Like a cartoon villain kept alive by the forces beyond the control of the rational, NAMA refuses to die. Despite not a single independent commentator lending it his support, and despite Michael Somers of the NTMA not knowing the nature of what is being put under his organization’s umbrella, NAMA rolls on.
Any responsible Government, undertaking a gamble involving tens of billions in taxpayers’ funds will start by publishing an exact cost-benefit assessment of the proposed scheme. First, the assumptions, then the results. To date, the Irish Government has failed to do this.
So let us attempt our own estimation of all NAMA costs and returns.
To calculate the impact a venture such as NAMA requires estimates of various costs net of the potential streams of income discounted over time. In our calculations we assume inflation of 3%, as consistent with the historic averages for the countries similar to Ireland. We take 15 years as an estimate of the life of NAMA. Other assumptions are also crucial.
In the case of NAMA the main costs are threefold: the cost of borrowing billions to take the toxic assets off the banks, the face value of the bonds, and the operating cost of running NAMA. Income to NAMA is the yield that can be achieved on the toxic assets, plus the value of assets at realisation.
Using similar inputs, two weeks ago, Davy stockbrokers suggested that NAMA could yield a profit of some Euro6 billion. Earlier this week, in his Irish Times article Alan Ahearne has simply asserted that “Nama’s assets and liabilities will roughly match”, without providing any estimates to support his assertion.
It is our contention that these claims represent a significant overestimate and that the true cost of NAMA is more likely to be in the order of losses of tens of billions Euros to the taxpayer.
A key question for NAMA is the price that will be paid to the banks for the Euro90b loans to be transferred. Unfortunately this key question is almost unanswerable until NAMA completes its purchases. In effect, under NAMA, the taxpayers can be compared to a blindfolded consumer buying an unknown quantity of an unidentified object for an unspecified price. Discussions have suggested “haircuts” of between 15 and 30% that is to say that the state would pay between Euro76.5b and 63b to the banks for these assets. This would of course mean that the banks would be left nursing losses of some Euro13.5b to Euro27b.
The key issue here is the extent to which the assets underlying assets have deteriorated. Figures upwards of 40% declines have been recorded on some such assets already. Our baseline scenario is that the NAMA assets will be purchased by the state at a 20% discount.
The amount paid for the loans determines the amount that will be required to be reinjected into the banks. As realised losses are offset against capital, the balance for the government is between overpaying for the assets (say a haircut of 15%) and thus giving taxpayers money to the banks through NAMA, versus a too severe haircut (say 60% for illustration) and causing them to require massive recapitalisation after NAMA. Irish banks total capital stands at approx Euro35b. As there is little room for the banks to absorb losses, we assume that 1/3 of the write downs they will take under NAMA will be reinjected back as capital. Our baseline scenario implies that some Euro6b will be required to be injected back as capital.
Once the assets are taken over from the banks, the entire face value of the assets will not be fully recoverable. At present the banks are taking 3-5% of assets as bad debts, which is low given the experience of OECD economies in previous property crashes even without a coincident credit crisis and global recession. Our baseline scenario is that 10% of the assets transferred will be worthless – in line with the historical records from the OECD economies.
What yield can realistically be expected from these loans? Historically the average yield from real estate in Ireland is of the order of 5-6%. If we assume that 2/3 of all assets yield this and the rest nothing we get an average yield of 4% on the basket of NAMA assets for our baseline scenario. This assumption is erring on being optimistic.
A major input into any analysis of a bond-financed asset purchase scheme is the cost of funding. Earlier this week Euro1bn of ten year bonds was issued at 5.2%. It is inconceivable that tens of billions of sovereign backed paper will be issuable at no strain on the spread.
Our baseline scenario is that NAMA bonds will be issued at 5-year maturities – consistent with the maturities of the majority of state-issued bonds over the last year. These will be issued at an average of 6% over the 15 years. This average is close to the current financing rate of 5.2% and thus represents a conservative assumption.
Another cost is that of running NAMA. The NTMA, NAMA’s parent organization, is a fantastic place to work where the average remuneration, including expenses, works out at over €166,000 per annum for 2008. NAMA will have perhaps 30-40 staff overseeing the bank property managers, so our baseline scenario has a running cost of approx Euro6.5m per annum. This can reasonably be expected to increase by 2-3% per annum – an extremely optimistic assumption given the past rates of increases in public sector pay.
Under these baseline scenarios we find that the present value of the cost of NAMA is of the order of a loss of Euro20b, after all income is factored in. This is equivalent to about 9 months total tax revenue or 13% of GDP.
This cost as a percentage of GDP is actually at the lower end of relative costs. World bank and IMF estimates of the costs of the Asian financial crises of the 1990s range towards 35% of national income.
If we take a more pessimistic perspective on yields, and cut the average to 3% while at the same time assuming that an overpayment occurs and the haircut is only 15%, with actual default on loans reaching 15%, the costs rise towards the Euro40b mark, still far below the relative cost of the Asian crisis.
In the end, there is no plausible combination of assumptions on NAMA costs and income that can yield a zero loss to the scheme from the taxpayers’ perspective. This may be the reason as to why to date the Government has not disclosed any specific calculations as to how it expects the NAMA to work.
Instead of pricing NAMA risks, Government officials are focusing their attention on comparing NAMA with the proposed German model for banks rescues. Such arguments are fallacious, as German plans are not designed to tackle the same problems that NAMA is aiming to address. Neither the scope, nor the actual debt instruments involved, nor the associated risks are the same for two plans. The only relative comparison that can be made between German and Irish plans relates to the present value of the haircuts applied to the securities transferred to each ‘bad bank’, as shown in the table below.
On the net, whether the German plan is better or worse than NAMA is moot point. After weeks of keeping the NAMA on life support tubes of propagandistic declarations, the Government should pull the plug on this cartoonish villain of public finances.
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Originally Posted by Political_Hardball
