State takes pain as Nama tries to keep banks afloat

ANALYSIS:The plan outlined this week is effectively the Government's admission that this is a bank-friendly deal

IF THE bank loans destined for the National Asset Management Agency (Nama) are really only worth €47 billion, then why is the Government going to pay the five participating lenders €54 billion? It’s a basic question and one that is right to plague members of the public given the risks that are being assumed by this Government on their behalf.

The question is particularly vexing when the Department of Finance has stated in print that the properties backing the loans have fallen on average 47 per cent in value, but yet the Government’s purchase price does not reflect the full scale of this decline.

The difference represents an overpayment of €7 billion, yet the Government plans to hold back only €2.7 billion of the difference from the banks and it will only pay this in full if the property market recovers, the banks help Nama recoup the loans from borrowers and the agency makes a profit.

With just 38 per cent of the difference between the market value and long-term economic value – the Government’s “fair” value or hope value that will be reached with a 10 per cent rise in property prices over 10 years – covered by the risk-sharing mechanism, the risks still lie with the State.

So much for the risk-splitting measure trumpeted by the Greens as a concession won from its Coalition partner, Fianna Fáil.

The State might be paying €54 billion for the loans, but this represents just the upfront cost of the grand Nama plan – it is no way certain that this will be the final cost.

It is also not certain that this will be the full upfront cost as Minister for Finance Brian Lenihan said the figure is an estimate and that it could change once Nama surveys every loan.

This process is expected to be completed by June 2010. A full assessment of the loans could yet throw up a very different figure.

The public will not know the full cost until some years down the road. The architects and engineers constructing Nama believe it will take about a decade for the agency to hold, manage, complete and sell toxic properties before it is clear whether the agency turns a profit. So, with this in mind, why has the Government agreed to pay over the odds – at a premium of 15 per cent – at the very outset? The reason is that paying the market value would be too heavy a cost to bear on a number of fronts.

Lenihan told the Dáil on Wednesday that setting a price based on the current value in a distressed market would require an injection from the Government of €4–€7 billion into the banks because the losses on the loans would be so great that their capital or cash reserves would be so heavily depleted.

He acknowledged that the hit would be so large and the banks so weakened that no private investor would touch them. Therefore, the Government would be the only potential source of capital for all five institutions, but particularly for the two publicly-quoted banks, Bank of Ireland and Allied Irish Banks (AIB), the country’s two largest lenders.

The required capital injection would be so large that it would bring the two banks under full State ownership given their combined market value of €6 billion.

The Nama plan outlined this week is effectively the Government’s admission that this is a bank-friendly deal that keeps the shareholders in the game and staves off the possibility of full nationalisation, a route Lenihan wishes to avoid due to the large expense involved.

Such a route means the Government avoids having to raise €10–€14 billion to fund the recapitalisation of the banks, Lenihan said.

And without the Nama plan, under which the Government is borrowing €54 billion at a very favourable rate of about 1.5 per cent under the blessing of the European Central Bank (ECB), the State must pay a higher rate of interest for €10–€14 billion following full nationalisation. It would also lump a further €600–€700 million a year in borrowing costs on to the State the Minister said, at a time when about €20 billion must be raised to bridge the gap between the taxes collected in a year and the cost of running the country.

Nama was initially sold as a plan to compel the banks to take the pain upfront on their bad property loans by forcing the lenders to accept losses on these assets as a result of the property crash. However, it has since emerged that the pain will actually be spread over a period of time and most of it will be borne in the short term by the State, not the banks. Saying that, Nama still appears to be the only viable route to take – or “the least worst option” as has been repeatedly uttered in public. Any other alternative poses much higher upfront costs. Nama pushes that cost out and buys time for the banks and the Government, but with taxpayers bearing most of the risk.

The involvement of Anglo Irish Bank muddies the water. The bank will sell Nama loans with a face value of €28 billion, the largest amount being acquired from any of the five institutions participating in the plan.

Given that the State is both the buyer (through Nama) and the vendor (as a 100 per cent shareholder in Anglo), the “haircut” on the bank’s loans, estimated to be about 33 per cent, raises the aggregate discount figure provided by the Minister due to the number of loans being acquired from the bank.

This riled Opposition parties, saying it masked a lower discount on the loans being acquired from Bank of Ireland and AIB.

However, it allows Anglo to draw about €20 billion in fresh liquidity from the ECB.

Nama is a complex plan to repair the banks, secure cheap European money from ECB headquarters in Frankfurt and inject it into credit-starved businesses.

The country is in stormy seas and the banks are taking on water under the weight of toxic cargo. The Government believes Nama is the most seaworthy lifeboat with oars and a powerful motor leased cheaply from Europe that should ensure safe navigation to calmer waters. This, the Government believes, will give the country enough time to bail out its banks and repair the financial system – and to keep these vessels sitting well above water.

Weather forecasts don’t cover periods of a decade into the future – the expected duration of this difficult voyage – so this Government and its successors will be praying to the weather gods that no hurricanes appear on the horizon. This lifeboat may seem flimsy and uninviting, particularly in these choppy waters, but the Government is trying to coax a reluctant and sceptical public aboard, promising clearer skies ahead.

However, it would appear that Lenihan’s lifeboat requires more work before its inevitable launch.