NAMA Business Plan: The Government forecasts that the National Asset Management Agency (NAMA) will make a profit of €4.8 billion - - which has been adjusted for inflation - - when the Irish “bad bank” is wound up in 2020. €15 billion worth of loans will default and adviser fees and expenses of €2.64 billion will be paid over the 10-year period.
Forecasting up to 11 years ahead, given the unimpressive past record, maybe more dependable than astrology, but likely not much.
The forecast appears in a draft business plan published by the Department of Finance last night showing the projections on the cost of operating the State agency.
The Department of Finance says that its plans are based on "aggregate data which has been provided by the institutions".
The department has not been able to "verify the integrity of the data" because "the NAMA team has not had direct access to individual transaction records and loan files."
This is a very serious issue because what the Government is in effect saying, is that six months after the April announcement of a plan for a "bad bank," it cannot say if the LTV (loan-to-value) value is reliable and if the quality of security is dependable, including personal guarantees.
It's likely to emerge in coming months, that some of the loans advanced by Anglo Irish Bank, involve complicated shelters, which may be difficult to unravel.
NAMA's profit is forecast to be €5.5 billion by 2020 and adjusted for inflation €4.8 billion.
NAMA will buy loans of €77 billion from five lenders at a price of €54 billion to free up the banking system to enable it provide credit to the economy.
The estimated aggregate average loan to value (LTV) rate for these loans is approximately 77% i.e. the value of the real estate collateral at the time the loans were originated was €88 billion. The loans were made over a number of years and not all were made at the peak of the market.
The plan says in order to estimate the aggregate current market value of assets to be acquired, it is necessary to estimate the decline in value of the underlying property collateral since the loans were originated. It is estimated that Irish property prices have fallen by an average of 50% since early 2007 across all the sectors and regions comprising the NAMA exposures. Various factors, particularly geographic location and future cash flows including rental income, will impact this valuation. NAMA estimates an approximate 47% average decline on an aggregate portfolio basis including the impact of declines in overseas markets. This suggests that the current market value of property loans to be acquired by NAMA is €47 billion (€88 billion less 47%).
The plan expects borrowers owing €15 billion to NAMA to default on the loans over the projected 10-year lifespan. The agency expects to be able to recover €4 billion of these loans by selling assets, mostly properties, backing the loans over four years from 2014 to 2017.
The Government expects the remaining €62 billion owing by borrowers to be repaid over the 10 years, primarily between 2013 and 2020 at about €7 billion a year.
The plan says the default rate of 20 per cent is based on “conservative and prudent assumptions” given the risk of a prolonged recession and the “concentrated nature” of the loans.
It says this compares with a default rate of less than 10 per cent experienced by Barclays in the UK in the early 1990s.
The Dáil last night passed the second stage on the NAMA Bill by 77 votes to 73.
The Government expects the legislation establishing the agency to be passed early next month and it plans to move the top 10 to 15 borrowers into NAMA and to recruit 30 of the agency’s proposed 75 to 100-strong workforce before the end of the year.
The top 10 borrowers owe €16 billion, while the biggest 300, who will be transferred into Nama by next March, owe €50 billion.
Budgeted fees and expenses of €2.64 billion over the 10-year life of NAMA relate mainly to the process whereby the banks’ loans will be transferred to the agency.
The draft plan states that Government officials are in talks with the British authorities about the impact of NAMA on the UK property market and on the British-owned banks in Ireland, which include Ulster Bank and Halifax-Bank of Scotland (Ireland).
Risks outlined by the Department of Finance:
1. Protracted valuation process – due diligence obligations, legal challenges and/or lack of preparation by institutions
The risk that the transfer process takes significantly longer than currently projected and that, therefore, the injection of liquidity into the banking system and the corresponding flow of credit into the economy is delayed, in turn impeding economic recovery. Restoration of the availability of credit is a necessary precondition for the recovery in real estate prices required for NAMA to break even and, more generally, for an early recovery in economic conditions in Ireland. One source of risk is that institutions will not be sufficiently prepared in terms of data collation and this could lead to delay and disruption of the acquisition timetable. A further risk is the prospect of legal challenges to NAMA’s business operation which may delay and impede it in achieving its objectives.
