Thursday, April 8, 2010

Economics 08/04/2010: AIB first Nama loans

Earlier this week, Nama had completed the first transfer of loans from AIB. Per official report, Nama bought loans with a nominal value of €3.29bn for €1.9bn in NAMA bonds, implying a discount of 42.2%. This was below the discount of 43% announced by the Minister for Finance last week.

But what do these figures mean? Without knowing exact nature of the loans, it is hard to tell just how much did Nama over pay for the loans. Here is an averages-based estimate, however.

First, let us reproduce the original claimed discount of 42.2% using averages. Table below does exactly this:
In the above, I assume:
  1. Vintages of loans transfer running between 2005 and 2007;
  2. 2 year roll up on interest maximum allowed in the loan covenants;
  3. Roll up of interest commencing at a new rate in year 2008 and running through 2009;
  4. 2 scenarios of average interest rates applied (Scenario 1: 5% pa, Scenario 2: 6% pa) – as you shall see below, these are optimistic rates;
  5. Declines in values affecting different vintages as follows: loans of 2007 vintage – decline of 50% in value of the loan; loans of 2006 vintage – 40% and loans of 205 vintage – 35%.
As the last row shows, taking a simple average across all scenarios and vintages yields a discount on the loan face value of 41.7%, which, factoring in 0.5% Nama-reported risk margin yields the effective rate of 42.2% - bang on with the desired.

Having matched Nama numbers, let’s examine the assumptions and bring them closer to reality:
  1. Let us use the actual average annual lending rates for non-financial corporations reported by the Central Bank Table B2 (here)
  2. Let us also adjust the loans for security of collateral claims – remember, per official statements from Nama many loans (in the Anglo case up to 20%) are non-secured, with effective claims against the underlying assets of nil) – to do this, we induce the following security risk adjustments to value: 6% for vintages of 2005, 9% for vintages of 2006 and 12% for vintages of 2007. So the average is 9.9%. Although these are significant, remember – reports of 20% for Anglo loans are based on untested cases. It remains to be seen how higher these will go should other lenders contest Nama take over of the claims.
  3. Since Nama valuations were carried out through November 2009, we must factor in further declines in value, so let us push up value discounts to 35% of 2005 vintages, 45% on 2006 vintages and 55% on 2007 vintages. Again, these are conservative, given evidence presented in the commercial courts.
  4. Instead of running alternative interest rates scenarios (remember – I am taking actual rates reported by the Central Bank), take two different scenarios on vintages compositions: Scenario A assumes uniform distribution of loans across three vintages, Scenario B assumes a 20% for 2005 vintage, 30% for 2006 vintage and 50% for 2007 vintage split.
  5. Finally, let us estimate two other alternative scenarios: Scenario 1 has no mark ups charged on average lending rates, Scenario 2 has a set of mark up reflective of higher risk perception of loans, especially in 2008-2009 period. Remember, lenders became unwilling to provide funding for property investments in 2008-2009, which means they would be expected to charge a higher interest rate (risk premium) on loans related to property than those reflected in the average corporate lending rates.

Tables below show the results of model estimation:
Alternative scenario 1: Nama overpayment over the current market value ranges between 42% and 51% or €561-638 million.
Alternative scenario 2: Nama overpayment over the current market value ranges between 48% and 57% or €617-688 million.

So averaging across two tables: Nama overpayment on AIB tranche 1 loans is estimated at between 42% and 57% or between €561 million and €688 million. At a lower estimate range, this suggests that Nama is at a risk of overpaying some €26 billion for the loans it purchases, should this type of valuations proceed.

Of course, some would say this overpayment reflects the expected long term economic valuation of these loans. Fine. Suppose it does – how long can it take for the LTEV to be realised to break even (real terms) on Nama assets then?

Let’s make two assumptions:
  • suppose that Irish property markets see price increases of 150% of expected economic growth,
  • suppose that expected long term economic growth will average in real terms between 2% and 3% per annum.

If Nama overpays 48% on the current value of the assets (lower range of my estimate), Nama will break even – absent its own costs of operations and funding – and assuming full recovery of the loans per their value – by the end of 2027 if the growth rate average 3% pa or by the end of 2035 if the growth rate averages 2% pa in real terms.

If Nama overpays at the top of the estimates range – 57%, then real recovery will take up to the end of 2039 if the average annual growth rate is 3% or up to 2053 is the average growth rate is 2% per annum.

Again – notice that these figures do not include:
  • Legal costs of running Nama;
  • Losses that might occur on the loans since November 30, 2009 valuation cut off date;
  • 3 years long roll up interest holiday built into Nama;
  • Operating costs of running Nama (inclusive of very costly advisers it contracts);
  • Cost of Nama bonds financing
  • Cost of actual working through the bad loans
Still thinking Anglo is the worst case scenario for us?


Unknown said...

Since your analysis of AIB Constantin, the shares have rallied 7.38% on NYSE today.
see here

Unknown said...

After reading this Constantin
have you an opinion on whether Anglo shareholders should be rightly given 22 cent for every share they held, because that was the closing share price

TrueEconomics said...

Patrick, on AIB - it might be a rational move - if AIB is disposing of completely irrecoverable assets at a premium that my estimates suggest, the markets might see a signal that the book will be improved significantly enough to warrant some future growth.

I do not buy this story, because I do not see any future growth potential. Instead, I buy the following 'liquidity supply' story - most of banks shares globally have been overbought by now, so that finally, the trickle of surplus liquidity tsunami unleashed by global monetary authorities is reaching the sickest corners of the universe... i.e. AIB.

This is fine - all asset bubbles end with a bang.

On Anglo - if the bank does have some residual value - the shareholders should be reimbursed. But I do not see how that can be the case with Anglo, given taxpayers had to inject so much cash into it. The tricky part is to prove that 22 cents was not a reflection of the real value of the bank. And here, the timing and the manner of nationalization are certainly a problem for the Government. Should they have waited for a few days, the market price would have gone down on the news and the nationalization could have been carried out ex post price deflation.

Alas, our great minds in Finance are simply clueless...

wpower said...

Excellent analysis as usual.When arriving at your conclusions of when Nama breaks even should it also display how much cash that would have been available for "normal state expenditure" is taken annually over the thirty plus year ?