Brendan Burgess
Founder
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Evaluation of the Current & Prospective Conditions in Irish Credit Markets: The full summary can be found [broken link removed]. Most of it is taken up with discussing whether we should have an asset management approach or an asset guarantee approach.
As most are agreed on the Asset Management approach, I have extracted what I consider to be the most relevant bits below. There is actually very little covering nationalisation issues.
7. Against the backdrop outlined above it is imperative that initiatives should be undertaken that will lead to stability in banks deposit and term debt liabilities and eliminate the need for a renewal of the guarantee. To achieve this requires removing all doubts about capital adequacy of the credit institutions and their capacity to deal with prospective loan impairments.
16. AMCs[Asset Management Companies] seem to offer tempting prospects for avoiding many of the shortcomings associated with a continuation of the existing bank-property developer relationship. Potential advantages include: (i) economies of scale in administering workouts (since workouts require specialized, and often scarce, skills) and in forming and selling portfolios of assets, (ii) benefits from the granting of special powers to the government agency to expedite loan resolution and (iii) the interposing of a disinterested third party between bankers and clients, which might break “crony capitalist” connections that otherwise impede efficient transfers of assets from powerful enterprises. The latter may seem particularly beneficial in circumstances markets, where ownership concentration and connections between borrower and banks are often very close.
17. Sweden’s AMCs provide examples of some of these potential advantages, but other countries have found it difficult to realize them.1 First, government agents may lack the information and skills of (more highly compensated and incentivized) private market participants. Second, government agencies do not operate in a vacuum; they, too, are creatures of the societies that create them, and government agents must negotiate, rather than dictate, solutions, just as private market participants must do. In negotiations with government agencies and private participants alike, the strength of one’s position depends on one’s “threat point” (the ability to credibly threaten adverse consequences to one’s bargaining opponent, if agreement is not reached).
18. Notwithstanding, it is considered that AMCs, by virtue of the potential advantages they contain (as noted above) have the potential to bring about better economic resolution of the impaired loans of Irish property developers than relying on existing bank management and banker-developer relations, which have brought about the problems in the first place.
23. The acquiescence of the ECB as to the issue of a bond of the stated face value should be procured before any decision is taken by Government to proceed with the recommended approach contained in this report. [Note: Bold in the original report]
Consequences of Additional Capital Investment
24. Any additional capital required to cover losses on transfer to the AMC could result in substantial State ownership of certain credit institutions, depending on the price at which capitalisation is undertaken and the precise form of the capital investment. However, there is an important distinction between this position and fully nationalised entities. Notably, and similar to the RBS and Lloyd’s Banking Group in the UK, both institutions would retain their stock exchange listings and their shares would continue to trade on the Irish and London Stock Exchanges. Accordingly, as and when market conditions improve and the performance of Irish banks return to growth there will be a natural exit mechanism available whereby the Government should be able to divest itself of its majority ownership, should it wish to do this, in an orderly manner that allows it to realise gains on behalf of the taxpayer over time.
How the NAMA should be capitalised: Bond Issued by Government or with the Benefit of a Government Guarantee
29. The advantage of this approach, from the point of view of the banks is that it severs any link between the bank and the outcome of the impaired loan. Moreover, since the credit quality of the bond is Government there is zero risk weighting with consequential savings in capital. Another advantage is that the bond, in the hands of the banks, should be eligible collateral for the purpose of Repo agreements at the Central Bank and this, could be used by banks to replenish liquidity. The disadvantage, obviously, is that it adds substantially to the national debt.
Impact of Increase in National Debt
30. A key question is whether the measures underlying the bond issue (i.e. the creation of an asset management agency and associated banks’ recapitalisation measures) are considered by capital markets to resolve the capital adequacy question about Irish banks and the Proposal for a National Asset Management Agency: Abridged Summary of Report of Special Advisor At NTMA 8 8 April 2009
associated attrition being experienced in banks’ deposit liabilities which in turn has created the need for the Guarantee scheme? Another key factor relates to the underlying public finance position and current efforts towards stabilising the deficit, which is widening beyond expectations. Then there is the question of the impact of such expansion of the debt on the capacity to service the debt. Ireland has the capacity to absorb additional debt service costs if these were to come about. Finally, the proposed issuance would not take place without the support of the ECB. Of itself, that would tend to mitigate adverse speculative reaction. However, there remains the risk however that the market may focus solely on the ‘headline’ news, pushing CDS levels wider, unless the strategic plan is explained comprehensively and clearly.
