Tuesday, October 20, 2009

Economics 21/10/2009: Ireland = the most leveraged SPV on Earth?

And so we now learn than Nama beast has mutated into a high-risk derivative game with ghost investors, imaginary assets and illusionary payoffs. We are, for all intent and purpose, in the BaNama Republic.


Here is the story: per Annex H of the original statement of intent to establish Nama (April Supplementary Budget 2009 : here), the state will set up a Special Purpose Vehicle (SPV) to issue bonds (Nama bonds) that will be guaranteed by the State. Per Eurostat analysis (here) these bonds will not be counted as Irish Government debt.


First point to be made – we are now the first developed country in history that is about to throw the weight of its entire economy behind a private undertaking of extremely risky financial engineering nature.



€54bn worth of Nama Bonds will be issued by this SPV. SPV will be 51% owned by private equity investors who will supply €51mln worth of capital. Total capital base of SPV will be €100mln. This SPV will be borrowing (by issuing bonds) €54bn – which means that on day 1 of its running, the SPV will be 54,000% leveraged or geared. This will imply that Irish Nama-SPV will be leveraged in excess of LTCM – the infamously riskiest of all major investment propositions that anyone saw in financial history before Nama SPV idea came to being.


Point two: the Irish state will be engaged in the riskiest derivative instrument undertaking of all known to man to date.



To cover up the farcical arrangement (with folks with €51mln buying €77bn worth of risky (but recoverable, by Minister Lenihan’s assertions) assets), maximum 10% of SPV value can be distributed in profits. 10% of what you might ask?


CSO submission to Eurostat states that: “The profits earned by the SPV will be distributed to the shareholders according to the following arrangement, which reflects the fact that the debt issued by the Master SPV will be guaranteed by the Irish Government:

  • The equity investors will receive an annual dividend linked to the performance of the Master SPV.
  • On winding up of the Master SPV, the equity investors will only be repaid their capital if the Master SPV has the resources; they will receive a further equity bonus of 10% of the capital if the Master SPV makes a profit.
  • All other profits and gains of the Master SPV will accrue to NAMA.”

Two possibilities: 10% of expected (by DofF) Nama profits or 10% of Nama assets?


In the unlikely event of 10% of assets, the lucky ‘private equity’ folks can get 10%*€54bn*51% share – or €2.754bn – on the original investment of €51mln. They face no downside other than their initial capital injection less whatever dividends they collect prior to default, as bonds are guaranteed by the State. I assume this is a fantasy land. But one cannot make any rational assumptions about Nama anymore.


In a more likely event, it will be 10% of Nama profits. Ok, per DofF, Present Value of Nama profit is €4.7bn * 10% * 51% = €239.7mln. With principal repayment this means they will collect a cool €291mln on day last of Nama existence if DofF projections stack up.


We know nothing about the dividends, but we do know that the dividends will be paid out over 10 years. For some sort of decorum the Irish Government will have to allow SPV to appear to be legitimate and therefore it will allow it to pay a dividend on assets managed. Suppose the dividend will be around ½ of the standard management fee for assets, or roughly 100bps on revenue generating loans or 2.5% on net cash flow. Per DofF Table 5 of Nama business plan, this will add up to €12bn*1%*51%=€61.2mln using the first method or €61mln computed using the second method. In present value terms. Thus €51mln in initial investment will generate:


Scenario 1 – Nama works out per DofF assumptions = €352mln (inclusive of principal) – a handy return over 10 years of 690% or 21.3% annualized. Not bad for a government guaranteed scheme…


Scenario 2 - Nama loses money and is pronounced insolvent. Investors lose €51ml of original investment, but keep €61mln in dividends. 100% security, 0% risk...


Which brings us to the third point: as Irish taxpayers, we are now in a business of paying handsome returns to private equity folks (more on those below) in exchange for them covering up the true nature of our public finances. A good one, really.



Who owns this SPV? This is an open question. 51% will be held by ‘private investors’. 49% by Nama. 100% of liability will be held by you and me. Is this a Government throwing the entire weight of the sovereign state behind a privately held investment scheme? You bet.


But wait. Who are those ‘private investors’? Can Sean Fitzpatrick be one of them? Why not? Of course he can. Can Ireland’s non-resident non-taxpayers be amongst these? Why not? Of course they can. So as taxpayers we will be issuing a guarantee to tax exiles? Possibly. But wait, it gets even better – can the banks themselves be investors in SPV? Well, of course they can. Wouldn’t that be a farce – banks get to unload toxic waste on taxpayers and then make a tidy profit on doing so…


One way or another – parents struggling to put their kids through schools, elderly people struggling to pay medical care costs, single parents trying to balance work and raising family, young folks studying to better their lives – all of them and all of the rest of us will be bearing 95% responsibility of assuring that some ‘private investors’ will make a nice tidy profit, so Minister Lenihan and Taoiseach Cowen can go around the world claiming that Irish bonds that underpinned Nama were not really Irish bonds!


Which brings us to the fourth point: Why is Eurostat assured by this massive deception scheme to accept it?



Globally, G20 summits one after another have been focusing on how we will have to deal with the risks of the traditional SPVs and other ‘alternative investment’ assets classes that spectacularly imploded during the current crisis. Yet here, in a Eurozone country, a Government is actively setting up the most leveraged, highest risk SPV known to humankind. Surely there is a case to be made that the EU authorities should be actively stopping such reckless financial engineering instead of encouraging it?


The entire SPV trickery works because the Government has managed to convince the Eurostat that SPV will be fully operationally independent of the state. So far so good. But, Nama will sit on the board with a right of veto over SPV managerial and operational decisions: “The NAMA representatives on the Board will maintain a veto over all decisions of the Board that could affect the interests of NAMA or of the Irish Government.” Furthermore, Minister Lenihan and his successors will have veto power over Nama decisions and will be the final arbiters of Nama. Is that arms-length getting to finger-length?



At this point, there is only one institution still standing between the madness of the runaway train of Nama and the crash site of the SPV-high leveraged high finance gables with taxpayers money. That institution is ECB. The ECB will have to be concerned with non-transparent (Enron-like) accounting procedures that are being created by the Irish Government when it comes to accounting for Nama bonds. It has to be concerned if only for the sake of the Eurozone stability and its own reputational capital. Will ECB step in and tell this Government that enough is enough?

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