The National Asset Management Agency, more commonly known as N.A.M.A., is a new body which will operate as an independent commercial agency under the aegis of the National Treasury Management Agency. Its task will be to deal with the problems caused by excessive lending by the banks during the property boom. These are massive and complex problems, not easily understood, often understated, and frequently misrepresented. ITIC spoke with Tony Foley, Head of Economic Finance and Entrepreneurship at Dublin City University (DCU), to attempt to explain N.A.M.A. in non-technical language. Here’s the result…
BANKS AND LENDING
Role of banks
Banks obtain money from deposits and from borrowing on the money market. They lend this money at higher interest rates to borrowers. The difference or spread between the interest rates is the source of profits and operating expenses. This provides funds to cover bad debts, operate the banks and give a return to shareholders. Banks normally expect that only a very small share of loans will not be repaid. The loan may be fully lost or there may be an asset, e.g. land, which is used as security and which can be sold by the bank to recover all or part of the loan. Banks also hold reserves which can be used if operating profits are too low to cover the bad debts.
The problem which N.A.M.A. is intended to fix is that the Irish banks lent very large amounts of money to individuals, mainly for property related projects, which will not now be repaid according to the original loan agreement, if ever.
An example will illustrate. Suppose a property developer borrows €1 billion to buy various tracts of land on which to build projects such as apartment blocks, housing estates, office blocks, shopping centres or hotels. When completed and sold the projects would have generated enough money to repay the loan and make profits. Let us now suppose that the property market collapses, and the price of land and buildings decline so greatly that there is no point in building on the land. The land and any buildings may now be worth, say, €300 million on the market, but the borrower owes €1 billion and is unable to repay the loan. The banks could seize the land, but its current sale price would not cover the loan.
Some borrowers may have given personal guarantees to repay the loan and, in our illustration, the borrower may have a spare €700 million to add to the land price and repay in full. If so, all would be well. This happy (except for the borrower) situation is going to be very rare indeed. The borrower’s resources just simply will not cover the loans.
Essentially, it means that the banks will not get back large sums which they loaned. This is a serious problem as the monies loaned belongs to depositors or was borrowed on the money markets, and their owners will want it back.
Let the banks sort the problem?
Unfortunately the banks cannot sort the problem. It is too big. There may be about €70 billion to €80 billion in bad loans. Say the banks could recover €30 billion of this, which is optimistic, they would have a bad debt loss of up to €50 billion. They do not have the corporate resources to cover this amount. They would not be able to pay back all the deposits and money market loans made to them. They would be out of business. If all depositors and lenders to the banks looked for their money the Government would have to fill the gap because of the bank guarantee scheme. Even if the bad loans could be worked through over a period of years by the banks they would be limited in making credit available while they improved their balance sheets.
N.A.M.A. and Options
The Government proposes to buy the bad loans and some good ones from the banks. The Government talks of a total of €80 billion to €90 billion of loans. This would relieve the banks of the worry of the bad loans, remove them from their balance sheets and enable banks to make new loans and start providing credit again. N.A.M.A. will manage these loans and seek maximum payment of them. If necessary it will seize physical assets and activate any personal guarantees to ensure recovery of the loans. The big issue is what price will be paid by N.A.M.A. (or we taxpayers) to the banks for the loans.
The closer the price is to the full value of the loans the better for the banks. The bad debt, or write down provision, would be low. The attractiveness of the banks would increase because the bad debts were gone and shareholder value would increase. Unfortunately the gap between the current value of the loans and the amount actually recovered eventually by NAMA would be large, and borne by the taxpayer.
If N.A.M.A. pays a low price for the loans e.g. €30 billion, reflecting their possible current market value, the banks must make a large bad debt provision of €50 billion to €60 billion. They could not remain in operation on this basis, but the Government has said it will provide additional resources for equity in the banks if this arises. The Government would then end up as the majority shareholder. A price reduction (haircut) of about 20% (reflecting possible very hopeful longer term value of the assets relating to the loans) has been discussed but we for now do not know the actual price. With a 20% reduction, the question arises as to whether N.A.M.A. can ever recover the buying price of the loans through its operations.
The argument for nationalisation of the banks is that there is less need to identify an appropriate price as both the banks and N.A.M.A. would be owned by the taxpayer.
The Government has said it would impose a levy on the banks if N.A.M.A. did not break even over some long period of time. However, in the meantime, the taxpayer would be carrying the cost of a high purchase price and the bank shareholders would be happy. But it may not be practicable to threaten to impose a levy, because the threat of a future levy to cover possibly tens of billions of euro would restrict the current operational freedom and value of the banks.
No good options
The banks need to be fixed and the bad debts removed. There is no good costless way to do this. There are lots of bad loans, and they will not be repaid in full. The taxpayer will inevitably bear a substantial financial burden. If the aim is to minimise the cost to the taxpayer and get a better contribution from the bank shareholders, the high purchase price is not the best option. However, if the aim is to strengthen and improve the attractiveness of the Irish banks, regardless of whether it involves a substantial transfer from taxpayers to shareholders, the high purchase price model is of course the best. The issue is not actually NAMA or an alternative; it is the price that is paid to the banks for the loans in question.
In recent days the Minister for Finance has been at pains to emphasise that banks will not be overpaid for the loans, and that the taxpayer will be protected as far as possible. This emphasis on protecting the taxpayer is a very welcome and belated aspect of the ministers presentation and defence of the project. Of course, as noted above, if the price of the loans is relatively low there will be a major question mark over the ability of the banks to absorb a very substantial bad debt provision, or write down on the loans. We are then back to substantial, or majority, or total Government ownership of the banks. The sooner all this becomes clear the better. If the current Government emphasis on the proper price for the loans is carried through, and the cost to the taxpayer is kept as low as possible and seen to be so (although it will still be large), I can see N.A.M.A. being implemented and accepted by a grudging public.
Our man from DCU, Tony, is of the view that the current approach seems to imply a relatively high purchase price for the loans, which would result in the taxpayer carrying an excessive share of the risk and the burden. But he is also adamant that other institutional structures, including nationalisation, will not make the bad loans go away. The policy task is to get the least bad situation for the economy and for the taxpayer.
So now you understand all about N.A.M.A. VISIT OUR BLOG and let us know what you think.
September 2nd 2009