Sharing Unanticipated Gains and Losses on Impairments: Provision for Equity, Warrants and Claw-back Arrangements
32. The projected value of impaired loans is sensitive to the underlying assumptions and there is need to protect the State from potential unanticipated losses. One way of achieving this would be for banks, which are transferring impaired loans to the NAMA to provide a warrant to purchase shares in the bank which can be exercised by the Government in several years time at a price – and here’s the key – which depends inversely on the value of the impaired debt at that future date. The future date needs to be set far enough into the future for the market in these kinds of assets to have settled down and their price less imponderable. If the valuation of impaired assets is significantly greater than anticipated at the time of transfer, the warrant will end up too costly to exercise. If the valuation proves to have been wrong and the assets end up worth far less than at the time of transfer the Government will hold an equity stake compensating it in the end for the additional losses it has taken on the assets. Another mechanism would be to use claw-back arrangements in which Government, on the winding up of the NAMA, would determine if it has made a profit or a loss in its lifetime. Any profits would accrue to the State but any losses incurred by NAMA would be clawed back from the participating institutions by means of a levy over a number of years.
Valuation Issues at Transfer: Supplementary Assessor Process
36. In the case of mandatory transfer of assets a Supplementary Assessor Process could apply. In this approach, the valuation is done prior to transfer and payment by the NAMA itself, following expedited due diligence. The Assessor structure then follows subsequently at a suitable time to ensure that the amount paid was indeed fair. This has a number of benefits in that the timeframe in which the Assessor operates in is no longer relevant to the timing of the transfer, the NAMA can price more strategically taking into account the market impact of the pricing and there is only upside for the banks when the Assessor ultimately
As most are agreed on the Asset Management approach, I have extracted what I consider to be the most relevant bits below. There is actually very little covering nationalisation issues.
7. Against the backdrop outlined above it is imperative that initiatives should be undertaken that will lead to stability in banks deposit and term debt liabilities and eliminate the need for a renewal of the guarantee. To achieve this requires removing all doubts about capital adequacy of the credit institutions and their capacity to deal with prospective loan impairments.
16. AMCs[Asset Management Companies] seem to offer tempting prospects for avoiding many of the shortcomings associated with a continuation of the existing bank-property developer relationship. Potential advantages include: (i) economies of scale in administering workouts (since workouts require specialized, and often scarce, skills) and in forming and selling portfolios of assets, (ii) benefits from the granting of special powers to the government agency to expedite loan resolution and (iii) the interposing of a disinterested third party between bankers and clients, which might break “crony capitalist” connections that otherwise impede efficient transfers of assets from powerful enterprises. The latter may seem particularly beneficial in circumstances markets, where ownership concentration and connections between borrower and banks are often very close.
17. Sweden’s AMCs provide examples of some of these potential advantages, but other countries have found it difficult to realize them.1 First, government agents may lack the information and skills of (more highly compensated and incentivized) private market participants. Second, government agencies do not operate in a vacuum; they, too, are creatures of the societies that create them, and government agents must negotiate, rather than dictate, solutions, just as private market participants must do. In negotiations with government agencies and private participants alike, the strength of one’s position depends on one’s “threat point” (the ability to credibly threaten adverse consequences to one’s bargaining opponent, if agreement is not reached).
18. Notwithstanding, it is considered that AMCs, by virtue of the potential advantages they contain (as noted above) have the potential to bring about better economic resolution of the impaired loans of Irish property developers than relying on existing bank management and banker-developer relations, which have brought about the problems in the first place.
