Economics 12/08/2009: An afront to our democracy

So Mr Carroll's case has been now refused the examinership by the Supreme Court. Welcome news - at least there is a remnant of sanity left in this country and it is the Judiciary. But the telling reaction to the highest court in the land verdict came from the Department of Finance. In a blatant disregard of the Supreme Court powers, a mere civil servant-run lowly department (that is but a fraction of one of the three pillars of the state) has in effect told the Supreme Court (the highest body of another pillar of this state) to pack off.

In a response penned, most likely well in advance of the Supreme Court decision, the DofF stated that (quoting the Irish Times report - here): "The Department of Finance rejected any suggestion that the Government’s plans for Nama were affected by the court ruling. “It makes no difference – Nama will proceed as planned,” said a spokesman for the Minister for Finance. “We’ve always made clear that Nama will operate in line with EU Commission guidelines, which set out the use of the long-term economic value measurement.”

So Supreme Court telling the nation that, in agreement with the Commercial Court, its assessment of Mr Carroll's assets is that these assets are not worth even 15-20% of loans advanced to the company, 'makes no difference' to the NAMA. We will still pay Euro60bn for the same assets.

Now, do the math, Mr Carroll owes the banks over Euro2bn. He has trouble paying on Euro136mln. His companies are generating around Euro27-30mln per annum - and that according to his company records, that Commercial Court, in the context of his the survival plan, identified as “lacking reality” and bordering, if not trespassing, on the “fanciful”. So here we are, the valuations of Mr Carroll's loans quality is in (this time confirmed by the highest authority in the land):

• According to the courts, Mr Carroll's loans are not worth 21.3% of their face value (in other words, a discount of 78.7% on their value will not bring the price down to the current market valuation) (Euro265mln out of Euro1.26bn = 21.3% value of assets);
• The balance sheet below illustrates clearly that even assuming 7% annual cash flow growth, plus 5% asset growth per annum for 2008-2020, a very benign interest rate environment (note we assume max cycle interest rate of 10% on Mr Carroll's borrowings in Scenario 2) and disposal of all his properties in the end of the term, the net market value of Mr Carroll's companies in 2020 will be a negative Euro5.7-7.5bn.

Now, it is the only attempt of estimate Mr Carroll's loans net worth at this stage known to me, so do take your time to read through it. The really, really scary part, that if NAMA were to buy his loans at a 50% discount, NAMA will be making a cumulative loss of between Euro2.41-2.56bn by 2020. If the discount were to 70%, NAMA resulting losses will be Euro1.19-1.34bn. At a 70% discount, folks!

And DofF still thinks we shall all p***s off: NAMA is here and there is nothing we can do about it!

This is bad news for:

• the responsible and accountable Government and governance, for our DofF in effect is stating the position of the State as 'NAMA - no matter what'; and
• the Irish democracy, for DofF has expressed absolute and public disdain for the highest court of this land.

And thus we have (courtesy of http://farm3.static.flickr.com/2452/3813875003_7e58e1ddc3_o.jpg):

Economics 04/08/2009: NAMA, Liam Carroll & Short Termist Bonds

I should make it a habit to direct every NAMA post reader to my proposal for NAMA 3.0 here.


Yeps, Supreme Court came in on the side of the Government, throwing a lifeline to NAMA and forcing taxpayers into deeper losses. My earlier note stand now (see here) with all the gory implications for losses on Mr Carroll's loans now being back in the NAMA court.

But two birdies have chirped to me that there is more brewing up in the land of NAMA-fantasy. Apparently, the rumor has it, the Government plan is to issue short term bonds to cover NAMA liabilities. Given that NAMA will start issuing bonds in 2010 for this undertaking, the short term nature rumored is for a 2011-2012 bonds.

This, if true, makes no sense for several important reasons. Here are some:

(1) Issuing short-term debt with maturity before 2013 is equivalent to a financial suicide. The reason is simple - there is no credible (or for that matter even an incredible one) commitment from the ECB that

• such issuance can be rolled over at the same or lower interest rates to cover maturing bonds; and
• the EU will allow these bonds to remain off the balance sheet of the Government upon the roll over.
  

(2) Issuing short term bonds will be a fiscal suicide, for their maturity, and roll-over date, will fall dead on in the years of heavy Exchequer borrowing and maturity of other - 2008-2009 issued bonds. Given that the market demand for fixed income paper worldwide will be thinner then (due to increased appetite for equities-linked risk), a flood of rolled over bonds can risk derailing the borrowing programmes for Irish sovereign debt. Now, if you are a forward-looking investor, expect Irish yields to run away from the benchmarks once again, then.

