The proper price of NAMA bonds

The State takes the gain, and the banks shareholders take the loss and the risk, in the NAMA scheme. The terms on which the deal is done- the value of the transferred assets and the consideration to be paid for them – should reflect this reality. I try to estimate a fair price for shareholders below and I argue that they should be given share purchase warrants, just as the State took share purchase warrants from them, a few months ago, when it invested high priced preference capital.

Have no fear, NAMA will be good for taxpayers

Have no fear, NAMA will be good for taxpayers

People forget that all commercial and development loans (“assets”) are being transferred by the banks to NAMA, not only distressed or impaired loans. This alone is a snatching away of shareholders property, taking away from them cash flow and profit on which future earnings can be built. This is “real money” that is being taken- i.e. borrowed- by the State, at a tiny interest rate of 1.5%. This seems like a real rip off, when you consider that the Sate is demanding 8% from the banks on the €7 billion preference capital which it has injected, along with warrants giving it the right to buy ordinary shares cheap!. That’s a Big Price the banks are paying. One hopes that at least the same 1.5% interest rate will be used to discount the future value of these above water loans, when calculating the overall NAMA bond value.

The other, non-performing, assets which the State is to take over are very likely to be worth more in the future than at present, simply because there is almost no market at present, due to the international financial implosion (which the Irish banks had nothing to do with).

If the banks were to unload all this property at “current market value”, then it is possible that they would be taking a hit of c. €20 billion, which would indeed wipe out their capital. (In that case, the taxpayer would have to find €20 bn. to recapitalise the banks, whether he owned them or not…and where would he find that?…and at 1.5% interest?…or even 4.5%, his current borrowing rate?). That would be heading down the road to foreign ownership. Of course, if the banks were allowed to write off these losses over a period of years, then they would be able to absorb these losses from their normal operating profits, which amount to c. €4 billion annually. But unfortunately,
they can’t do this, because accounting “rules” require that all the banks assets be revalued to reflect their true current market value, or realisable value, on the banks’  Balance Sheets. (Some months ago the US government “eased” these rules for US banks, so that real losses of US banks could be hidden. Also, the UK insurance scheme, their option to a NAMA scheme, has the effect of permitting banks to write off losses over a few years)

So, accounting rules are not to be changed, for the moment- but, it seems, they are under active and urgent review at EU level- and at the same time we must save our main banks, which are in distress mostly because of enormous mis-management of international financial economies in recent years (and which was never flagged by our academic economists, or our media). (OK, our banks made some bad loans, too, but the market has crashed because of the general situation, not because of Irish bad loans). So, in comes NAMA, the best solution available. But, how is NAMA to estimate the correct value of these impaired assets?

Please note: If the assets are to be valued at “current market value”, then the banks dont need NAMA…they can simply unload the assets on to the market. (And this would be very unfortunate for the State and the taxpayer, because they are actually the main beneficiaries of NAMA…). So, almost by definition, NAMA should pay more than “firesale” values. Yet, what should the correect value be?..The banks need to know how much they must write off now, because of accounting rules as well as for the future benefits of certainty when they go fund raising after their balance sheets are cleaned up.

The correct price/value is the present discounted value of the future sale price of the assets, adjusted by future tax considerations. While most people would expect the future sale price to be higher than current market values, some commentators are insisting that the taxpayer should not be forced to take that gamble in agreeing a higher price now and hoping that it is achieved in the future. But in fact, the national interest requires that a high price relative to current market value should be paid. The national interest requires well funded banks, that can go into the international financial market and access tens of billions of extra deposits (and maybe some private capital) which will be needed as the basis of expanded lending programmes in Ireland in the coming years. Also, what the taxpayer “pays” for NAMA assets is not real cash (which he would have to borrow) but IOUs–bonds, issued by the government and redeemable at some future date–maybe in ten years time. In return for these IOUs, the government will be able to sell banks’ assets, turning them into cash as needed, and using that cash to fund normal government budgetary activities. So, to an extent, the more the “taxpayer” “pays” for NAMA assets, the better…the more the banks will be contributing to the national budget, and therefore the less the “taxpayer” will have to contribute. (This is because everyone understands that the price agreed with the banks will be “guaranteed” by the banks, and if the sale proceeds of the assets do not reach this figure then the banks will not be able to protest if they are levied in the future, or if the bonds are redeemed at less than face value)

Note again: There is No Risk to the taxpayer…he is in fact a big beneficiary ! NAMA is a Loan of some yet unknown period, From the banks To the government.

But, how much might be a justifiable, defensible, notional value of these assets?. This is a figure which the ECB and European Commission would be expected to accept as being under the State Aid threshold. I dont know exactly what that should be, because I don’t know all the details of the loans…and who does? (But Kevin McConnell of Bloxham Stockbrokers has just published a very good looking analysis which seems useful in estimating the extent of the problem, though I have yet to study it in detail). But it seems to me that we could estimate a reasonable value as follows, and here I apply a principle that 100,000 ordinary Irish shareholders should not be punished for their forced agreement to a scheme wherein the Exchequer and taxpayer are the main beneficiaries:

1. A reasonable estimate of current market value, as many specialists are curently preparing …PLUS
2. The average estimate by specialists of future growth in value, less, say, 20% for safety purposes, then discounted to todays value…PLUS
3. An extra payment, reflecting the loss of tax deductions which the banks would have gained and the State would have “paid” if the banks were selling the assets and not the State…PLUS
4. An extra payment, of 3% or 6.5% (floating) per annum, representing the difference in interest rates between what the NAMA is paying the banks until IOUs (bonds) are redeemed – 1.5% – and what the State should be paying for its borrowings- 4.5%- or, indeed, what the State is charging these same banks on preference capital already invested – 8%.

In spite of all of that, there is still the risk being put on bank shareholders, that the NAMA valuation of their assets will be substantially less than true future value. (I state again…there is no risk- a big gain in fact- for taxpayers but a big risk for shareholders, some of whom having already suffered up to 95% loss of their savings as well as annual dividends). The best way to get over this may be to issue Warrants to the banks shareholders. The details would have to be worked out  but in principle these warrants would have greater value if the banks are less likely to be hit for extra “payments” to NAMA in the future..i.e. if the realised proceeds of sale of banks assets are more likely to be profitable to the State/taxpayer. So, if NAMA makes, say €20 billion profit, when all is said and done, in ten years time, or so, then these warrants will have a certain value to their holders- bank shareholders. If, on the other hand, NAMA makes a €20 billion loss on sale of banks assets, then the warrants will have less value, or none, reflecting the fact that the government will be hitting the banks for retrospective extra payments to cover the NAMA losses.

The State helped itself to warrants, convertible into 25% of the ordinary shares of AIB or BOI, as a kicker for itself when it invested €7 billion in preference share capital, feeling that an 8% dividend was not to be enough. Now that it is “borrowing” for itself €50 bn. to €90 billion of banks assets, and at an interest rate payable to the banks of only 1.5%, the least it should do is hand back those warrants to shareholders, or create new ones to be given to shareholders, and exchangeable into the warrants presently held by the State.  Of course, we need to examine the terms of the warrants which the State holds, which I will do soon, if they are known.

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