There will be no gain unless NAMA starts inflicting pain
This year the toxic loans agency has to accept that some debts belonging to bankrupt developers must be written off
AS the year ended, NAMA, the toxic loans agency, was suffering something of an identity crisis. The agency headed by Brendan McDonagh and Frank Daly knows what it isn't.
At various times during 2010 McDonagh and Daly told us that NAMA isn't a "liquidation vehicle'', isn't a "bad bank'' and most certainly isn't a "bailout for developers or the banks''.
Officially it is an asset management company but this somewhat hazy and neutral description sits uncomfortably with the public, the political establishment and with Irish business.
What all three groups want to know is this: is NAMA ultimately a good thing? Is it going to produce a profit for the taxpayer? Is it actually helping to solve the bank's liquidity and solvency problems or making them more acute?
For others NAMA is a vehicle for vengeance, the body that should punish reckless and leveraged developers in ways the banks have failed to do since the onset of the credit crisis. This group accept that NAMA has stepped in to the shoes of the banks; they just wish the agency was wearing steel-capped boots rather than brogues.
So how has NAMA's first year gone? On the plus side, of course, the agency is up and running, it has most of the staff it needs in place, it has secured funding, it has seen off a legal challenge in the High Court from developer Paddy McKillen and crucially it has taken over the ownership of €71bn of loans -- removing their toxic effect from bank balance sheets. These are considerable achievements. The overwhelming legal defeat administered to McKillen was a major victory for the agency, even though virtually nobody in Irish business ever thought McKillen was going to win his case (the Supreme Court were considering an appeal at the time of writing).
To take over €71bn of loans from the banks while only incurring one legal challenge was one of the satisfactory outcomes to the year for NAMA. Two years ago Sean Dunne was among a group of developers reported to be considering challenging NAMA's powers. In the end the developers were utterly compliant in the face of NAMA and never raised any legal objection, McKillen aside.
The banks have also benefitted from the liquidity given to them by NAMA. They have exchanged €71bn of highly dubious and illiquid property loans for Irish government NAMA bonds which have been eligible as collateral at the ECB. This has in some respects kept the banks alive, although as the year ended the ECB were no longer prepared to keep this drip-feeding operation going forever.
The liquidity benefits of NAMA are unarguable, but the other part of NAMA -- the valuations of the assets -- is where a review of its role becomes more contentious.
NAMA has been absolutely savage in the price it has paid for bank loans compared to the book value of these assets. The average haircut or discount on the loans of 58pc is almost 30pc above the discount the banks were telling the market they expected to be hit with earlier this year.
This has two dimensions. Firstly, it means that NAMA is not giving the banks too much of an uplift compared to the real mark-to-market price of these assets; but, secondly, it does mean NAMA is punching huge holes in the balance sheets of the banks, forcing the State to plug the holes far earlier than it would ever have wanted. Incidentally it also leads to the effective nationalisation of AIB.
Depending on your view, this is a good or bad thing. For bank executives it is a very bad thing because it means that performing and non-performing loans are being purchased at the worst possible stage of the economic cycle, triggering huge balance sheet losses for the banks and propelling them towards state control.
All this is true. But there is another equally convincing argument. If NAMA did not exist the banks would simply be allowed to drift on, holding on to €71bn (and most likely more) of impaired loans which they would offset with endless capital injections for years -- maybe even a decade.
They would soon resemble the famous Japanese "zombie" banks of the 1990s, barely adequately capitalised and unable to lend into the real economy due to extreme risk aversion. Of course credit availability in Ireland is squeezed even with NAMA, but it arguably would be even worse without some kind of an asset management agency.
There is also a more philosophical issue in relation to NAMA and it is about extracting value. Would the existing banks be more likely to extract value from the existing set of land and development assets than an independent agency?
Based on their track record and close personal links to certain developers, one would have to be sceptical of the Irish banks' ability to make the right decisions with regard to these loans. Of course, whether NAMA is the right body to make those decisions either only time will tell. But the original reason for NAMA -- as outlined by its original designer Peter Bacon -- was to break the "link'' between the banks and their developer customers.
While the banks can no longer hoard the property assets in question, the hoarding by NAMA of these assets is equally problematic and this is where it is difficult to see how NAMA can work effectively.
A large portion of the NAMA portfolio is assets bought in the bubble years of the boom, when values of commercial and speculative property peaked.
These prices will not be scaled again for years, potentially for a decade or more. So every single one of these parcels of land is under water and will remain so. The companies behind these assets are hopelessly insolvent and it is hard to see what future they have.
They have assets which are in negative equity but the double whammy in many cases is there is no income coming in either, making resurrection all but hopeless.
So what is NAMA going to do? There seems little point in keeping these companies going because the debts they hold are essentially unrecoverable.
Instead the debts either get written off (not NAMA policy) or NAMA works with the developer to try and extract some value, and then writes off the rest. But even that is problematic. Any official write-off programme for developer clients of NAMA is highly contentious, certainly as long as Ireland adopts total opposition to debt forgiveness for householders.
No Irish government, with any hope of re-election, would be able to stand over a policy where debts get written off for developers but have to be repaid -- in all circumstances -- by householders.
Even so, NAMA has huge powers to squeeze developers financially. For example, most major loans are so-called 'on demand' facilities, which means that once a developer either breaches their loan agreements (covenants) or misses a few repayments, the entire loan can be called in or NAMA can enforce security by seeking a judgment.
Personal guarantees can be called in at this point, which would leave most developers bankrupt and, in some cases, losing their family home.
So far NAMA has not done this and the movement of assets in to the names of wives has also stymied the agency.
Enforcement action has been relatively mild so far, with only Bernard McNamara and developers linked to Paddy Shovelin facing the wrath of NAMA in the courts.
In fact some developers, such as Johnny Ronan and Richard Barrett of Real Estate Opportunities (REO), have actually benefitted from NAMA by getting fresh working capital and having loan maturities pushed back.
It is early days of course. Several of the top 30 developers have been told to rewrite their business plans, upping the amount of assets they are going to sell and reducing the annual salaries they expect to pick up.
As first reported in the Irish Independent, many of them have also been told to halt their sponsorship of sporting events -- and bequests to charities are also to be cut out.
But is this enough? Not likely. The transfer of assets into the names of spouses and the continued use of helicopters by some developers sticks in the craw of taxpayers and the political classes. In that context NAMA is only likely to be seen as a success if it administers some pain in 2011.
As one observer of the agency said in private recently: "They need a Sean Quinn moment."
This is a reference to the decision early in 2010 by Financial Regulator Matthew Elderfield to take on Quinn Insurance, owned by Sean Quinn and family, in a highly public way in the courts.
With gigantic legal fees agreed and in place, NAMA certainly has the resources to dole out the pain in the commercial court. What 2011 will show is whether NAMA's leadership has the required steel.