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.

Economics 15/10/2009: NAMA Business Plan Falls Flat

Updated 09:01

Note: Karl Whelan's post on Nama Business Plan is available here.


So let us start with Nama Business Plan published tonight: the main claim is that Nama is expected to generate a net present value return of €4.8bn by 2020.

I beg to differ. Here is why in two steps:

Step 1:

“This €77 billion is made up of approximately €49 billion land and development loans (€28 billion and €21 billion respectively) and approximately €28 billion in associated loans.” Of the latter, €14.2bn is in derivative instruments.

Now, land values have fallen by some 70% plus, with some land now valued at a 90% discount. What the recovery rate on these loans? Assume 30-35%, to the total loss of €18-20bn.

Development loans currently carry default and roll-up rates of well in excess of 40%. Suppose Nama buys an average portfolio of these and that the default rate rises to 1/3 of all stressed development loans. Expected loss here is therefore around €7-9bn.

Associated loans include second recourse and non-recourse loans and cross-collateralized loans. They have lower seniority on underlying assets. And this includes (50%) derivatives – instruments that actually cannot be priced directly without requisite information that has not been supplied by DofF. So suppose the default rate here is the average of the above two rates, or ca 50%, to the total loss on this part of the book of €14bn.

Add this up: total expected loss on Nama loans book value is €39-43bn before we factor in roll ups of interest. Day one of operation, Nama will be holding the portfolio of loans with expected value of €77-€41=€36bn against the liability of €54bn, which implies it will be in the red to the tune of €18bn.

Make another clarifying assumption. Assume that for the last segment of the book – the associated loans – derivative instruments are similar to the average market derivative contracts as stipulated in Table 3 of the BP. This pushes losses on this part of the book up by additional 25-35% of the derivatives segment value. The total loss Nama will incur on day one of its operations will then be a staggering €21.7-23.1bn.


“The estimated aggregate average loan to value (LTV) rate for these loans is approximately 77% i.e. the value of the real estate collateral at the time the loans were originated was €88 billion. The loans were made over a number of years and not all were made at the peak of the market.”

Suppose this is true, although I have no confidence that this number is real. Suppose average vintage of the loans is 2005. Land is currently at below 1999 levels in pricing. Development projects are around 2001-2002 pricing and completed property is around 2004. Assuming we are at the bottom, average LTV on these loans today is around:
€28bn/0.77*0.3+€21bn/0.77*0.5+€28bn/0.77*0.85=42.7/0.77=€55bn
This is LTV ratio on Nama purchase as of today of 98.2%. Not 77%, but 98.2%.

If average vintage of Nama loans shifts to 2006 (a more likely scenario, as Nama will not be buying an ‘average bank loan, but a non-performing loans portfolio with so-called ‘performing’ loans to be mixed in coming from stressed loans side of the balance sheet), then the actual today’s LTV shifts to:
€28bn/0.77*0.2+€21bn/0.77*0.42+€28bn/0.77*0.81=37.1/0.77=€48.2bn
This is LTV ratio on Nama purchase as of today of 112%. Not 77%, but 112%.

Incidentally, Nama ‘Business Plan’ contains no sensitivity analysis of this sort or of any sorts – neither for expected inflation, nor for spreads on bonds, nor for cost of administration, or for any other assumptions.

Step 2: redoing Nama balancesheet:

Table 5 clearly states that Nama expects life-time default rates for all loans and derivative instruments transferred to be 19.35% of the book value of loans at origination! Business Plan admits (page 9) that in the last year alone the banks took a charge of €7.3bn on the book – just under 10%. Thus, DofF expects 2009-2011 default rate to be only 10% more. This is for a book that overall contains 40% non-performing loans already! It is simply a case of amazing degree of optimism.

Let us do the math for alternative scenario. Suppose the default rate overall will be 33%, in which case without challenging any other DofF assumptions in Table 5, the net gain of €4.8bn turns into a loss in present value terms of €10.2bn. Just like that!

Now, let us challenge the assumption on Nama yields. DoF data is shown in the Table below. The second table changes yield assumptions and retains my default assumption above:
Now, per table 2 above, combined assumptions of more realistic default rate and more realistic yields (consistent with current yield, adjusting for default rate expected through 2011), and recognizing that derivative instruments yields are unlikely to be achieved at all, bottom line Nama is now expected to yield an €8.6bn loss in present value terms.

Shall we move on? Assuming slightly steeper curve on the cost of bonds financing, table below shows that expected Nama losses can reach €11.5bn in present value terms (Table 3).

One last thing left to do. Recall that per Nama own Business Plan admission, 40% of loans are currently producing a yield. This implies that 60% are non-performing. If yield curve were to rise over time as Nama assumes, these loans are not going to start repayments at any time in the future. So suppose the default rate assumption goes to 45%. Table below shows the end game:
A loss of €19.1bn in real terms!

And this is before we compute the opportunity costs of this money.

Conclusion: DoF estimates for Nama make absolutely no sense. The best scenario I get is a loss of €10.2bn. The worst one yield losses of €19.1bn.

Note: the above do not include the cost of managing the Nama loans by the banks. These ordinarily range around 0.5% of the total loan value per annum. Suppose the banks will be able to pass these costs on their paying customers (you and me). The net effect will be an annual added cost to businesses and paying customers of €270mln.


Note: All Nama flows are targeted for 2013, which in effect saddles future Government with the entire obligation under Nama. A rescue package, then, for banks, developers (with a repayment holiday until 2013) and... FF...