Brian O'Doherty's Blog  

OK, Part 1 of the Four Year National Revival plan (FYNRP) is to stop doing the things that are getting us into a deeper and deeper hole and start earning some respect from our creditors.
Take NAMA. A good idea in principle when first launched, it has become a monster !. Instead of “saving” the banks and helping them with their liquidity problems, it has probably contributed greatly to loss of our national financial credibility and, therefore, to serious deterioration in the banks’ funding position (and decimated shareholder values). I mean, what foreign investor will purchase the guarantee of the Irish government (when our banks come looking for funds with that guarantee)…a government which guarantees (NAMA) bonds which carry an interest rate of 1.5% (when the reality is that our interest rate should be four or five times that)- who are we trying to fool?..Then, when they look at the Term Sheets for the bonds they see that there is no real redemption date- commitment to repay the bonds for cash, and of course they realise that there is no capacity to repay them; so they figure that the bonds aren’t really for adult serious people at all, but just artifically constructed to enable the banks liquidity problem to be thrown onto the ECB, with no ultimate payment date. With this sort of carry on, how can we expect the markets not to downgrade our credibility?
So, lets rewind NAMA and give the banks back their property (AIB/BOI) and their lost profits (temporarily at least). That will reduce our long term National Debt- meaning our bank property repayment obligation- by €20 bn. or so (- the nationalised banks may not benefit, so don’t include them yet) and our financial market rating should improve
Then, we must help the banks out of the position where their property has been devalued by public officials by around €18 bn or so (- I’m guessing the figures for now-) and work with them to rebuild their position and especially their funding. The State guarantee can be maintained for a while. Also they can use their exisitng holdings of (non-NAMA) government bonds as collateral for short term ECB borrowings. Then they can consider other options, including separation of truly toxic debt into bad banks, the possibility of finding friendly foreign takeover parents, merger of the two Irish banks, the setting up of assets value insurance schemes- which we should have done, it seems in hindsight- and, especially one real opportunity…the upcoming change in accounting rules.

The International Accounting Standards Board has proposed new rules for banks’ accounting treatment of impaired assets/ loans. Bottom line is that these estimated future losses of banks should be spread over the remaining periods of the loans in question–that is “amortized” – instead of being fully recognised up front (as by NAMA). Our banks are crippled because thay have had to accept a value for their loans/ assets which reflects a completely illiquid non-market- which we have at present- although the loans do not mature for many years into the future and in fact circumstances could change in the future and foreseen losses could in some cases become profits. For many reasons this is not a realistic way to estimate real losses, so many foreign governments are ready to adopt new rules which would greatly improve the banks current protfit positions. The Irish government should press very hard to get these new rules immediately adopted by the EU, or perhaps go ahead itself. It could also change the law here, if necessary, so that stated accounting losses can be re-calculated for two years backwards.

I submitted this to the IrishEcomony.ie blog today and reproduce it here for the other two readers:

About these widening spreads….I suspect they are related to NAMA, which is the source of the great majority of new Irish debt.
Last February I worked out approximately that, based on the preliminary NAMA Business plan, the interest rate that NAMA, a government agency offering sovereign-guaranteed debt- was offering–c. 1.5%- at a time when the real price of Irish sovereign debt was 4.5% (God be with the days !..), amounted to c. a €10 bn. euro extra hidden hit on Irish banks over the period of the proposed NAMA redemptions.
That figure has now changed a little, but can only be worse as the spread between our NAMA discount rate and our secondary market sovereign rate rises towards 7%. The market-rated yield on sovereign debt is based on an amalgam of the individual yields on all pieces of our sovereign debt. NAMA bonds can/must be seen as official debt and they are worth something in the region of face value less 33% I would guess (- I might try to run calculations later-) and so are pulling the average down substantially
Its only my theorem, but , if true, it suggests that the best thing we can now do to protect our sovereign rating is to re-wind NAMA and find another solution to the bank liquidity problem.

It seems to me to be improper for the State to guarantee the bonds being issued by NAMA-SCAMA, when the said organisation does not have the readies to redeem them at maturity and the State also is blatantly obviously unable to pony up tens of billions of euros for the same purpose if its guarantee is called. Such imprudence on the State’s part is likely to be eventually twigged by investors (and the ECB) and will result (or has resulted) in the State’s loss of credibility and the NAMA scheme’s collapse along with the banks it should have been trying to support. In reality, the Good NAMA has become the BAD NAMA and brought down the banks with it, ruining shareholder value (and, according to some stories floating around at the recent AIB EGM) even causing some suicides among very distressed elderly shareholders.

