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Private sector role vital to keep debt ‘off balance sheet’
25 October 2009 By David Clerkin, Markets Correspondent
Despite all the noise generated over the National Asset Management Agency (Nama) over the past six months, it fell to Eurostat, the European Commission’s statistics agency, to shed new light on the detailed workings of the new bad bank last week.
It offered its opinion that Nama’s borrowings would not be included in the national debt, thus granting the government’s wish that Nama would be a so-called ‘‘off the balance sheet’’ vehicle. Eurostat also released details of its dealings with the Central Statistics Office (CSO), which had sought the opinion on behalf of the government.
Correspondence between the two agencies revealed that Nama will not, after all, be the body that hands over government bonds worth €54 billion for toxic loans originally valued by the banks at €77 billion. These currently have an estimated market value of €47 billion.
Instead, Nama will create a special purpose vehicle (SPV) to acquire the loans. Nama will own 49 per cent of the SPV, with the remaining 51 per cent - and thus majority control - belonging to unidentified private investors.
It is the SPV, not Nama, that will issue bonds (essentially IOUs), although these bonds will be guaranteed by the government.
If Nama or the SPV fails to recoup enough from its loans to repay these IOUs, the government will stump up the difference.
Eurostat underlined the importance of making sure that the SPV was majority-owned by the private sector, rather than by the government or its Nama offshoot.
The agency agreed with the case put to it by the CSO - that, while Nama should be classified as part of the government, the SPV (as a company in which Nama held only a minority stake) should not. Eurostat’s decision was not entirely unexpected - it had given a similar thumbs-up on the accounting treatment of schemes established by the French and German governments.
But it came as a relief to the government and was heartily welcomed by Minister for Finance Brian Lenihan.
‘‘The preliminary decision of Eurostat means that the acquisition of the assets from the financial institutions by Nama may be treated as off-balance sheet in the budgetary arithmetic under European national accounting rules," said Lenihan. ‘‘In other words, it will not increase the general government debt ratio, and neither will our budget balance be directly affected by the Nama initiative."
But Eurostat’s concession was described as ‘‘rather indulgent’’ by sovereign debt analysts at French bank Société Générale (SocGen).
‘‘This represents a much more liberal interpretation by Eurostat of what is public and what is private," said SocGen’s Ciaran O’Hagan. He said that the decision ‘‘helps lift the pressure off Ireland’’ and that it was ‘‘also helpful for ratings’’, meaning that it would make Irish government bonds seem more attractive than they might otherwise have been.
‘‘We have strong misgivings over the setting up of Nama," he said. ‘‘However, the genius of the plan is that . . . it buys Ireland time, allowing the government to protect its domestic banks and the interests of their investors, if at a cost to taxpayers and sovereign bondholders’’.
But in order to keep the Nama-related debt off the government’s balance sheet, the agency will have to engage in some complicated juggling of its structure.
It needs to find private investors willing to provide 51 per cent of the €100 million that will be necessary to get the SPV up and running.
This will involve some hard selling by the Department of Finance and the National Treasury Management Agency (NTMA), the state’s cash management arm. They are believed to be targeting major pension funds and heavyweight institutions both overseas and in Ireland, although it is unclear whether Irish banks or their asset management arms will invest.
But at a time when private investors are displaying little appetite for risky projects, taking a stake in the Nama SPV may not seem to be the most attractive home for their money.
The deal will offer investors an annual dividend, payable if Nama receives more from the loans it will buy than it has to pay out on its IOUs. They will also receive a 10 per cent bonus on their investment if the SPV makes money over its lifetime.
But what investors will plump for this, when there are so many investment alternatives on offer? Eurostat noted the government’s assertions that the Nama exercise would make a profit over its lifetime - but it was not convinced.
Noting the government’s view that the Nama SPV would make profits in today’s terms of €4.8 billion, assuming property prices increased by 10 per cent over the next ten years, it said: ‘‘Eurostat is not in a position to judge whether this condition is plausible." It added, however, that it would find it ‘‘reassuring’’ if private investors bought into Nama on this basis.
It opted not to accept an argument made by the CSO on the potential for property prices to rebound, although it did note that ‘‘the Irish authorities believe that, under the current conditions, the market value for properties is artificially low’’.
According to the CSO, ‘‘Nama have been advised that, while there may be some short term fall in MVs [market values] after assets are purchased, ‘based on capital values, the bottom has been reached in the US, Britain and Europe’, and in Ireland, ‘the market expects that the bottom may be reached in the last quarter of 2009 or the first quarter of 2010’ ". It did not disclose its source for this advice.
For Nama chief executive Brendan McDonagh, however, the presence of private investors in an SPV will present greater complexity than would have been the case if Nama had bought the loans through a company in which it had 100 per cent ownership.
The terms governing Nama’s relationship with the SPV will force Lenihan to walk a fine line. He will be conscious that, if Nama is seen to have control, its debt could end up on the government’s balance sheet - but he will also need to guard against any loophole that could leave Nama exposed and unable to act as it wished in relation to individual loans.
The SPV will have its own board with ‘‘autonomy of decision in its day-to-day operations’’, with private sector nominees in the majority to reflect the fact that it is majority privately owned. Nama’s nominees to the board, however, will maintain a veto over ‘‘all decisions of the board that could affect the interests of Nama or the Irish government’’, according to correspondence between the CSO and Eurostat.
From Lenihan’s point of view, as if Nama were not complicated enough, he must also sell a complicated structure that he feels is essential for his desired accounting treatment. Since it first emerged, the Nama scheme has been an exercise in trying to buck the unmerciful logic of the markets.
Now Lenihan must buck logic again, and put his €54 billion gamble in the hands of a company over which he has less than total control.
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