Wednesday, July 7, 2010

Economics 7/7/10: Nama New Business Plan

Nama New Business Plan (NBP) was published and it took me some time to dust out my old models and run through the numbers.

Let’s put it in simple terms – Nama’s latest installment in its own version of the hall of mirrors is so distorting, when it comes to representing the reality, that even a person with no education in finance would see that it simply a cover up for a scam.

Here are some points worth mentioning before we depart on the journey through numbers
  1. NBP contains no Profit & Loss or cash flow projections. For an undertaking committing between €38.5-40.5 billion of taxpayers cash, this is simply remarkable (arrogance? Or negligence? You decide
  2. NBP contains even fewer financial details than its old plan. The only relevant piece of new information it contains that has not been disclosed before is in the table 4 on page 25, which, given that no specific cash flow estimates linked to annual operation is provided, is a complete hearsay – or in scientific terms – an unfalsifiable conjecture. In common terms, it is known as bullsh*t
  3. NBP states (then rolls this statement into core assumption) that 25% of loans taken over in Tranche 1 are ‘income producing’. It does not explain the extent of this ‘income’ being generated in relation to the value of the loans. Let me explain – suppose I take out a loan for €100mln at 5% per annum. My payment on interest should be €5mln per annum. Barring capital repayment, if I pay my bank €4,999,999 a year, I am in arrears and the loan is not performing. But if I pay Nama €1.00, it is an ‘income producing’ loan. Get my example? In other words, it is a leap of faith to assume that 25% ‘income producing’ loans is the same as 25% ‘performing loans’
  4. NBP states: “the actual LTV ratios that have become evident during the Tranche 1 due diligence process have been higher than those indicated by institutions last autumn”, but never explains by how much. This is critical, since LTVs underpin the expected recovery rate in case of asset liquidation. Suppose Nama takes on a loan for €100mln that is secured against a property worth (at the time of loan issuance) €120mln to LTV of 83%. Suppose that underlying asset deteriorated in value by 60% since loan issuance and that in the long run, it is expected to appreciate by 20% to LTEV of €57.6mln. Foreclosing on this loan will mean a recovery rate of 57.6%. However, were the LTV at loan issuance at 90%, the recovery rate drops to 52.8%.
  5. NBP omits any provisions for rolled up interest on the developers’ loans. At €81 billion face value, and taking average retail interest rates for 2004-2007 reported by the CB, we are looking at €18.8 billion of foregone interest – a direct subsidy from taxpayers to developers. In arriving at this number, I used loans depreciation schedule provided in Nama new plan page 10, the average charged rate of 4.7% (assume static over 2011-2018, despite the fact that one can safely assume that this cost of capital is (a) too low, given Irish Exchequer is borrowing currently at 5.4% and (b) is likely to rise in time with upward sloping yield curve).
  6. Nama makes an implicit assumption that it can dispose of all properties held by it at the peak of their Long Term Economic Value. This requires something that no one in the world, short of God, possesses: (a) perfect foresight, (b) ability to fully control disposal markets and (c) incur no cost of disposal. Clearly, this assumption is simply a sign of deeply rooted inability of Nama staff and directors to think straight through their own effective costs and valuations
  7. NBP makes no provision – at all – for the cost of ECB-linked financing of the bonds, which will have to incur the cost of at least 1% in monetization. This will add up, for the life time of Nama (again, using Nama own depreciation schedule mentioned above) to the total subsidy to the banks from taxpayers to the tune of €2.4 billion.
  8. “The fees that NAMA will pay over its expected ten-year life amount to about €1.6 billion. A breakdown of the 2011 budget shows that a significant proportion of these fees will be incurred as payment to the participating institutions to administer loan assets on NAMA’s behalf. It is likely that there will also be significant fees incurred arising from enforcement.” Yet, in the actual estimates on page 25, Nama plan allows for just €2.5bn, in the worst case scenario, in total for the costs of its own operations, banks’ fees on administration of loans, for all legal fees to be incurred by it and all other expenses. This rises to €4.8bn in the best-case scenario. Nama already employs almost 90 officers, not counting various board members and an army of consultants. These alone will be swallowing around €250mln in salaries and perks. Legal costs can be safely put to equal about 2.5% of the loans incurred – a double of the relatively standard closing & operations legal costs, taking up over €2bn. Toss in the fees of €1.6bn provisioned and you have sums that do not add up.
  9. There are repeated claims that Nama will pursue debtors to the full extent of the loans. This warrants understanding of Table 4 estimates as the full recovery scenarios, implying that in Scenario A, combined recovery rate on all loans is 55.2%, Scenario B 60.7% and Scenario C 49.6% relative to the €81bn face value of the loans. But these are massively exaggerated numbers. Practice in the UK in the 1990s and in Ireland in the 1980s suggests that real gross recovery cannot be greater than 40% of the face value of the loans. And this is before we take into account the present value discounts and rolled up interest (prior to Nama acquisition of the loans and after).
  10. Page 20 of the NBP states: “Derivative transactions with a nominal value of €14bn (principally interest rate swaps) will also be transferred. A substantial number of these derivatives are nonperforming and NAMA will pay nil consideration to acquire them.” If these derivatives are nil value, then why are they a problem on the balance sheet of the banks? Answer: because they are nil value today, but have a non-zero probability of exploding in the future. This is why they are being transferred to Nama. What does this mean? If you are on a wrong side of an interest rate swap, your potential liability is unlimited (as in infinite). This is also why in the current market place, the cost of unwinding these swaps today will be around 10-20% of their face value or €1.4-2.8bn. This, of course, is an approximation, but Nama is now stuck, courtesy of taking on these derivatives, with a liability between €1.4-2.8bn at the very least and an unlimited loss at the worst. A picture of iceberg peacefully floating in the path of Titanic comes to mind. Yet, no provision for unwinding these derivatives was made in the NBP.
  11. NBP does not address any of the concern about non-transparent governance of the core Credit, Audit and Risk Committees of Nama, which still contain no provisions for external members presence on them. Neither does it address the issues of full and automatic disclosure of all properties held, development applications lodged and funding disbursed, as should be required of such a massive public undertaking.