(3) Short term maturity does not take into account the main risk to NAMA valuations, namely that by 2011 or for that matter 2013, the assets taken over by NAMA will be priced at any significant upside relative to what NAMA will pay for them, implying that, under short-term issuance, this Government will face the need to

• engage in a massive refinancing operations
  
• at the time when its balance sheet liabilities will be almost at their peak (see Department of Finance projections);
• pay higher expected cost of borrowing than today; and
• potentially, load the NAMA liabilities onto Government own balancesheet, while
• facing market prices and demand for real assets that is well below the valuations applied by NAMA.
  

If you look at the latter point. DofF uses 7 year U-shape cycle as its basic assumption. Peter Bacon last week stated that the cycle is expected to be 5-10 years. My estimations, based on NBER research (here), show that the average duration of the U-shaped cycle in historical data for OECD economies for 1970-2003 episodes of house prices collapse co-measurable with the one we are experiencing today is between 18 and 23 years. This range is dependent on how you time the cycle, but it refers to a nominal price cycle, unadjusted for Forex devaluations that accompanied such cycles in other countries and inflation. Japan (in down cycle since 1989-1990), Germany (since 1972-73), Italy (since 1981) and Sweden (since 1979) have not recovered to date.

Considering rolled up interest charges on impaired loans, banks' restructuring of interest payment schedules on so-called 'performing' stressed loans that in any other country would be classified as having defaulted, NAMA will be purchasing assets from the banks at an extremely shallow effective discount.

For example, a discount of 30% applied to a loan with 1.5 years (since July 2008 through December 2009) rolled up interest at 10%, and a built in re-financing cost of 1% will be equivalent to an effective discount of just 18.1% relative to the original principal of the loan itself. If, in the mean time, the underlying asset value itself has depreciated by, say 40%, then
NAMA will be buying a Euro 60 asset for Euro81.86. Now, in order for NAMA to recoup the original cost of purchase (not counting the cost of financing the purchase and managing the asset etc), the asset value needs to appreciate by a compound 36.4% within the span of the bond
finance. Thus between now and 2011 when the alleged bonds should mature, the annualized rate of appreciation required on the assets for NAMA just to recoup the original loan amount would have to be 16.8% per annum!

If anyone in the Department of Finance thinks this is a sane bet on a market turn-around, God help us.

Short-term financing of long-term obligations, as we should have learned in the current crisis, is equivalent to giving steroids to an unfit athlete and sending him out to run a marathon.

Though to repeat once again - this is just a speculation at this moment in time although two independent sources have tipped me on this one.

Economics 04/08/2009: NAMA & Liam Carroll - the saga continues

Oh, you have to love the drama and tension surrounding NAMA.

The latest thing to hit the rumour mill as we expect this afternoon our Suprem Court's rulling on Liam Carroll's appeal of the High Court decision to deny his companies examinership protection is that, allegedly, BofI and AIB are considering a buy-out of ACC Bank. Now, this is a rumor at this moment in time, and I have to stress this once again - it is a rumor - but given that:

• ACC can be, probably had for ca Euro130-140mln;
• ACC's books are so toxic (30% plus impairement across the property portfolio, 39% impairment across commercial property alone that its parent Rabo Bank would simply love to get rid of it for any sort of money;
• ACC's removal from the challenge to Liam Carroll and other developers would allow the big 3 of Ireland to continue on their chosen paths to the taxpayer-financed feeding trough of NAMA;
• ACC's buyout wouyld please the masters in the Government; and
• NAMA would more than compensate the buyer for the extra cost (say ACC is bought at a 50% discount to the book, then NAMA buys roughly 75% of former ACC 'assets' at 30% discount, implying a nifty return of Euro 5 per original expenditure of Euro 100, and you get to keep 25% of the ex-ACC assets too...

It would be no brainer for the AIB or BofI to load up on more toxic stuff to swap it for taxpayers cash.

From our, taxpayers' perspective, this is equivalent to throwing children off the sleigh in hope of holding back the wolves. The only hope we have at this stage is that a swift turning down of Carroll's appeal by the Supreme Court throws these schemes wide open.