NAMA was meant to operate like an old-style Fianna Fail “good stroke”, in which the government would pretend to negotiate a rescue for banks with the ECB via a special ERB-funded “liquidity scheme”. In effect the government would use a pre-existing ECB liquidity scheme for Eurozone banks (which operated between the ECB and the banks and had nothing to do with governments) by giving the Irish banks NAMA bonds which they could use as collateral for borrowings from the ECB. In exchange the government takes tens of billions of property from the banks, at distressed market values, which it can hold or sell at its own leisure, with the banks paying overhead costs. So, it actually pays the banks nothing in real terms but leaves them hoping that the ECB will lend them money. And, the government gets credit, and the banks get abuse, for this scam, which is branded as a “bail out” . Yes, a good stroke and lets bash the banks!

The problem is that this was not agreed with the ECB…Instead, the liquidity problem (version: Irish solution) was dumped onto the ECB, which in any case only lends short term (6 months or maximum a year). There is no guarantee that after 6-12 months the banks loans from ECB will be rolled over, for the many years it will take for NAMA to eventually redeem the bonds and thereby pay for the property it has taken. Meanwhile, the banks have been forced, uniquely in the world of banking, to recognise enormous losses up front, without the benefit of a future rise in values. (Other banks around the world have lost more, you know, but don’t have to recognise the losses all in one go, upfront !) So, international investors see Irish banks being in a position where they must sell off their profitable businesses to raise immediate capital and also have no certain route to medium term funding, other than the guarantee of an almost bankrupt Irish exchequer. The last straw is when the government values the shares of the biggest bank at 50 cents, six times lower than even last years peak, and therefore effectively wipes out 90,000 elderly shareholders across the land.

It wasn’t the banks that brought down the State: it was vice versa.

Directors of public companies have certain legal (and moral) responsibilities vis-a-vis shareholders, including duties of care and loyalty and the duty of full disclosure of pertinent facts surrounding matters on which shareholders are asked to vote. These responsibilities are particularly important at a time when the company is being taken over, which is in effect what is happening to AIB today. It will soon be majority-owned by the State and later by some foreign institution, in all likelihood.

Therefore, the reasons for selling AIB’s stake in M&T- where it is the largest shareholder- should have been explained to shareholders, and so, also, the options to selling the stake should have been explored and discussed. To the extent that they weren’t, the shareholders were voting in the dark on a very important resolution.

Of course, the idea of selling the stake in M&T has been around for months and may have been mentioned, even discussed at a previous shareholders meeting (although it was never voted on or approved). But the context has changed dramatically. The shareholders voted to participate in NAMA as the main plank of a plan which would rescue the bank from its liquidity difficulties and save the bank from majority State-ownership; and the other parts of that plan included sale of M&T and Poland, and the raising of €7.4 bn. in new capital. But, just as it seemed the bank was making progress on that plan, NAMA and the regulator blew it apart with a sudden demand for an extra €3 b n. of fresh capital. Consequently, the main benefit to shareholders of selling M&T no longer exists…In fact, it only makes it cheaper for the State to take control of the company. Therefore, the logic of selling it needs to be revised and explained to shareholders: it has not been, so far.

It seems that the directors of AIB have caved in and will meekly go along with the decisions of NAMA and other government officials, which have the effect of passing control over to the government, rather than exploring other options. One of these might be to keep the M&T shareholding and invite M&T to take over AIB at €2 euros a share, giving existing shareholders a 600% uplift from present values. Or find another foreign buyer—the State will have to find one in the future anyway, so why shouldn’t present shareholders do the deal for themselves now?.. Or back out of NAMA, retrieve the €10 bn in lost value on NAMA property and set up AIBs own “bad bank” as Barclays did…Or maybe even transfer residence abroad, to the jurisdiction of a more credit-worthy government, whose guarantees are still acceptable to international funders..Shareholders would prefer any of these options to what the State and bank directors are doing to them today.

None of these may work and maybe there are no other options. But that’s the sort of analyses that shareholders should have received. (Other serious questions about the circumstances of the sudden extra bill from NAMA also arise, including the question as to whether NAMA actually kept its side of the bargain by giving AIB bonds which are truly tradable at face value for real liquidity…I doubt it)

I was strongly in favour of the NAMA scheme, when it was first revealed: It seemed like it could really help resolve the banks’ liquidity problem, while costing the taxpayer nothing.

