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:
- reduce demand for taxpayer funds, while assuring that some private markets trading in banks' equity will remain post-Nama Trust implementation; and
- per above study, lead to a long term improvement in the cost of liquidity for Irish banks.
6 comments:
Constantin,
I have just come across your site. I enjoy your appearances on TV, though it does rather appear to be just Vincent Browne.
Can I post my final comment to Eoin on irisheconomy.ie?
You see, Constantin, (apart from the citizen/taxpayer getting the wrong end of the stick) my ultimate difficulty is that the market itself is being undermined. Let’s give the politician the benefit of the doubt. They think they are “doing their best”.
Constantin,
NAMA will create a “statist” monopoly in CRE for a decade. It is the defined mission.
There will be no price discovery, there will be a monopoly, there will be no stimulus to enterprise.
Anyway here it is.
http://www.irisheconomy.ie/index.php/2009/09/17/the-economist-likes-nama/
Eoin Says:
September 20th, 2009 at 12:14 pm
“I’m not claiming that “misallocation of capital” isn’t a problem. I just have issues with your solution along the lines of “There must be a mass liquidation of a significant portion of CRE.”. Again, explain?”
Eoin,
I am glad we agrees that the misallocation of capital is a problem. I take the view that the bigger the misallocation the bigger the problem.
Maybe I should have said that NAMA will be a de facto monopolistic provider of CRE and development land. This is economic perversion.
With (I think I’m right) €28Bn going to Anglo and €6Bn going to Nationwide the bulk of the bailout is going to banks that are patently insolvent.
I don’t think anyone would seriously suggest that Anglo, with five branches in the State, will be lending to newsagents in Roscommon, fish & chips shops in Donegal or car mechanics in County Clare.
The €28BN given to Anglo is a massive misallocation of capital. Probably the same for Nationwide.
They should be thrown to the dogs along with their bondholders. I don’t buy the argument that Ireland “Sovereign” would be barred from debt markets as a result, though Government action to date has placed the Sovereign in an awkward position.
Let the liquidation begin. Let the market decide what value is. Rents for commercial space would plummet and allow indigenous (or foreign) enterprise a competitive edge in a Global/European market place. This competitive edge might assuage the negative effects of uncompetitive labour costs.
“Thats seems likely illegal/unconstitutional, and would amount to a temporary nationalisation of private contracts/property, in order to force down their value.”
NAMA itself is likely “illegal/unconstitutional”.
What of the property of the citizen/taxpayer that is being appropriated to the cause of NAMA?
Do the property rights of citizens count for nought?
Eoin,
Forget NAMA. Think about supply and demand. Think about price discovery. Think about a country where the state controls all land and property. Ignore the, very real, prospect of political interference in the allocation of that land and property.
Think about the wider world.
Nobody would invest in such a country. Their interests could be undermined by the state at any time.
Back to NAMA.
NAMA provides the state with the most perverse of reasons to manipulate prices. That is, to corrupt the process of price discovery.
That perverse reason if the political futures of those who propose NAMA.
NAMA (in its current form) is an economic albatross around the neck of enterprise for at least a decade.
In short, in terms of economic recovery, price discovery (the essence of a free market), and fairness to citizens, NAMA is about as useful as tits on a bull.
NAMA is not Quantitative Easing.
NAMA will not provide credit to enterprise.
The warrants on equity of AIB & BOI are close to valueless.
Question
Given that Independent news and Media is negotiating with its bond holders for debt-equity-swap, should the irish banks not have done the same?
Martin - absolutely. Debt for equity swap is both more efficient structuring of capital and a necessary part of the process of travelling down seniority rights ranks. My Nama Trust (aka Nama 3.0) proposal has this built into it.
Constantin
How do you force the debt equity swap without it being perceived as a default? Is it only sub-debt you are talking about? Did they not do a debt-debt swap on large chunks of this recently, effectively costing the original sub-debt holders a fortune?
