY

IT HAS proved a prolonged and at times frustrating gestation period, but the policy prescription to stabilise the Irish banking system and help kick-start credit creation has finally reached its implementation stage. Nama’s journey has been an understandably arduous one, confronted as it has been by a welter of legislative, regulatory and, not least, administrative needs. Now, the first €16 billion tranche of a circa €81 billion asset-transfer scheme has been effected, and the positive reactions in the funding markets for both Irish Government and bank debt augur favourably for economic recovery.

There was never any speedy or painless solution to the Irish banking crisis. Years of lending profligacy had rendered the system chronically over-levered, and utterly dependent upon the whims of international wholesale markets for funding. The global credit crisis may have exposed the liquidity shortcomings of the Irish banks, but their solvency difficulties were inherently home-grown, with a scale of loan-book toxicity that demands the collective responsibility of lenders, borrowers, regulators and commentators alike.

Informed by those catastrophic case-studies involving Iceland (banking nationalisation) and Lehman (bankruptcy), the Irish authorities have pursued the “least worst” option of system recapitalisation and part-nationalisation. A guiding principle has been that each of the five covered institutions is “systemically important”, such that creditor obligations continue to be discharged in a manner that befits Ireland’s deficit-financing dependencies in both the exchequer and banking accounts.

For all the clarion calls of the nationalisation and “burn the bondholders” brigade, such actions would do little to ameliorate the revealed loan losses of the profligate years, but would occasion grievous and self-inflicted wounds in relation to their financing.

The combination of Nama haircuts and non-Nama “stress-tests” on Irish bank loan books is now triggering a circa €22 billion recapitalisation requirement by the end of the year, with the prospect of a further €10 billion capital need for the hapless Anglo Irish Bank in coming years. Such capital will be raised through a combination of discounted-debt repurchases, asset sales, rights issues and Government injections, the latter likely to amount to a further €11 billion in 2010 and a cumulative €22 billion since the crisis began.

To be sure, these are horrendous numbers, but, as the necessary price to be paid for financial stability, they appear more than manageable in the context of Ireland’s still relatively contained stock of public indebtedness.

Courtesy of Nama and the stepped-up prudential requirements of a new and vigorous financial regulator, Ireland will soon find itself with two of the most strongly capitalised banks in Europe (AIB and Bank of Ireland). This realisation is already playing out in Irish bank funding markets, where credit spreads are now tightening appreciably against European peers. For example, subordinated debt spreads for Bank of Ireland have tightened by as much as 120 basis points over the past five weeks.

As with the experience of Irish sovereign bond spreads over the past 12 months, which have fallen by as much as 180 basis points against their German benchmark, the implementation of credible policy solutions to our fiscal and banking challenges will be rewarded by substantial improvements in our funding capabilities. In as much as Ireland has recently been transformed from pariah to poster-child in the fiscal consolidation stakes, a similar re-rating now awaits our quoted financial institutions. This is a key ingredient towards the much-needed revival in credit creation as economic recovery takes hold.

Domestically, malcontents continue to vent their spleen against the Government’s stabilisation policies, in stark contrast to the increasingly receptive audiences overseas, including an endorsement from the International Monetary Fund last week. Of course, continued political opposition is the obligatory stock-in-trade, but the relentless criticisms of both media and academia is more bemusing at this juncture, not least given the paucity of credible alternatives proffered to date.

For example, Brian Lucey’s latest condemnation (Country’s future staked on most volatile of markets, Opinion and Analysis, April 1st) of those who “do not know a subordinated bond from a Smartie” needs to be juxtaposed with his own basic misunderstanding of how the process of Nama financing will proceed.

Far from engaging in “funding short to borrow long, the very tactic that brought down Lehman”, Nama will in fact continuously match its assets (loans) and liabilities (bonds) with Euribor-based variable interest rates, the positive spread between which ensuring that performing loans trump non-performing loans in rendering Nama cash-flow positive on an operational basis.

Lucey’s other suggestion elsewhere last week that Anglo’s €28 billion deposit book should be trade-sold for circa €21 billion was equally misplaced, such proposition appearing to confuse the bank’s assets with its liabilities.

Those who will judge the success or otherwise of Nama by the speed with which Irish credit aggregates revive need reminding that any renewed willingness to lend must be accompanied by a willingness to borrow. It is instructive in this regard that Irish households have voluntarily chosen to reduce outstanding credit card balances for the past 12 months, this most easily accessible of bank credit line being eschewed amid the prevailing economic despondency. It is not for nothing that credit creation is a lagging indicator of economic performance, be it at home or abroad.

As the Irish economy moves through stabilisation towards a slow recovery, so too will precautionary savings (among both households and corporates) begin to run down before any resumption of borrowing appetite. A pick-up in bank lending is not therefore a necessary component of the initial recovery story, but its contribution will be imperative towards a lasting economic upturn.

History has shown that in the unfolding aftermath of all investment bubble-bursts, participants traverse the entire psychological spectrum from euphoria to despair. In this vein, one might characterise recent Irish economic history as reflecting the euphoria of 2007, the denial of 2008 and the anger of 2009. If past is prologue, then 2010 will prove to be the year of acceptance, wherein a chastened but substantially adjusted real economy and banking system can reclaim the recovery path.

Donal O’Mahony is global strategist with Davy stockbrokers and financial managers