Remember, the banks had extended billions in commercial and development property loans, against security which was fast-falling in value in the crashing property market. To fund these and other loans long term, the banks needed liquidity. NAMA was to provide this liquidity by taking over the relatively illiquid property loan assets (which NAMA would not have to “mark to market” and could afford to sit on until property recovered) in exchange for liquid government bonds, which the banks could use to borrow cash from the ECB. The banks were to take a substantial haircut, 20-30% was envisaged, and be prepared to take on the long term price risk also, but, otherwise, they would have clarity in their balance sheets and financial position and could commence to rebuild profitability. There was no risk to the taxpayer who, in fact, would be in a strongly positive cash flow position. That was the Good NAMA, which would protect our banking system, keep it Irish owned, and deliver liquidity for the economy

What we got was the Bad NAMA: The Government was forced to accept the reality that, in fact, the scheme was a loan to the State by the banks, so interest had to be paid on the loan as long as the bonds- mere promises to pay real money in the future- were not redeemed. So, it chose to pay an artificial interest rate of c. 1.5%, which was the special interest rate the ECB used in its liquidity arrangement with banks across the Eurozone and nothing to do with the Irish government. This rate immediately devalued the bonds: considering that the Irish sovereign interest rate, reflecting perceived risk of Ireland and its government, was c. 4-5% – 6.5%, there was no possibility of selling on these Irish government-guaranteed promises at face value: in fact, over a period of ten years, the discount would have to be almost a third. Even then, the bonds were hardly marketable at any price, as they carried no redemption date (for cash) whatsoever! And, by reason of issuing so many bonds, the State’s financial credibility was undermined and its borrowing rate rose. Then, the ECB, who the Irish authorities initially claimed had been specially negotiated into the scheme-, must have wondered why it was expected to continue funding Irish banks until the NAMA boys redeemed the bonds, when its funding scheme for Eurozone banks had an increasingly short term horizon. Next thing that happened was that NAMA, forgetting its original objective, and thinking that the taxpayer might be at risk sometime, began to raise the haircut to astonishing levels, well beyond what could be sustained by the banking system, to the point where the Irish banks were obliged to mark down their portfolios to distressed price levels and without prospective benefit from a future market upturn, something which they could have done without any State rescue scheme, and which no other banks in the western world were forced to do! (Other countries bailed out, not the banks but their customers, so that banks could be repaid, or offered insurance schemes with the State holding the risk, or simply printed money and bought toxic assets from their banks at face value). Finally, NAMA backed out when push came to shove, as when AIB, having absorbed or set aside c. €10 billion in NAMA –related losses, and then looked like it was making progress in raising another €7.4 bn of new capital, as dictated by the Regulator, was hit by a sudden and last minute extra three billion bill from NAMA, in circumstances yet to be fully revealed.

So, there you have it: the Good NAMA set out to save the banking system and the economy; the Bad NAMA wrecked the banks profitability, put them into nationalisation or thereabouts, and leaves Irish depositors with the prospect of having their savings managed by foreign banks and regulators in the future.

We can look around the world and see banks still stuffed to the gills with truly toxic debt, credit default swaps and other fairy tale derivatives which can never be encashed or repaid, or offloading the stuff onto their central banks or propped by local government schemes, but still surviving, still functioning normally in the interests of their economies, as independent, privately-owned banks; and we can then look at ourselves and we must say: What a bunch of idiots we are, right patsies!

(Note: My sympathy for the banks does not extend to Anglo or Nationwide)

Apologies to my readers, especially avid fans, for the time out in the last few months. There was a lot of disruption in my routine, with move of office, move of house and move of city (to Greencastle, County Donegal, lovely spot). I found it difficult to keep up to speed with the details of some of the topics I’m interested in, such as NAMA, banks, Irish economy, diaspora, export development, etc (–these topics are related to each other in various ways..), but I’m now ready to start working on them again. This is a sort of trial post to see if the site is still working properly. I hope you will visit again soon.

Í read on that good blog, www.Irish Economy.ie, that the State proposes to provide promissory notes as its capital commitment to the funding of Anglo Irish Bank. If that’s true then it means that Anglo must be planning to raise equity elsewhere in order to meet the new (still just proposed) Basel III standards ( wherein banks should aim at having 7% core equity capital). Otherwise we have a situation where the Regulator and Central Bank Governor are insisting that the main privately owned banks – AIB/BOI- must meet this rather stringent standard, while the government -owned bank is allowed to compete without meeting regulatory standards…Can that be true?

