Friday 28 October 2016

How markets value loan portfolios is key to understanding why Nama did achieve the best possible price

Brian McEnery

Published 15/09/2016 | 02:30

A protester takes part in a rally against NAMA in Dublin city centre in 2009 Photo: David Conachy
A protester takes part in a rally against NAMA in Dublin city centre in 2009 Photo: David Conachy

I have been a member of the Nama board since December 2009. My professional background, with over two decades of experience in corporate finance transactions, prompted me to take a particularly strong interest in Nama's sale of Project Eagle.

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Like the other members of the board, my role was to ensure that Nama was getting the best deal by using my expertise to scrutinise the transaction in detail and independently challenge the assumptions that ultimately informed the decision to sell.

Like the other members of the board, I have no doubt that the sale of the portfolio achieved the best achievable price. I have no doubt the sale was a better outcome than retaining the portfolio.

The principal difference between the C&AG and the Nama board is the difference between a notional accounting value, based on assumptions, and the real-world market value.

The fundamental issue is the discount rate that a loan purchaser will apply to a portfolio like Project Eagle.

Loan purchasers have to consider two risks. The time value of money risk is based on the fact that a euro today is worth more than a euro in five years. Buyers have to work out how to value in today's terms money that they will receive in the future.

They also have to contend with the business risk around future cash flows. The greater the risk or uncertainty about future cash flows, the less those cash flows are worth in today's terms.

In my day job, I have acted as an advisor to major loan purchasers, I know first-hand that a 15pc discount rate is typically used to price loans similar to Project Eagle. Buyers have to take account of the inherent uncertainty associated with poor quality assets in poor locations.

My strong professional view is that the C&AG report fails to take account of this. Its main findings appear to be based on a fundamental misunderstanding of how markets value loan portfolios.

The report suggests that Nama should apply the same discount rate to value all loans, irrespective of the location or quality of the underlying properties.

The C&AG is, in effect, saying that Nama should value land in rural Northern Ireland and regional Britain in the same way as Nama values prime shopping centres or office blocks in prime locations in Dublin and London. But the risks are completely different.

This is simply not credible. I know of no accountant who is prepared to ignore all known market and commercial logic in this way.

In addition, I am Chairman of another State agency, Hiqa, which is charged with auditing the Irish health sector. Viewed through that additional perspective, I am surprised and extremely disappointed by the quality and methodology of this review of Project Eagle.

Despite repeated requests, the C&AG refused to meet with me or other members of the Nama board.

The C&AG also chose not to engage with the international loan sale broker that oversaw this sale or indeed with any other Irish or international loan seller or market expert.

The C&AG is questioning the board's rationale for selling Project Eagle but he refused to discuss any aspect of the sale with the board.

Wearing my Hiqa and professional accountant's hat, I find this inexplicable.

I find it equally inexplicable that the C&AG did not engage with any market experts.

I believe this goes a long way towards explaining the fundamental weaknesses in the report, and its complete lack of understanding of how loan sale markets work.

In Hiqa we are tasked with reviewing often very complex medial issues in hospitals and elsewhere in the health system.

Our policy in all such cases is to engage appropriate external medical expertise and to engage directly with the hospitals and other institutions on all areas of concern. That is only right and fair and is the only way to get to the truth of disputed matters.

The end result is that the C&AG concludes that the sale of Project Eagle may have resulted in a "probable loss" for Irish taxpayers. Yet the report contains no evidence or market rationale to support this conclusion. It provides no evidence that another bidder or higher price were available in market, then or now.

Ultimately, no desktop valuation exercise can reflect the reality or the complexity of the painstaking work of resolving a troubled portfolio on an asset by asset basis. From my experience, surprises are more often unpleasant than pleasant, and the costs of passing up a firm offer that takes away the risks in a protracted workout can often be seriously underestimated.

The reality is that of all the assets that Nama acquired throughout the world, we identified the Northern Ireland assets as among the most likely to be difficult to exit as they are so unattractive to potential buyers.

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Therefore, when we received an approach at an attractive price for the portfolio from a major global investment company, we were obliged to take it seriously.

Our view at the time was that we should determine what the portfolio was worth and offer it to the wider market at that price.

We only agreed to sell it because there was an offer that reflected the market value - and one in excess of the minimum price (stg£1.3bn) that we were prepared to accept.

Nama's valuation was sound and is based on the conventional market-standard valuation methodology. In other words, it was a true market valuation.

Nama was right to sell this portfolio at £1.322bn. I have said so ever since it was done. I will continue to say it.

Brian McEnery is a partner on the Corporate Finance and Recovery Team at BDO and is the incoming International President of the Association of Chartered Certified Accounts (ACCA).

Irish Independent

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