Now to the numbers. I took the very assumptions contained in the Nama New Business Plan and added one more scenario, with following additional assumptions to cover the holes in Nama own statements:

Loans taken on board:
(Typo corrected, hat tip to Anonymous). Note: the above estimated recovery is the basis for price appreciation in the following table.

Nama NBP scenarios reproduction and my estimates:

Assumptions, in addition to those in Nama NBP are: property uplift over the lifetime of Nama is 15% (this is 50% higher than Nama optimistic scenario of 10% uplift, thus allowing for a greater margin of error in estimates); 1% ECB discount window financing on bonds plus 25bps charge; €5bn in additional investment by Nama drawn in 2015, reducing overall cost of financing to 5 years. Net present value excludes in my scenario excludes rolled up interest on developers’ loans and discounting to present value (Nama claims that it is discounting its NPV at 5%).

All of this means that my estimated loss for Nama of €14.6bn is extremely conservative, allowing for any errors in other figures and assumptions.

Adjusting for NPV at 5% discount, as in Nama plan produces the following summary estimate:

As a reader of this blog remarked on the topic of Nama new BP, “The effortless miscalculations, the assured non-sequiturs, the lofty indifference to facts: all reveal [the new Plan] as a master copy of what Princeton philosopher Harry Frankfurt defined succinctly in his 1986 paper, On Bullshit.” I couldn’t have said it better. Thanks, Patrick.


Anonymous said...

Should the total on your first table be 28.48 billion rather than 26.950 billion and the total percentage 35.2% ?

Brian Flanagan said...

Constantin, you may be interested in my review of Nama’s latest busines plan at

It covers general issues about the plan and comments specifically on Nama’s commerciality, approach to debtors, accounting policy and creeping losses. I conclude that Nama’s strategy is to disclose as little as possible about future prospects and intentions but endless detail after the horse has bolted. This is no way to run an organisation that could end up costing taxpayers tens of billions and resembles the “in denial” strategies of the very same banks that it is meant to be rescuing.

Your projections add fuel to a timebomb that will burn behind closed doors and cost us billions.

Anonymous said...

There's no doubt that there is institutionalised self-deception clearly on display in this report.

I look forward (ghoulishly) to the next installment - the cover up of this self-deception that will be necessitated by your analysis and no doubt that of others.

The 'cover up of the cover up'. - Although we've had quite a fair number of iterations at this stage, already.

Anonymous said...

Assuming a property tax is introduced this year and a 1000 euros is levied on a 300k house with a 30 year mortgage,then without compounding the figures , a very simple estimate would mean an additional 30k added to the mortgage.
The banks would calculate what mortgage they would give in conjunction with an escrow account for property tax of 1000 euros per year.

This property would then be devalued by 10% .
(oversimplifying calculations).

So if the overall market drops by 10% then Nama calculations must then assume a similar drop.

If water rates are also introduced then a similar reduction in property prices will occur with follow on consequences for NAMA valuations.

Anonymous said...

Why have so few bank staff been fired?.

Anonymous said...

Whatever happened to due diligence? NAMA seems to believe that carrying out due diligence is accepting what the banks tell them. And we all know how honest the banks are, don't we?

laughingbear said...

One of these days, people who read this blog here will realize that it is not an economic report anymore since a long time.

It is a crime scene report.

Unknown said...

Great post.....

Property prices will not recover in Ireland anytime soon.....even on a 10 year window...latest forecasts (by myself and a colleague) indicate that another 20% could come off over the next 3 years quite easily given low occupier demand and a glut of excess stock (in commercial) and that residential could drop by over 30% more if the forecasted emigration by ESRI and subsequent strategic default rise from a small percentage of those leaving comes about. Saying that capital values or rents will increase from present levels at all over the next 10 years is a stretch....on that count alone, NAMA is in fantasy land.

tax attorney said...

If they do is their performance then linked to the 35bn euro. If so, as you point out, they will be rewarded for a costly and abject failure.