Wednesday, March 31, 2010

Economics 31/03/2010: Nama funding scheme - Maddoffian Risk Pyramid

The saga of Nama continues, folks. Ah, and no, I do not mean the dumping of €8.3 billion to the Anglo which miraculously declared losses of €12bn = €4bn injected by taxpayer in 2009 + €8.3bn injected today. Had the Exchequer given Anglo €15bn last night, the bank would have declared losses of €19bn. And not even the admission on the public airways, by our illustrious 'public interest' director soon-to-be-chief of Anglo, Alan Dukes, that Anglo will most likely need more than additional €10bn promised to it by overly-generous-with-other-people-money Mr Lenihan.

Oh no - the really worrying thing is contained in the notes from March 26th issued by Nama (available here) that detail the financing arrangements that Nama will undertake to cover the purchases of the loans from Irish banks.

Some time ago it was rumored that the Government was setting on the following scheme:
  • Nama will issue 12 month bonds
  • With interest rate rest at Euribor-Libor plus a margin every 6 months
  • Which are to be fully unconditionally and irrevocably guaranteed by the state as ranking pari passu with the Nama other unsecured and unsubordinated debts.
At the time, myself and other analysts said that such a scheme would be a disaster. Now, per latest documentation from Nama - this is exactly the scheme chosen to finance Nama acquisitions.

Let me remind you what the problem with this scheme is.

Nama is buying long-term loans with work-out period stretched over 10-15 years. It will use short term financing to get these through. Problem 1: borrowing short to lend long is what got out banks into this mess in the first place. Now, Nama will have exactly the same risk-loaded funding structure as the worst of our banks. For example, at the peak of risk-loading, Anglo carried about 50% of its funding in short-term inter-banks loans. Nama will do the same for 100% of its funding requirement. Scared yet?

Nama will be loading up with short term debt as the yield curve for Libor and Euribor is pointing up. In other words, every progressive reset (6 months) and roll-over of the debt (12 months) will be more expensive to the State. My third year UCD undergrads last Fall knew that this is a bad risk. Nama, having paid millions to advisers and 'experienced' staff couldn't get it right! Trembling yet?

Nama will be rolling over bonds on an annual basis. This means annual transactions costs (making the entire borrowing much more expensive) and reliance on the ECB to re-collateralize the bonds (putting Frank Fahey's 'free lunch' funding out to new tender annually). Is anyone actually thinking about any of these risks out in the Treasury Building on Grand Canal Street?

Adding insult to injury - despite being issued by the agent different than the Sovereign, Nama bonds will be tax-exempt. In other words, issued at Euribor of, say 2.75%, the notes will effectively be priced at around 3.44%. Worse, the Guarantee statement obliges the Irish state to cover incidental and other expenses of the bond holders and exempts them from all and any taxes relating to the Guarantee. In other words, should the bond holders resell their Nama bonds at a profit (in part determined by the Guarantee), there will be no tax on such a resale.

In short, it appears that neither Nama, nor an army of its excruciatingly expensive advisers, nor DofF, nor the Government have any knowledge that normal interest yield curves are upward sloping - cost of borrowing, normally rises in time. Or may be they simply do not care. After all, its our money they are gambling with.
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