2. Valuations outside expected range
The risk that the bank asset valuation and acquisition process produces an outcome which is significantly different from current expectations with respect to the major parameters and assumptions set out below and used in the analysis to date:
- The market value of the underlying property assets (€47 billion)
- Interest rollup (estimated €9 billion)
- Actual aggregate average LTVs (average of 77%)
- The proportion of acquired assets which are cashflow-producing (40%)
- Margins on income-producing assets (2%)
- Default rate (20% assumed)
3. Economic risk
The risk that, notwithstanding the availability of credit, economic growth in Ireland will remain sluggish for a protracted period in response to the impact of the budgetary tightening that began in 2008 and is likely to continue for the foreseeable future. The ESRI forecasts GDP contraction of 7.2% this year and 1.1% in 2010; the latter incorporates the effect of a moderate pick-up in economic activity from the middle of the year onwards. Over the period of NAMA’s expected life span, moderate annual growth rates would be required in order to stimulate the demand for commercial, retail and residential property that would be necessary for NAMA to achieve its target of breakeven or better. This risk would be compounded if the main European economies were to experience strong economic growth over the coming two/three years and Ireland simultaneously remained weak. Under this scenario, ECB interest rates would rise at a time when the Irish economy might be poorly placed to absorb the deflationary impact of higher interest rates. The key issue, therefore, is the extent to which the deflationary impact of budgetary tightening could be offset by the stimulatory effect of the stronger economic performance of Ireland’s main trading partners.
4. Risk of prolonged property market depression
An associated risk is that the market values of real estate assets underlying loans acquired by NAMA will fall significantly after the reference valuation date and recover only slowly over the early years of NAMA’s operation. NAMA would not wish to be in a position for a protracted period where the aggregate value of its assets was less than the consideration it paid for them. If economic conditions do not improve, there may be some public pressure on NAMA to begin disposing of assets and start the process of reducing its debt earlier than currently envisaged.
As against that, many informed observers are of the view that prices/yields are close to the bottom of the cycle, particularly as far as UK property is concerned. NAMA’s portfolio will be diversified (33% outside ROI) across different regions and sectors and, as such, is unlikely to be synchronised in terms of market recovery. As such, default rates are likely to differ and opportunities to dispose of assets are likely to arise earlier in some markets than others.
5. Market risks, including risks arising from the acquisition of foreign assets.
NAMA will have significant exposure to interest rate risk and will need to manage this intensively by reference to the Euro and Sterling interest rate cycles in particular. Due to the potential costs involved, interest rate risk is a key exposure for the NAMA Board to assess. NAMA will have a substantial loan (and potential property) portfolio in the UK, US and other jurisdictions with currency, foreign tax and foreign law risks inherent in overseas investment. As about 30% of the assets are denominated in currencies other than the euro, exchange rate fluctuation will be a key risk for NAMA. It will create accounting volatility in the P&L which will be potentially difficult and potentially costly to hedge, particularly in relation to assets which do not produce cash flows.
6. Business Strategy
Strategic business decisions which would be perceived as involving policy errors or misjudgements on the part of NAMA and its Board:
- Credit and Risk strategy: decisions as to which borrowers to support and the extent of such support.
- High profile insolvency and enforcement cases.
- Strategic views taken of various markets and market sectors.
- Asset management strategy: the timing and pricing of asset disposals and decisions relating to investment, etc.
- Suboptimal refinancing – timing and rates.
- Possible conflict between NAMA’s commercial mandate and other mandates or considerations e.g. transparency, social dividend mandate, administrative law requirements and market-making functions.
- Distortion of competition.
7. Reputation risks
- That NAMA would not be perceived to be carrying out its mandate in a commercial manner; that it would be considered cumbersome, bureaucratic and subject to excessive regulation and oversight; that it was incapable of responding with agility to market opportunities.\
- Hard cases: NAMA, while acting commercially, might be perceived as being strong-armed in its dealings with some borrowers.
NAMA, as soon as possible after its establishment, will compile and maintain a comprehensive Risk Register which will enumerate the various risks to which it will be exposed and the controls and risk mitigation measures that will be in place to address them. Other than those outlined above, significant risks to be addressed will include IT risks (e.g. unauthorised access to NAMA systems and data, data integrity, personal data and customer confidentiality etc.), treasury risks (interest rate and currency exposure) and various operational risks such as banks and service providers not carrying out their functions in an agreed manner.
The recruitment of key senior staff with requisite experience, knowledge, good standing and reputation will be one of the key issues facing the NAMA Board and the NTMA. Failure to attract high calibre staff would have a detrimental effect on NAMA in terms of how successfully it could achieve its statutory policy objectives and in terms of its reputation as a commercial entity.