23. The acquiescence of the ECB as to the issue of a bond of the stated face value should be procured before any decision is taken by Government to proceed with the recommended approach contained in this report. [Note: Bold in the original report]
Consequences of Additional Capital Investment
24. Any additional capital required to cover losses on transfer to the AMC could result in substantial State ownership of certain credit institutions, depending on the price at which capitalisation is undertaken and the precise form of the capital investment. However, there is an important distinction between this position and fully nationalised entities. Notably, and similar to the RBS and Lloyd’s Banking Group in the UK, both institutions would retain their stock exchange listings and their shares would continue to trade on the Irish and London Stock Exchanges. Accordingly, as and when market conditions improve and the performance of Irish banks return to growth there will be a natural exit mechanism available whereby the Government should be able to divest itself of its majority ownership, should it wish to do this, in an orderly manner that allows it to realise gains on behalf of the taxpayer over time.
How the NAMA should be capitalised: Bond Issued by Government or with the Benefit of a Government Guarantee
29. The advantage of this approach, from the point of view of the banks is that it severs any link between the bank and the outcome of the impaired loan. Moreover, since the credit quality of the bond is Government there is zero risk weighting with consequential savings in capital. Another advantage is that the bond, in the hands of the banks, should be eligible collateral for the purpose of Repo agreements at the Central Bank and this, could be used by banks to replenish liquidity. The disadvantage, obviously, is that it adds substantially to the national debt.
Impact of Increase in National Debt
30. A key question is whether the measures underlying the bond issue (i.e. the creation of an asset management agency and associated banks’ recapitalisation measures) are considered by capital markets to resolve the capital adequacy question about Irish banks and the Proposal for a National Asset Management Agency: Abridged Summary of Report of Special Advisor At NTMA 8 8 April 2009
associated attrition being experienced in banks’ deposit liabilities which in turn has created the need for the Guarantee scheme? Another key factor relates to the underlying public finance position and current efforts towards stabilising the deficit, which is widening beyond expectations. Then there is the question of the impact of such expansion of the debt on the capacity to service the debt. Ireland has the capacity to absorb additional debt service costs if these were to come about. Finally, the proposed issuance would not take place without the support of the ECB. Of itself, that would tend to mitigate adverse speculative reaction. However, there remains the risk however that the market may focus solely on the ‘headline’ news, pushing CDS levels wider, unless the strategic plan is explained comprehensively and clearly.
Sharing Unanticipated Gains and Losses on Impairments: Provision for Equity, Warrants and Claw-back Arrangements
32. The projected value of impaired loans is sensitive to the underlying assumptions and there is need to protect the State from potential unanticipated losses. One way of achieving this would be for banks, which are transferring impaired loans to the NAMA to provide a warrant to purchase shares in the bank which can be exercised by the Government in several years time at a price – and here’s the key – which depends inversely on the value of the impaired debt at that future date. The future date needs to be set far enough into the future for the market in these kinds of assets to have settled down and their price less imponderable. If the valuation of impaired assets is significantly greater than anticipated at the time of transfer, the warrant will end up too costly to exercise. If the valuation proves to have been wrong and the assets end up worth far less than at the time of transfer the Government will hold an equity stake compensating it in the end for the additional losses it has taken on the assets. Another mechanism would be to use claw-back arrangements in which Government, on the winding up of the NAMA, would determine if it has made a profit or a loss in its lifetime. Any profits would accrue to the State but any losses incurred by NAMA would be clawed back from the participating institutions by means of a levy over a number of years.
Valuation Issues at Transfer: Supplementary Assessor Process
36. In the case of mandatory transfer of assets a Supplementary Assessor Process could apply. In this approach, the valuation is done prior to transfer and payment by the NAMA itself, following expedited due diligence. The Assessor structure then follows subsequently at a suitable time to ensure that the amount paid was indeed fair. This has a number of benefits in that the timeframe in which the Assessor operates in is no longer relevant to the timing of the transfer, the NAMA can price more strategically taking into account the market impact of the pricing and there is only upside for the banks when the Assessor ultimately