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Thursday, 28th March 2024
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Bad bank/Asset Management Company is the right solution Back  
A research report by Davy’s Stockbrokers, ‘Bad Bank/AMC is the right solution', says that the NAMA proposal is a solution for Ireland's banking system. The report gives a comprehensive analysis of NAMA, and while it broadly supports the premise of the NAMA proposals it also highlights some of the potential pitfalls.
What ultimately matters is what can be made operational. Centralising all the problem assets into one vehicle in a small country has scale advantages and lends itself to dealing with problem clients on a portfolio basis - that is a huge advantage. In Sweden, Securum focused on larger ticket loans and therefore dealt with 400 borrowers covering 3,000 loans. As Ireland is a country with less than half the population of Sweden, we doubt that we are dealing with even that number of relationships. For example, the PWC report on Anglo showed that the top 20 development and top 20 investment property exposures accounted for 25 per cent of group loans.

However, we see a number of problems with a single structure:
• The biggest issue is how we get the parties to agree on what should be transferred and at what price. This is a complex task and one complicated by the existence of cross-collateralisation and multibanking. Securum’s (the Swedish state company founded in 1992 during the financial crisis in Sweden 1990–1994) case involved a bank that had already been nationalised. Here we have multiple independent banks, so this is where mandatory powers could come into play.
• A second problem relates to operational issues. While it would be staffed with many professionals from the property/investment and corporate finance industry, it would be necessary to take people from the banks themselves who are familiar with the clients concerned (though not necessarily the people who initially granted the loans). Getting them to join a venture whose ultimate mission is to make itself redundant as quickly as possible is no easy task.
• The venture would also be dominant in the property market in Ireland for years to come and probably the only ‘buyer’ of such assets. That situation would not be ideal if we want to achieve price discovery, but it would, however, be better than nothing.
• It might also be more difficult to shield a single AMC from political interference/controversy.
• The central AMC stands a better chance of getting off the ground if the valuation row is settled at the end rather than at the beginning. As Allied Irish Banks and Bank of Ireland are still independent entities, a fact which further complicates the process of reaching agreement, one way to surmount this obstacle is if the disagreement over property valuations can be deferred. The parties could split any valuation difference today, recapitalise on that basis with equity/debt and find a mechanism to settle the outcome in five to ten years’ time when the assets are sold/easier to value. This kind of mechanism was employed to support UBS last October.

So Allied Irish Banks and Bank of Ireland retain an interest in a ring-fenced pool within the AMC, and they get a kicker if the mark-down on day one proves to be overly punitive. This could be used to buy back government equity/preference shares. If the hit does not prove to be large enough, the option is worth zero and the government covers the residual hit with longer-term, claw-back mechanisms that comply with EU rules.

Why is the AMC route preferable to insurance?
As we outlined in our joint broker note of last week, the AMC option - rather than insurance - was our preferred approach to dealing with the issue of property loans on bank balance sheets. Both ultimately achieve the same objective - the state takes some of the hit for the banks - although there are many differences. These include the timing of writedowns and therefore what capital ratios look like, the level of capital that is needed up-front, who manages the problem assets etc.
We outline the pros and cons associated with each approach:

The asset protection/insurance route

Positives
• Hits taken by the banks are lower in the early years than under the bad bank route, allowing pre-provision profits to support ratios. Second loss or tail risks are likely to be 90% covered by the state.
• The up-front capital injection from government is either zero (e.g. Lloyds) or lower than the bad bank route.
• Capital ratios in early years can be flattered by treatment of the fee if paid in shares (just optics though).
• Allows banks to pay for this protection out of future earnings rather than pay now in the form of equity issued at depressed valuations.

Negatives
• Given EU rules and lowish capital ratios to start with, any scheme for the Irish will probably require some equity injection to cover the first loss (as was the case with RBS).
• The Irish state takes on board an unquantified/unfunded liability when the market is already sceptical that Ireland Inc. can pay its way.
• Leaves management of problem loans in the hands of the banks, which may still be slow to take write-offs (only 50 per cent of first loss goes against core tier 1), i.e. moral hazard issues.
• Problem loans are too big/complex for banks to manage alone and would distract from day-to-day business.

The bad bank/AMC route

Positives
• Historic experience shows that bad banks are ideal vehicles to handle distressed property assets.
• The NPRF is ‘cash in hand’ that can cover the write-downs on transfer together with most, if not all, of the capital required by the AMC to operate (at least day one).
• Allows property and corporate finance specialists to get the best value from the property assets and frees up the banks to focus on ‘good banking’.
• Quickest way to restart the economy with banks returning to profitability earlier.

Negatives
• Does not allow pre-provision profits to support earnings.
• Requires more government capital up-front than insurance route.
• Can it be made operational in good time? Are the human capital resources there to staff the one or more vehicles required?
In deciding which approach to run with, we think there are two key objectives to consider:
• What approach will best convince bond and equity markets that Ireland Inc. can fund its way out of this recession?
• What is the best way to get credit flowing again, restore confidence and kick-start economic activity?

In our view the AMC route wins. Management at the Irish banks have a huge credibility problem with respect to their property books. Moreover, any approach which leaves these assets on balance sheet is a recipe for a zombie bank scenario and would not be optimal in our view.

In addition to this, the NPRF is available if necessary to fund it now and hence limit the market’s concern about future unfunded liabilities. We say limit deliberately as we are conscious that the NPRF may not cover 100 per cent of the likely liability. Many market participants are not aware that this fund exists as the EU does not take this into account when calculating Ireland’s General Government Deficit ratio.

We would note though that we can find no specific reference to the NPRF in what the government has published. The bottom line, however, is that it is there and can be redirected rather than the state raising new borrowings.

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