NAMA: Impact and Implications for Businesses Valerio Pot

1
NAMA Impact and Implications for
BusinessesValerio Potì (DCU Business School)

• NorDubCo
• Dublin City University, 3rd November 2009

2
Plan

• A brief history of the 2007-2009 financial crisis
• Summary of NAMA and its philosophy
• Implications for businesses/SMEs

3
2007-09 Credit Crisis

• The making of the banking crisis
• 2006 credit delinquencies up in the US and UK
• 2007 20 US sub-prime lending institutions go
  bust, investment banks start to look with
  suspicion at widening credit spreads and withdraw
  from securitization market, liquidity in
  inter-bank markets start to dry up, Northern Rock
  goes KO (nationalized in Feb 2008)
• Q3 2008 crack Lehman, UK government bails out
  RBS, HBOS and Lloyds TSB, bank shares plunge
  worldwide

4
In Ireland in the Meantime

• April 2008 (sources UBS survey of bank balance
  sheets and Raiffeisen Bank)
• Ireland's average loan-to-deposit ratio is 163.1
  percent
• Irish Life Permanent (ILP, country's largest
  mortgage lender) ratio of 277.4 percent, one of
  the highest of any western financial institution
• Second-highest ratio, at Bank of Ireland, stands
  at 160.3 percent
• For the typical US commercial bank, the ratio was
  about 100 to 110 percent. The average ratio in
  The Euro-zone was 86.6 percent.
• Sept 2008 government guarantee of all bank
  liabilities (400bn pledge)
• Nov 2008 heated policy debate, myself and 4/5
  other economists write two IT opeds calling for a
  10/15 bln recapitalization
• Jan 2009 Anglo-Irish nationalization
• April 2009 (Peter) Bacon Report and launch of
  NAMA idea
• Sept 2009 publication of draft NAMA Bill

5
NAMA Business Plan

• Highlights
• NAMA will purchase bank assets through the
  issuance to participating institutions of
  Government-guaranteed securities, along with NAMA
  subordinated debt at a discount to the nominal
  value of loans being acquired. Subordinated debt
  will amount to 5 of the total amount of
  securities issued.
• Latest twist is the SPV, but that changes
  nothing.
• Participating institutions may use the securities
  as collateral with the ECB and/or with market
  counterparties in order to obtain cash. It is
  expected that the resulting injection of cash
  into these banks should enable them to facilitate
  the flow of lending into the economy.

6
NAMA Portfolio Key Parameters
7
Lending to Businesses/SMEs

• Neither NAMA nor business plan have any specific
  provision
• Increase in lending is simply the hoped outcome
  of the cleaning up of the banking books
• Will this happen?

8
NAMA and ECB

• One (main?) beneficiary is the ECB
• It has already lent Eur 120 bln to Irish banks
• The Eur 54 bln from NAMA will likely be used, at
  least in part, to replace lending secured by
  dubious (toxic?) commercial banks assets with
  lending backed by the full faith and credit of
  the Irish taxpayer

9
Why is Government Rescuing the ECB?

• Likely a subtle political deal
• You take responsibility for your banks debt, we
  leave you in charge of your own banking
  regulation and, most importantly, your tax policy
• Subtext of comments made by key EU (German
  Finance Minister) and Irish figures (former
  Taoiseach Garret Fitzgerald) is very clear

10
Bottom Line

• This means that only a fraction of the Eur 54 bln
  will translate into fresh cash injection that
  banks can lend on
• Impossible to guess how big this fraction will
  be, high political nature of the underlying deal
• Availability of credit will likely improve mainly
  thanks to returning activity in inter-bank market

11
Question

• Is there such a huge demand for credit?
• Probably not so much demand of financing for
  investments, but thirst for short term facilities
  to finance working capital as stocks have piled
  up and it takes longer for receivables to
  translate into cash
• Thats likely to stay in short supply, not due to
  NAMA or the financial crisis, but the end of the
  secular downwards trend in bank capitalization
  (BIS argues that at least 10 CR is needed in
  good times)

12
Final Thoughts

• Short term facilities to finance working capital
  are an instance of high risk unsecured lending
  for which banks will have less and less appetite
• Not due to NAMA or the financial crisis, but the
  end of the secular downwards trend in bank
  capitalization (BIS argues that at least 10 CR
  is needed in good times)
• Regulation and capital requirements are going in
  that direction too
• For 20 years, this trend inversion has been
  offset by rising equity market valuations

13
Bank Capitalization Over Time
14
Conclusions

• NAMA is the latest step in a sequence of measures
  taken to preserve the stability of the banking
  sector in Ireland and its place in the
  Euro-system
• No specific provision on lending to businesses,
  beneficial effect on lending the hoped outcome of
  banks balance sheets cleaning up
• Because of long-term trend in bank
  capitalization, businesses will have to adjust to
  operating with lower levels of debt and higher
  levels of risk capital (own funds arrangements
  that limit downside)

15
New Bank Capital Requirements

• Transition to Basel II/CRD3 (or CAD III) might
  exacerbate shortage of capital allocated to SMEs
  lending, due to the smaller scale and lower
  visibility of these companies, even though
  provisions have been made to limit this danger
• Favourable treatment granted to the retail
  portfolio under Basel II/CAD III, along with
  provision of a special correction factor for SME
  loans in the IRB corporate portfolio
• Commenting in general terms about the effects on
  credit supply remains extremely difficult, since
  much of the changes will depend ultimately on the
  individual characteristics of the various
  institutions.
• Different lending procedures and varying risk
  management expertise will lead to variegated
  outcomes throughout the industry
• Better rated banks able to maneuver more and lend
  at better rates and, on the overall
• Good news looks like tightening of capital
  requirements in proposed Basel III/CRD4 will hit
  residential loans more than lending to businesses
• idea that residential mortgages, not businesses,
  were the epicenter of the crisis