Thursday, August 27, 2009

Economics 27/08/2009: Rabo and Namaeland

And so the news come out of the depths of Irish banking sector, like an old Soviet sub, with its nuclear reactor still glowing red. Rabo is, as logically expected, on its way out with ACC delivering 20% loans losses and values on underlying assets down 50-60%. Well, there’s more to come according to them and there is no hope a recovery mid-term. This is all happening while the Government is spinning the idea that Nama is going to be just fine because, apparently, it will be taking loans with low LTVs… Hmmm...

Let me see – anyone wonders why Rabo is not buying this story? Simple: a loan written in 2007 with an LTV of, say 50% in the amount €100 had collateral underlying it valued at €200 back then. Table below shows the expected losses on Nama purchasing such a loan under Rabo impairments and stated declines in underlying value.

The above factor in the rolled up interest and a 20% impairment rate on loans. Interest accrues over 2007-2010 and all values are brought into 2009 Euro. 2007-2009 inflation is assumed to be cumulative 2%. 2010 inflation is assumed to be zero. Interest roll ups are taken at 7% in 2007, 9% in 2008 and 11% 2009-2010.

What is clear from the above is that even before we factor in the cost of bonds issuance, the cost of subsequent recapitalization, and the costs of operating Nama, the required gains on 2010 expected values of the underlying properties (assuming 20% are completely bust) required to restore Nama to break-even on its purchases in 2021 will be in the range of 2-5.5% annually in the case of 40% discount paid by Nama on assets and between 4% and 8.3% in the case of 30% discount paid by Nama.

Now, let us factor in  the cost of financing the Nama bonds and the cost of recapitalization post-Nama. Table below shows identical results to the table above, except with the bond financing cost (over inflation – of 3% pa through 2021), plus Nama recapitalization demand at 8% on the value of the loans transferred (a gross underestimate, but hey, let’s give them some slack):

Yes, folks, that is right – to get break even (almost, as we still did not count the cost of Nama operations, plus the cost of redeveloping loans, etc, but we can cancel these out with property yields, just to cut these endless estimates) on Nama, Ireland Inc will need to run annual property markets inflation of 12-15.1% per annum for 10 years after 2011! And this is based on 50%-60% LTVs!

I mean, are you surprised Rabo and the likes are not rushing to buy into our “Low LTVs” Namaeland?

Note of caution: I am just using Rabo numbers here - this is clearly not a complete picture of Nama, but it does give us the latest up-to-date picture of what is going to be happening in Nama.

18 comments:

adrem said...

Constantin

Will you explain your spreadsheet more clearly please - I'm not following it.

If you take a loan of 100 given in 2007 (Jan 1 presumably). And assume zero interest payments in 2007 (7%) and 2008 (9% for some reason) and 2009 (11% for some reason !!) you get a total loan amount of 129.5

This loan is secured on a property that was originally worth 200.

The bank has already part written down this loan (presumably you are taking that into account) - shall we say 10% or is that too high? Lets for the sake of it ignore the fact some has been written down and just run with the full loan (we can keep the already written down bit as our profit).

So we have a property worth original 200 and a loan of 129.5. NAMA purchase the loan at a 30% haircut - so they give the bank 90.65 for that loan. That means that provided they secure more than 90.65 for the property that was once worth 200 then they are in the black. That implies that provided the property has fallen in value by less than some 55% then NAMA will not lose money on the transaction.

To expand us back up from one bank and one made up property (and some very made up interest roll up assumptions) is it your contention that the broad property market has fallen by in excess of 55%? Where's the evidence for that? Certainly parts of it have fallen by way more than that (I'm thinking rural "development land" that is really farm land) but across the whole lot and allowing for the fact that both performing and non-performing assets will form part of NAMA where is the evidence that the market is down more than 55%?

And that assumes a 30% haircut - if the haircut was 35% the implied market fall would have to be even steeper.

TheFruit said...

With all the funny money pumped into the system - quantitative easing etc. are we (as in Europe & indeed the US) not going to start approaching a point where prices prices of everything could start rocketing - maybe at a rate that might be uncontrollable by central bank interest rate rises? Right now, there is no money moving no matter how much is pumped in. But this could change rapidly very soon as infrastructure projects ramp up.

Might is not make values of assets held by NAMA suddenly rocket as well? (I am assuming an international contagion in massive inflation rates)

I wonder is this the gamble Aherne et al are banking on? A lot depends on the probability of this happening I suppose.

Then again, maybe nothing much will happen internationally. Maybe we are stagnant (for the next 10-20 years) in which case there is just more and more of a global wind down as supply chains falter and countries become more inward focused simply becasue globalism has failed, in which case, does it matter one whit about NAMA and what it may do as the end game is the same?