Economics 02/08/2009: Liam Carroll's case

For those of you who missed, here is my article from Saturday edition of Irish Daily Mail

An Irish person recently remarked to me in the context of NAMA that “If any other electorate in Europe, nay, the world, faced this scandal, their citizens would be on the streets.” They would. We have been led to believe that NAMA is a necessary solution for the banks having to write down the odious development debt acquisition of which over the years past was cheered on by the Government through tax breaks and the stamp duty widnfalls. In reality, NAMA is Ireland’s own financial Chernobyl – a self-inflicted devastation of taxpayers’ finances perpetuated for the sake of doing something about the crisis.

By denying the examinership to Liam Carroll’s six companies, the Irish High Court has put itself out as the sole branch of State that stands between the innocent taxpayers and this redlining reactor.

First, let me clearly state that I have no objection to proper developers who build what is truly demanded by the market. They too will be the victims of the NAMA debacle.

Pursued by a creditor, the ACC Bank, Liam Carroll has been languishing in the High Court for a better part of this week, awaiting a decision on whether he will be granted an examinership for six of his companies. An alternative for Mr Carroll was to face an appointment of a receiver – a sure bet that his companies will be shut down. This alternative has now come to its logical fruition – denying Mr Carroll the examinership, the court has forced him to face the music. Receivership is now all but inevitable.

The motivation behind this battle was NAMA. Mr Carroll would like his companies debt to be assumed by the state, allowing for them to continue as an ongoing concern. Mr Carroll even hoped to convince the folks running the bad bank to give him few quid to finish some of his
failed projects. A pipe dream for a businesses that, by his Senior Counsel’s admission generates just €22-23 million in annual revenue against the debts of roughly €1.4 billion. Now, do the maths – a company that was supposed to be bought by us, the taxpayers into NAMA will not be able to cover even 15% of its annual interest bill.

Mr Carroll’s case has serious implications for us all – the Irish taxpayers – as the underwriters of NAMA.

Mr Carroll’s Senior Counsel Michael Cush told the court that the six companies in question, had historically been very successful businesses. But he said more recently they had suffered credit problems, the downturn in the property market, and some “problems with investments”. Per Mr Cush, the companies are clearly insolvent and if liquidated, their unpaid debts will reach €1 billion. This indicates that there is no hope for a recovery of the business and that examinership was rightly denied to them.

But it also shows that there is not a snowballs chance in hell that NAMA will be able to recover any positive value from Mr Carroll’s companies, unless it forces his banks to write down at least €1 billion of some €1.4 billion in loans amassed. That NAMA will do nothing of the sorts, preferring to continue the circus of pretending that these businesses worth something in excess of their debts is clearly something that the courts disagree with.

The NAMA legislation published this Thursday states that the taxpayers will be paying for the current values of the banks loans, while the developers will be pursued for the original loans amounts. Mr Carroll’s case illustrates that currently insolvent businesses continue to accumulate liabilities (rolled up interest and fresh demands for continuity funding) that simply cannot be repaid, ever. These roll up debts are odious, for they are extended to the clearly insolvent companies in the hope that NAMA will simply cover them at a higher rate than the markets would were the banks to go out into the open trying to liquidate these development loans.
Which means that NAMA will be using our money to pay for the rolled up interest on top of already grossly overvalued loans of insolvent enterprises.

Do a simple math, with a 50% fall in the value of underlying assets, 11% interest charge on the non-performing loans and a 25% NAMA discount, the taxpayers will be overpaying for the assets they by to the tune of 70% plus. Put simply, imagine walking into a shop and seeing a TV set on sale. The sign reads: ‘Sale! Original price €100. Sale price €170”. That does look like Minister Lenihan’s bargain for the taxpayers.

Liam Carroll’s case also shows that over the last year, soft budget constraints for insolvent businesses, like Liam Carroll’s empire, were accepted by the banks solely on the anticipation of a state bailout. If not, these banks actively engaged in destroying their shareholders’ wealth by undertaking knowingly reckless decisions. Take your pick.

I have absolutely nothing against Mr Carroll's enterprises, other than the simple argument that if they are insolvent today, the should be shut down today and they should not be allowed to accumulate additional liabilities at our, taxpayers' expense.

The examinership case for Mr Carroll’s companies was not warranted from day one of his application to the court. Minimizing losses to the economy and the taxpayers resulting from his companies farcical ‘operations’ required an appointment of a receiver and no restructuring period under the examinership would have done any good to their solvency. If only the same wisdom of the courts can be applied to NAMA itself.