There is no silver bullet solution to our truly enormous banking fiasco

HIGH Court judges Peter Kelly and Frank Clarke found the business plans of Liam Carroll’s Zoe group to be artificial and fanciful. I fear the NAMA plan would equally fail their scrutiny. This does not mean NAMA isn’t a viable solution.

The emerging enormity of our banking fiasco is such that there clearly is not a single silver bullet solution. Finance Minister Brian Lenihan has to be commended for his level of self-assuredness, even if the facts don’t stack up.

The IMF estimated Irish bank losses to be €35bn arising from toxic loans of €90bn. Whatever formula is devised to absorb this financial disaster over a decade is fraught with danger. The greater the impairment and write down of loans, the more capital is required for bank balance sheets. The higher the amount of bank recapitalisation, the less the market will finance it and the liability reverts to the taxpayer. These sorry consequences are most evident in Anglo Irish Bank and Irish Nationwide.

The largest single portfolio to be transferred to NAMA is €28bn from Anglo. The precise level of discount on its loan book has not been announced. It is estimated to be in excess of the average 30% discount benchmark. Taxpayers have already paid €3.8bn against accrued Anglo losses. Financial pundits estimate that two further cheques of this amount may be payable from the Exchequer by September 2010 and September 2011.

The total recapitalisation could be €8bn in a worst case scenario. This is dead money without prospect of a return. We should all be bitter and angry with Mr Fitzpatrick, his colleagues and the regulators.

The contagion of picking up the costs of refinancing the banks doesn’t end with Anglo. The mess at Irish Nationwide Building Society is truly horrendous. When the losses are crystallised on their loans of €8bn transferring to NAMA there will be a shortfall in excess of shareholders’ funds. An unpaid bill of up to €1bn will have to be picked up by the taxpayer. It is insolvent, yet Michael Fingleton walked away with an annual salary of €2.4m last year, a bonus of €1m and a pension to the value of €27.6m. Huge rewards for overseeing a lending catastrophe. It’s a great little country.

This dilemma of harsher haircuts leading to more bank capital is at the core of excessive optimism with the NAMA arithmetic. There are four key assumptions underlying the NAMA plan that are highly questionable or false. Let’s start with the current market valuation of €47bn for the assets to be transferred to NAMA. This comprises three categories: land banks (36%), development projects (28%) and associated loans (36%). These graduate from green field sites to established properties with leases and paying tenants. There is no supporting documentation from the Government to explain the accuracy of the €47bn figure — because no such proof exists.

The courtroom evidence in relation to Carroll and Fleming indicates these assets may well be worth less than €40bn. If a liquidator brought this property portfolio to the market now it would not achieve a sale because there are no buyers. If there were buyers there are no lending institutions to provide the finance.

Even if there were both buyers and bankers, the quantum of property would flood the market. Any current market value is subjective, notional, theoretical and therefore hypothetical.

The second flaw in the NAMA sums relates to “interest roll-ups”. If an individual loan portfolio is non “performing” this means the borrower is not making any repayments at all.

Typically, most developers haven’t any income on their sites and unfinished properties. They haven’t been paying interest for the last year or two. The banks performed a major stroke by including this unpaid interest in the book value of these loans. Take an example of a €100m loan where no interest has been paid for the past two years. This would now have a book value of €110m. If you apply a 30% discount to the €110m, the actual haircut becomes 21% instead.

The 30% average discount conceals the true reality of the generous deal that AIB and Bank of Ireland have received from the taxpayer through NAMA. It is estimated that the Anglo and Nationwide write-down could be closer to 40%.

This means AIB and Bank of Ireland’s discount could be as low as 20%. If you then apply the rolled-up unpaid interest calculation you can see that they may walk away with an exceptional deal, especially if the property market falls further and the ultimate devaluation on the assets ends up being 50%.

Thirdly, NAMA and the taxpayer carry the risks of the impact of a rise in interest rates. It is not clear what rate assumptions have been made over the next decade. They can only move upwards. If the extra costs, through higher interest rates, result in more non-performing loans, then the fallout will have to be borne by us. This could amount to more than €10bn.

The fourth underlying assumption with NAMA is that this loan/property portfolio will not decrease further in value over the next two years (ie, the market has now reached the lowest point). Nobody knows how property markets will perform. For residential development there has been some life restored to the first-time home buyers’ activity. Real demand exists for such new homes, given our population growth. Mortgage finance is constrained because of job insecurity and falling incomes. The dynamics of trading up in housing is at a standstill. Home-owners cannot move from apartments to semi-detached houses because they are caught in a negative equity trap.

IF ANY of these four factors prove to be wrongly assessed, the minister’s assertion that NAMA would break even, with a 10% recovery in property prices over a decade, will be seriously erroneous. NAMA’s business plan must be more rigorously stress-tested by independent experts.

The fundamental concept of this plan is clever. It seeks to convert chronic illiquid loans and property into bonds that can be cashed at the counter of the European Central Bank. Their willingness to underwrite the scheme gives it credibility. Ultimately they will have to be repaid. Therein lies the legacy of unknown liability for future taxpayers.

The liquidity and solvency problems of our banks have to be tackled. Any plan will be riddled with faults. The NAMA legislation does not contain a tangible viable mechanism to oblige the benefiting banks to provide credit to the real economy. An effective method must be found to ensure this credit flow.

The worst feature of this bank bailout is the underlying sustained government requirement for higher property asset values. The State has a vested interest in higher commercial rents. This will damage competitiveness and employment, particularly in the retail sector.

The failure to proceed with abolishing upward-only rent clauses and leases is the first indication of this policy change. We have failed to learn the lessons from our past love affair with property. While banking may be systemic to economic recovery, the property sector is not.


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