I cannot help feeling we are on a knife edge balancing between rampant inflation or global economic blowout and it really does not matter what you do. Maybe the best approach is to just foot drag for a while until we see what is really happening out there. NAMA being this foot dragging exercise.

Dr. Constantin Gurdgiev said...
This comment has been removed by the author.
Dr. Constantin Gurdgiev said...
This comment has been removed by the author.
Dr. Constantin Gurdgiev said...
This comment has been removed by the author.
Dr. Constantin Gurdgiev said...
This comment has been removed by the author.
Dr. Constantin Gurdgiev said...

Adrem, great to see you checking the numbers.

Here is more detail on my calculations:

You have paid (at 30% haircut) 90.62 (2009 is included because by the time Nama actually pays for the property this year’s interest rate accrued will be counted in) for a property that is worth 50-60% less today than in 2007, i.e a property that is worth today €80-100.

Now, Nama financing this transaction at 5% (say) interest rate into 2021 (10 years ahead) and I also assume that the market bottoms out in 2010 at 60-70% decline to the values of the assets underlying these loans.

So in 2010, Nama would have paid (assuming zero inflation in 2010) €95.15 for a loan that will be (under my assumptions) worth only €60-80.

Plus, Nama has also paid the banks 8% recapitalization cost – raising the amount paid by Nama to €102.40.

Now, this is assuming the loans are non-performing at the worst. If we are to write off 20% of the loans as useless – i.e. defaulted – you get the risk-adjusted value of the loans in 2010 at €48-64.

You say the banks have written down the loans by 10 percent already. Ok, take a margin on the above value of say 15%. But let me remind you that I have not factored in the ECB discount on face value of the bonds (10-15% reasonable to assume)? And the cost of running Nama (including the cost of managing the loans on behalf of Nama by the banks – 3%), less the yield on Nama assets (6% for performing loans is a high enough number, but only roughly 50% are performing, so 3% across the entire book would do?). All in, you have -15%(banks writedowns)+10%(ECB shave)+3%(management costs)-3%(yield)= net correction to be applied to my numbers above should be around 5% in favour of Nama. Let’s do that on the asset value side.

Net result, under your and my assumptions: Nama – by 2010 will have paid €102.40 for assets worth (risk-adjusted) €50.4-67.2.

Dr. Constantin Gurdgiev said...

continued...

But the racket does not stop there, since the Government does not want a firesale, so costs multiply into 2021 (or beyond, in fact, as the Government has stated that Nama will run 15 years). These are compounded at 5% to be offset, under my assumptions by 3% yield against (my assumption) 3% inflation. You quickly get into my territory here.

Of course, I am using Rabo figures as a background for declines in property values. But hey, does anyone really think that buying a portfolio of loans accumulated by some of our most aggressive developers will be like buying assets that have seen a temporary correction of 30%? 40%?

Let us face the reality here – in 2006 when I was shopping for a house, a property with listed price of 600K went up to 635K barrier within an hour of the doors opening for the first visitors. Mark ups on listed prices were in the region of 5-10%. Now, asking prices have fallen by ca 30% plus since the peak. And you get to bid below the asking price with properties selling at 10-12% discount on asking price. So take a property in 600K range in 2006. It sold back then for 640K and at the peak went for ca 650K. It now would list for 420K and would sell in the region of 378K. A 42% decline on peak prices.

Now move forward to 2010. By then, my prediction, the property prices (asking) would take a hit of another 12-15% (or so), bringing the same 650K house of 2007 peak down to an asking price of 357-370K, or a selling price of 314-333K. A peak to trough decline of up to 52%.

And this is for the resale markets. In new homes segment, prices have fallen deeper and earlier, so I would say that on average, we are going to see a 60-65% collapse in new homes prices at the trough.

Now think of demand/supply relationship spatially. Despite prices ‘holding’ at smaller declines in the country as opposed to Dublin, this is not due to the demand/supply of there properties being in closer equilibrium, but because fewer people outside Dublin can actually afford selling their homes and many more people outside Dublin (within the commuter belt) are in deep negative equity (purchase vintages are younger in the new built areas).

Dr. Constantin Gurdgiev said...

Where do you think the development land, development projects, investment properties that are in trouble are concentrated today? Not in Dublin city center or South Dublin. Some high profile ones are there, for sure, but they are outnumbered by the sites outside the areas of real demand. What decline in values shall we assume for them? 70%? 80%? 90%? Or even 110% - as someone buying them would have to potentially pay for the removal of the rubble – the unfinished bungalows that have turned the countryside into a Soweto-styled slum.

Are these the same 20% loans in default already? Some are. Others are not yet classed as such. Who cares if the banks have taken a 10% haircut on these so far? Or a 15% haircut?

