Saturday, September 19, 2009

Economics 19/09/2009: Nama, bondholders and shareholders

Setting aside, for now, the issue of who subsidises who in Nama, a quick note on opportunity cost of the undertaking when it comes to the structure of Irish Financial Services in general.

June 2009 paper from a group of US and Canadian researchers, published for the European Finance Association, 2009 meeting (here) provides an interesting read. The study delivers "...a comprehensive analysis of a new and increasingly important phenomenon: the simultaneous holding of both equity and debt claims of the same company by non-bank institutional investors (“dual holders”). The presence of dual holders offers a unique opportunity to assess the existence and magnitude of shareholder-creditor conflicts. We find that syndicated loans with dual holder participation have loan yield spreads that are 13-20 basis points lower than those without. The difference is even greater after controlling for the selection effect. Further investigation of dual holders’ investment horizons and changes in borrowers’ credit quality lends support to the hypothesis that incentive alignment between shareholders and creditors plays an important role in lowering loan yield spreads."

Without giving too much technical detail, the study effectively says that inducing greater share of bond holders to also hold equity (or vice versa) results in lower cost of credit to the firm.

Now, recall that my Nama3.0 or Nama Trust proposal (here) has, as one of the first conditions for taxpayer bailout, a full or partial conversion of Irish Banks' debt holders into equity holders. This would have achieved two positive outcomes simultaneously:
  1. reduce demand for taxpayer funds, while assuring that some private markets trading in banks' equity will remain post-Nama Trust implementation; and
  2. per above study, lead to a long term improvement in the cost of liquidity for Irish banks.
Incidentally, the third net positive impact of such conversion would be effective risk-sharing, as bondholders will be given a direct stake in the Nama process, something that is not even attempted in the current 'risk sharing' proposals on the table.
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