Also there is continuing controversy over AIB’s solvency, with some “celebrity” commentatrors in the media stating that the bank is virtually “bust” and will certainly become majority owned by the State. On top of that there are still many commentators who do not understand that NAMA is a loan scheme wherein the banks make the loan to the State. Of course it suits the banks, up to a point, in that it is a quick way of liquidating rather illiquid assets, at a time of shortage of liquidty in the wholesale banking markets. But, as we have argued here for a long time, it is actually a hidden loan to the State at an outrageously low interest rate, and a big benefit to the taxpayer. So, I made a comment on the blog tonight, which I reproduce here for my other readers, both of them:

” At end 2010, AIB had net equity of c. 6 bn. The reason it has to raise €7.4 bn is because the NAMA people and Regulator have now told it to Assume that the NAMA discount over all its loans, including performing loans, will average c. 43% or c. €6bn more than was provided for; and on top of that the Regulator has decided it must not only have core tier 1 capital ratio of 8%- which it had at end-2009- but it must have core Equity capital of 7%, (c. €7 bn). (It had provisions of c. € 4bn against NAMA assets and another €1.3 bn against other loans, on top of the €6 bn equity)

In my blog I described (more accurately I should say”opined” ) how they can do that this year. AIB is far from insolvent, as some professors continue to claim- some commentators even use the word “bust”- its outrageous !- and barring some major unexpected development, the State shareholding in it, if any, will be a minority one

NAMA issues a bond, a promise to pay the holder (??- I assume, but is it tradeable, does anyone know?-) or the banks some real money in the future sometime. NAMA is technically a borrowing from the banks by the State/taxpayer. The government tried hard to obfuscate that fact, but the EU refused to accept the spin. Hence SPVs , etc…

In this day and age, and keeping in mind Basel III, bonds, loans and promissory notes will not add up to “core equity capital”. So, I dont know what the Regulator is at, if he imposes a stringent core equity capital ratio on AIB/BOI, but permits the owners of Anglo to get away with promises !

If NAMA bonds are acceptable to ECB–which it seems they are- then as far as I understand it, that would only be useable for raising “real money” loans from ECB by our banks on the ECB’s increasingly short term basis. I think the last one year loan was made yesterday and from now on only 6 month loans are available. So, what are the banks to do with these NAMA bonds after that?

If they are tradeable in the financial markets, as BL once said they would be, then, in order to trade at par value they would have to carry a coupon comparable to the sovereign guarantor’s current borrowing rate, currently c. 4.5%. If it is only 1.5%, – I dont know, can someone please advise?-then , based on the repayment schedule foreseen in the original NAMA Business plan, €50 bn of bonds face value would be worth, at NPV, something in the region of €10 bn less than otherwise. (Discount at 1.5% instead of 4.5%). ‘(This is extra real profit that the State is taking for itself, from bank shareholders, including itself, of course )

I suspect, though, that these bonds are unusual in that they are, for one reason or another, effectively not tradeable in the market. I just have that feeling. (Does anyone know for sure?). It may be why Eugene Sheehy was unwilling to confirm that AIB would cash in these bonds, when asked by a Dail committee. I admit I could be very wrong there…But I think journalists have not focussed enough on this aspect of NAMA. We simply have not asked the questions properly. (Another aspect we have let slip by is : What will the State do with all the NAMA cash, including property sale proceeds, which it will have available to it for years, before repayments begin to the banks?) (The idea that it will have to pay an average of €240 mn a year on lawyers fees is simply more obfuscation…Amazing how much you can fool, intelligent people!). That extra NAMA cash which it will hold is effectively a cash loan from the banks to the taxpayer, and at a steal of an interest rate– a scraping of the faces of the elderly bank shareholders ! (But maybe the interest rate has been adjusted since 1.5% was first indicated…?)
“

The consequences of the NAMA and allied announcements yesterday included a slight fall in the share price of AIB today, amid very heavy trading, and a sharp rise in the price of BOI. The market seems to think that the State will end up owning more of AIB- probably a majority most people say -than of BOI

I don’t see it, really. Instead, I think AIB have plenty of options and, although the challenge set for them by NAMA and the Regulator is certainly a big one, I think they can do it and end up the year with a market value in the multi-billions, compared to c. a single billion today.
I don’t have the exact figures with me, so all figures given below are approximations, from memory

AIB need to absorb c. €10 bn. of NAMA losses and then end up the year with an additional €7 bn. in equity. So, that’s their target, €17 bn., say. To reach that, they will deploy their starting (end 2009) equity of €6 bn. and their provisions of €4 bn. (for NAMA). That approximately takes care of NAMA (but we may come back to NAMA because I believe it shouldn’t really cost the full €10 bn.) Read the rest »

On Feb. 28 I wrote a piece entitled “A Gamble on AIB today?” (see below), in which I recommended a flutter on AIB at that time. I’m happy to say !..yes, happy, because at that time the share was c. 1.00 euro, and it since–almost immediately- rose to c. 1.65 euro last week…an enormous profit in a couple of weeks or three.