You indicate that the banks should be forced to look for external funding - but is that not what the govt is effectively doing? They are bringing in NAMA with it's haircut (of whatever level - lets leave that to one side) and as a result the banks are going to need multiple billions in capital - the state is not giving them that. By all accounts AIB is going to sell M&T and look for a minority stake taker (Canadian bank looking it over apparently) and BoI (supposedly) going the rights issue route. If the capital hole in the banks is filled post NAMA externally then the actual money cost of NAMA in year one will be zero (I'm assuming that the debt repayments to the ECB will be paid from the performing loans). Is that correct?
Adrem, good points for discussion.
I would start with subordinated debt holders at, ca 20-30cents on a euro equity swap. Put a gun to their heads and tell them 'Guarantee will be over if you do not comply any way, so take it or leave it.' Then you go senior debt holders and tell them the guarantee will expire and they have a chance to convert 25% of the entire debt holdings now at 110-125 cents of face value against market price of shares for an effective haircut of 2.5-6.25%. This is a shallow haircut and you get some equity out of it withour a default.
You then dilute resulting share holdings by buying equity in the banks in exchange for Gov bonds to recapitalize to the required levels.
You are right that the banks will need some additional capital post-Nama. This new capital demand will arise from two sources:
(1) a minor demand call to repair RWA damage done by Nama; and
(2) a major call when mortgages and personal and corporate debt defaults hit.
The Government is likely to step in on the first one, as - per BofI latest news - our banks won't be able to successfully raise shareholder equity on their own accord. Hence all the talk about 'the Government willing to consider majority stake' in the banks post-Nama.
However, if we inject new equity directly into the banks from day one - leaving bad loans on the banks' books, but financing through equity purchase the writedown of loans to more realistic valuations, RWA actually improves relative to Nama + Subordinated Nama issuance formula, so the secondary post-Nama demand for funding is not needed.
Repayment on Nama bonds out of book yeild is highly unlikely. Current yields on performing loans average around 4-6%. That 6% figure is completely out of fiction (see Ronan Lyons argument). Thus, assume the range is 4-5%. So 50% non performing loans, plus 50% performing loans Nama portoflio will yield 2-2.5% per annum across the entire portfolio. And this is before any future deteriorations in Nama-bought loans (do you think the banks have an incentive to sell the strongest loans to Nama or the weakest - marginally performing ones?).
Now add management costs (ca 0.75%) and Nama-own cost (ca Euro15 mln or 0.03%, double it for legal cost to be added), cost of rolling over 54bn worth of bonds (0.1% in fees) twice, net yield on the book is ca 0.99-1.49%.
Break even?..
Suppose property tanks another 10% between Q4 2009 and Q4 2010. The yeild conmpression on the loan book will - using current rents curve from Daft.ie - will be around 8-11%. By year end 2010, you have effective net yeild on Nama book of 0.77-1.29.
Does this cover 1.5% coupon?
I'm not actually qualified or experienced enough to comment fully (so take that into account !!) but -
1) The banks aren't being allowed choose the loans that are NAMA'd so the point that the yield will automatically deteriorate is probably not valid
2) I take your point on the yield on the book but would question the deductions - 0.75% for management? who's paying that? Not NAMA I'd reckon. Assumed 10% further fall in the NAMA book - is a pretty arbitrary assumption
3) I don't really get the point on the debt/equity structure (that's my ignorance now, not a criticism of your point !). Will what you are suggesting not cost several billion? Would the equity injection required not exceed the full nationalisation number? Would the cost of the debt you have to raise to invest in the banks not be as great as the NAMA cost but without the asset transfer? Why would I as a senior debt holder even contemplate taking a haircut in return for equity that my investment mandate won't let me hold? Surely they will simply say no? Knowing that the government cannot be seen to default on senior debt without creating even bigger problems down the line. I think the current approach of the govt keeping away from the debt holders completely and leaving the banks to deal with it makes at least as much sense.
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