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?


patrick1978 said...

Hi Constantin,
I dont think the ECB will step in here. There is a lot of corruption and fraud within the European Central Bank, even the current chief Jean Claude Trichet went on trial for a banking scandal at Credit Lyonnais.
They were jumping up and down at the thought of "sponsoring" a transfer of wealth(NAMA) from Irelands poor and vulnerable people to Irelands "Golden Circle".

yoganmahew said...

The other possibility is that the private investors only get 10% of the capital they invested or 10% of the total equity capital. This would be a small sum, but would amount, I suppose to a final dividend.

In any case, the wording is very unclear.

Greg said...

Excellent stuff. It’s unfortunate that so many assumptions have to be made. Over at irisheconomy it is suggested that the SPV is just a “method” being employed in order to keep NAMA debt off the national balance sheet. This could be right.

However I cannot imagine that the ECB did not have foreknowledge of the decision. They must have had. Otherwise there will be the most unholy of rows in Europe.

If that is the case then not only will bond markets know that Irish national debt is understated but also that the ECB is complicit in that understatement.

Why would the ECB do this? Because they are wedded to the idea of “sustainable” government borrowing across the EU. The Stability & Growth Pact.

Well it’s not much of a pact if it has to be done on a “nod and wink”.

The ECB should be honest and recognise that the banking crisis is a special case and allow a breach of the pact. Otherwise the pact itself comes into disrepute.

Anonymous said...

In the US there are inflation proofed bonds called TIPS.Investors are charged a premium through a lower bond yield.
The policies of the government are deflationary so the par value of these NAMA bonds will increase in real value without an inbuilt protection for the state.

Off balance sheet accounting allowed the investment banks to park Mortgage backed securities etc, following the repeal of the Glas /Steagal act which was established after the great depression to prevent investment banks using false deposit to loan ratios.
The State is now adopting the type of accounting standards used by Lehmans,Bear Stearns etc.


The Galway Tent said...

'SPV' smells like 'SPE'.

Any chance Andrew Fastow of Enron could secretly advise NAMA?

Mr Fastow is an expert at concealing massive balance-sheet losses by using a complex web of off-balance-sheet special purpose entities (SPE).

Andrew Stuart Fastow was the chief financial officer of Enron Corporation until the U.S. Securities and Exchange Commission opened an investigation into his conduct in 2001.

Fastow was one of the key figures behind the complex web of off-balance-sheet special purpose entities (SPE; limited partnerships which Enron controlled) used to conceal their massive losses.

He is currently serving a six-year prison sentence for charges related to this conduct.

Anonymous said...

NAMA seems to have concocted by someone eager to punish the Irish people. Maybe for the "national mediocrity" that lead to the dreadful humiliation of Brian Lenihan senior all those years ago.
We have assumed that NAMA was devised in good faith.
Maybe it's not!

S said...

NAMA is being perpetrated on Irish people by the bankers taking advantage an economic illiterate and clueless finance minister and complicit ministerial colleagues. I have no doubt that it will be a disaster and when that happens nobody will be held accountable.

Anonymous said...

Your chances of going back in time and NOT signing the lisbon treaty are higher than getting out of this mess.

MK1 said...

Hi Constantin,

I do am dismayed by the 'off-balance-sheet' accounting treatment of Nama in terms of state debt. A spade is a spade and ratings agencies, etc, and anyone involved looking at state debts will see it for what it is, government debt.

In terms of the Euro and the growth and stability pact, countries are breaching this left right and centre and the Euro rules are more aspirational rather than strict. We will be borrowing a lot more than the 3% this year (more like 12%!) and we are heading like a train way above the 60% target.

In summation though, Ireland's debt will be large whether Nama is on it or not. State debt is usually used to create assets (such as infrastructure, etc) so Nama debt, even if backed by "assets" should be treated the same.

Similar treatments of debt (long money versus short) and off-balance-sheet instruments (eg: CDS's) is what got the globe into the credit bubble mess in the first place. Accountancy and treatments are crucial to understanding whats going on, but it is a much maligned practice.


civic_critic said...

Greg said:
"Why would the ECB do this?"

For one thing, NAMA may well have been the price that the establishment demanded off the Europeans for passing the Lisbon referendum. A sort of international blackmail whereby, at a critical point and for a short time only, the Irish establishment had the europeans by the short and curlies. Lisbon is a much bigger project than a few tens of billions given to the Irish. If my hypothesis that this is what happened is correct then it is notable that the Irish establishment chose to use the leverage of the referendum for this purpose rather than any other purpose to the benefit of the country and its people. Which makes them treasonous in the most straightforward fashion.

The second point, about why they chose to create an off-balance-sheet vehicle, may perhaps also be found in the Lisbon Treaty. There is a stipulation in the Lisbon Treaty that if national debt goes over 60% of GDP then the EU is entitled to intervene in a country's politics and economics and impose IMF-like stringencies on everything from finance to the social sector. By making NAMA off-books this stipulation has not been activated. By making it on-books this stipulation would be automatically activated. At the moment it is not politically expedient to activate this but the government may choose to do so at some later time and may have agreed NAMA with the EU knowing that the EU could take control via this means at some later date to limit its exposure. If this is the case, then yet again we are dealing with traitors of the most unconcionable and blatant kind.

Unknown said...

The SPV is designed purely and simply to exclude the NAMA debt from the National Debt - in fairness they are being up front about the fact that they are structuring the whole thing in this way and why they are doing that. Enron-esque comparisons are not valid - there no one knew about the SPVs !!

The return to the private investors is their original investment (if the SPV has the funds) plus 10% OF THEIR INVESTMENT. So 51M in 56M out.

The use of private investors is necessary to enable the SPV approach to work in its objective of having the NAMA debt excluded from National Debt. It does seem a very technical ruling from Eurostat that would allow the differentiation based on shareholding even if the NAMA reps maintain a clearly mandated veto on all decisions.

I think for the most part they are trying to avoid Ireland breaching the EU national debt limits and this is a mechanism that allows Ireland to do that. I don't see that it changes any other element of NAMA in terms of risk to the State

Netzoners.com said...

The current corrupt government and their lackeys have managed to perpetrated the biggest financial fraud in Irish history

81 TD’s committed treason yesterday and the rest only offered a partial or token grumble to the proceedings

The opposition should be out on the streets demanding a General Election on this, the most important issue in the history of the republic

As a Republic we are now finished.

We are now stripped of our independence just like in 1800 with the act of union, we again yesterday witnessed, where the national parliament voted itself into oblivion

This now shows me that there is on opposition in this country.

The elite have now complete control over the media and can now implement the interests of the international bond investors

The only course of action left now is obvious!
more on

tax attorney said...

fat chance any of us will get the option.
Why isn't the equity being sold to the highest bidder?