Those of you who bought and then sold at that price (- this group does not include myself-), will be amused to see that the price fell to c. 1.40 yesterday and is now at c. 1.10 !!–almost all the way down again. The herd is in panic at the prospects of this afternoons announcement on what the NAMA transfer price will be, etc. That group of smart investors should be readying themselves to jump back in as soon as possible after the Minister’s statement. The gamblers will go in before his statement.

I dont believe he will take a majority or any substantial minority position in AIB. It simply doesn’t make sense. In fact, ‘twould be better if he agreed to take back his €3.5 billion and pass his preference shares and warrants to shareholders in a rights issue. That would leave the bank more attractive to prospective investors of an additional few billion to restore capital ratios, at a price of, say €5-7 euros a share.

In my humble opinion, AIB is fundamentally worth €15 euros a share or more, after these few billion in write offs are taken care of in a couple of years time. Just look around the eurozone at comparable banks- many of them in deep gratitude-for-government-aid mode- whose shares are trading at 15 times core earnings and more . AIB’s core earnings are €2 euros a share !

So, we have arrived at the moment of truth..NAMA is to reveal the price it will pay and the banking system will end up in government hands, according to the professional professors, the insider winkers, the usually well informad media commentators and the bewildered of RTE.

Well, I think they’re wrong. I’m sticking my neck out like an idiot, I suppose, but, in the midst of all the panic- share prices today are down c. 20% !- one should take a minute or two to calmly consider the realities: the last thing the State- and the citizens- need is majority-or substantial minority control of the two main banks. We simply can’t afford it !

The inevitable result of “nationalisation” is “re-privatisation sometime; and, at that time, who would buy the banks from the Government? Who could? The traditional investors in our banks- the 150,000 Irish resident individuals, of older age and simply looking for dividends as pension supplements- would have been wiped out and, if not dead, or in State-nursing homes, still suffering the bitter taste of savings lost investing in banks. No Irish corporations or institutions would have both the strategic benefit and the financial means to buy large stakes in the banks. The reality is that our main banks–and with them, control over all Irish owned deposits- would have to be passed over to foreigners. At that stage, we might as well throw away all pretence to economic sovereignty.

Admittedly the new Central Banl governor, Pat Honohan, made some very silly comments a few weeks ago, indicating that it is almost government policy to wipe out local shareholders and sell off our major economic assets. But he seems to have taken the foot out of his mouth in recent weeks.

In any case, I believe that Brian Lenihan and his advisors and top officials have a more sensible view of the importance of our banking system and of what is required from NAMA. And they would also realise that a move into State control would cause an immediate drainage of deposits from the system which could not be replaced by any government actions or guarantees and which would be a burden our economy could not support

Therefore, the right price for assets going to NAMA from the two main banks is the price at which the assets can later be sold for, subject to the maximum which the banks can afford while staying independently controlled in the private sector. This price, which may be around 30% discount on original assets values, is affordable by our nation- because its totally financed by the banks and it comes with an indemnity against loss provided by the banks, in effect. It is the price at which the banks will be able to raise capital privately- assuming some forebearance from Pat Honohan in the matter of unnecessariily early achievement of new stringent capital ratios- which most international banks cannot achieve in the short term anyway- and at which they can finance necessary activities in the rejuvenation of our economy

Aided by the likely positive change in the near future in the accounting rules pertaining to banks’ impaired assets – which will greatly help to diminish the impact on banks’ capital of residential mortgages losses- our two main banks will recover their relatively strong position over the next 2-3 years. The outcome for the nation will be far better than what we would achieve through (partial) nationalisation. And as for shareholders, don’t follow the herd but be strong now…have faith in Lenihan and look forward to a doubling of the share prices in AIB/BOI over the next few months. Indeed, shareholders should take up a rights issue, particularly if the banks could offer exactly the same terms on which they permitted the State to get in a year or so ago.