Sweden had to face a less steep decline in house prices, while having lower debt as percentage of household income than Ireland. It also had much shallower contraction in its economy and it faced short-lived shallow global recession. Despite this, having dealt with only 22% of its entire economy’s loans, after having forced the banks to write down their debts to mark-to-market levels and after having destroyed shareholders and some bondholders equity and debt, Swedish bad-bank set up has not achieved break even return on public investment in nominal terms. And Swedish housing prices have not regained (in real terms) their pre-crisis values to-date – almost 20 years after the collapse has begun.

What low LTVs can our Brian Lenihan be talking about? What ‘unappreciated complexities of the situation’ per Dan Boyle have we (the critics of Nama) omitted in our analysis? Who – amongst those of our political leaders who fuelled the artificial bubble and wasted public tax revenues over the last 7 years in Government – shall we trust with doing the right thing, as our ex-stock brokers advise us from the Prime Time podium? Which economic advisers – including those who have changed their tunes as many times as their bosses have changed – should be take on their word when they have no guts to face their policies’ critics face-to-face?

Oh, yes, Alan Ahearne did withdraw (virtually last minute) from tonight’s Prime Time.

Philip said...

There's a rail bridge that fell down last week effectively cutting off a lot of high price north county Dublin property from effective transport. I wonder what that'll do to the price of property short term. Lack of investment in local infrastructure guarantees low property prices. I think a 55% drop may be optimistic.

While we rush through a 90Bn committment, we will find it hard to raise the 25-50M needed for bridge repairs. It's the Penny wise Pound Foolishness mentality and yet the lads get to cream off a few % on commissions irrespective of the inefficiencies of their borrowing strategy. This is selfishness and no more.

I would like to see a well developed argument that property prices will recover any time soon from someone on the Pro NAMA side. Do these guys not know that the very money they are throwing away are ruining the country's ability to dig itself out of the muck it's in already?

adrem said...

Cheers Constantin

I suppose the difference really comes down to the old imponderable - I don't believe that the basket of assets that will transfer to NAMA will have a value as low as you do. I reckon the 55% ish mark implied by a 30% ish haircut is probably close to the money.

Also I think there is an element of disingenuity in the numbers - the whole point of NAMA is that the realisable value of the assets over the next (say) 10 years is in all liklihood greater than the trough value (most economic modelling of property bubbles indicate a recovery above trough levels at some point - I'm not saying a recovery to pre-crash levels just a recovery above trough levels). I think it is somewhat disingenuous therefore to calculate a "cost" of NAMA over 10 or 15 years and include in that cost a loss on the asset values based on a trough valuation - if you see what I mean. I don't think you can include long term costs AND trough values - you either sell em at the trough values now and have no long term costs or you have long term costs but make some reasonable allowance for recovery of some shape or form.

Dr. Constantin Gurdgiev said...

The best part, Adrem, we are actually discussing this. We can agree, disagree, argue, come to some sort of a 'golden' middle outcome. What we can't afford to do is to play Alan Ahearne and Brian Lenihan "Trust us" cards. That's my main point. They - the Government - have gone personal at some of us in the debate (I've been spared so far). And yet, their own record is so damn poor that it frightens me to allow them manage their own paper clips purchasing. Look at it the following way - I have numbers, you have some assumptions, so we can compare, query and disagree based on evidence or theory. They have former stockbrokers saying 'Nama won't pay Euro60bn for these loans", followed by the same "Trust us in this" even after their own legislative proposal says Euro60bn price net of costs! And I would love to trust the stockbrokers - many of whom are capable and competent professionals, except I will never forget the clients of theirs who were sold CFDs and risky private equity projects, even though they came in to buy pension-linked products.

And this is the best they can do in the Nama debate as far as finding proponents of the thing? I would rather debate yourself than Alan Ahearne or Brian Lenihan...

Baz said...

Constantin, are the journos at the Irish Times giving Irish developers an easy ride? Real Estate Opportunities according to this article are doing great: http://www.irishtimes.com/newspaper/frontpage/2009/0828/1224253408978.html
But according to The Guardian they are in big trouble: http://www.guardian.co.uk/business/2009/aug/28/battersea-power-station-real-estate-debt
Or do the developers themselves have no idea where they stand?

Brian O' Hanlon said...

"you either sell em at the trough values now and have no long term costs or you have long term costs but make some reasonable allowance for recovery of some shape or form."

I like that sentence a lot. Speaking from a non-economist, non-distinguished, non-architect point of view, of someone who knows just about every twist and turn in the construction game... I have to say, I like the above sentence a whole lot.

What that sentence above does, is it highlights for me in my own simple minded view of things, what is most important about construction. About good sustainable development in Ireland should aim for, over the next decade.

You want to watch those 'long term costs' in my view. The reason being is that the construction industry in this country, which has to mould itself around the loans, the land title and deeds, the individual private players in the property game.... still hasn't learned very much about management of 'long term costs'. In fact it doesn't want to learn either. It is like trying to teach Hamlet to a bunch of teenagers.

When I think about managing long term costs I have to think about a company such as ESB networks, which is all about managing a crucial asset on behalf of the nation's inhabitants, over a LONG period of time. When you invest in something such as a national power grid, it is understand that this thing has to be managed and cared for over 50 or more years.

So ESB networks is one kind of 'culture' where you can talk about 'long term costs' and recovery in terms of value over a long period of time. It is not awfully exciting, but they know how to do it.

But where property and construction is concerned in Ireland, forget it. Stick to a plan, which goes almost to the extreme of having no long term costs, and take the pain of selling at trough values. There is really no way around it.

In the meantime, we do need to look at ways in which property developers manage assets over a longer time frame, in order to gather more benefits from the investment. When property developers in Ireland see the added value they can create, and subsequently extract over a longer period of time, they will warm to the idea more.

But in the meantime we will not go from 'hunter gatherer' to Neolithic man, in ten years. No matter how optimistic Brian Lenehan or anyone else wants to be. You simply cannot change the DNA of an industry in such a short space of time. Anyone who would try, doesn't know what they are doing at all. I have been a project manager in the industry for long enough now, and I enjoyed seeing guys pass beyond 'knuckle walking' stages and straighten their backs a bit. But I am not going to get ahead of myself either.

Brian O' Hanlon said...

The Corcoran Jennison managed residential model is tried and tested over 30 years in the toughest areas of Boston. It is something we will have to introduce into Ireland, once we can sort out the politics with the housing departments in our local authorities.

If we did nothing else only that over the next decade it would be a vast improvement in the real lifes of many ordinary Irish families.

Feasta also invited a guy named Chris Cook over to Dublin late in 2008 to speak about his asset based finance systems. He is using them a lot to manage oil reserve assets in the middle east. It seems to work there, where you are trying to organise the business model, to get the best value possible out of the asset over an extended period of time.

But for heavens sake, saying that NAMA is going to work, is like taking a child you cannot even read yet and expecting him or her to earn a Phd within 15 years. We don't have that kind of talent in Ireland with regards to construction or property.

We should set the bar at somewhere we can achieve. The achievement will give us confidence, even if it is at a basic level. The only good reference that springs to my mind here is Clayton Christensen. Christensen spoke of how RCA for instance invested an awful lot of money in trying to make transistors work, to replace vacuum tubes in their TV sets.

Someone else came along with a much simpler challenge, to use transistors in hearing aids. The hearing aid users were delighted with the new improvement to the product and were no where near as demanding as the market for TV sets were.

We seem to be falling into that trap with NAMA, if you want my humble opinion. We operated a very, very, very basic model for construction and land development here in Ireland. It wasn't good enough for anything, even in the boom times. Except that the public had developed such an irrational appetite by 2006, that they would consume anything, and did.

If you have ever stood in line for chips at 1.00am after pub hours, you will know what I mean.

Brian O' Hanlon

Brian O' Hanlon said...

Rather than fill up your comments section with another long essay, I decided to comment about the Battersea site, at my own blog site here:

http://designcomment.blogspot.com/2009/08/yuppie-towns.html

Thanks for posting the link to the Guardian newspaper article.

Brian O' Hanlon

Martin said...

I Think NAMA will be passed and implemented. FF TDs will blow a lot of hot air, the greens will stumble, but ultimately it will be passed. The banks are more than happy with NAMA, word on the street is that One Irish bank tried to buy a foreign banks toxic loans, to ensure that they would not bankrupt a certain developer, thus exposing the real value of the assets. Ultimately it will be the banks bailed out by NAMA that will decide the long term value of the NAMA assets as they will be the ones financing there purchase when they come on the market. . The banks are all too aware of the long term economic value. They cannot get rid of these loans fast enough.
On the question of long term economic value, cast your minds back to the 70s & 80s, the IDA in their wisdom build factory units all over the country in the hope of attracting companies to use the pre build factories, most of there factories were never used, or if they were, it was on a limited basis. The same thing happened during the boom, Houses Industrial units; commercial retail parks were built all over the country. We build Houses, Commercial buildings that were not needed, in places no one ever heard of. So depending on their location, some of there loans have NO long-term economic value.

Fungus FitzJuggler III said...

The point is that we know that our economic models are BS. Yet they are trying to insist on them and putting 90Bn Euro into that pot. Why not allow the existing laws to apply?
Why do we need NaMa at all?

Give notice that the guarantee on the banks is to expire soon. And then let it expire. In a deflationary economy, no one lends money so clearing the banks of toxic assets will not help the banks.
The construction industry might like to get building going again. Do we compete with cheap land at firsale prices to get employment up? Or do we delay sales of land until, guess wht, more land is re-zoned! What will NaMa be worth then? Where does it say in the NaMa Bill that there will be no rezoning until NaMa is dismantled?