# Subordinated Debt , risk sharing and NAMA



## ipxl (28 Oct 2009)

So the minister has apparently clarified that the amount of subordinated bonds issued to the banks as part of the token risk-sharing in NAMA will be capped at 5% and the reasons he gives is that these bonds have to generate a coupon of somewhere between 5-7% to reflect the riskiness and that a higher proportion of allocation of sub debt within the NAMA bond issuance would have crippled NAMA's cost base.

How, broadly are these sub bonds meant to work ?
How do they represent risk sharing ? What's the downside for the banks ?

I ask because I reckon the majority of folks , even avid broadsheet readers who don't have a decent grasp of financial economics won't have a clue and I'm sure the terms on these bonds are of utmost interest to the taxpayer in how NAMA is defined.


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## DerKaiser (28 Oct 2009)

I think the idea is that if NAMA is wound up as loss making the subordinated debt holders will be the next to get hit after the €100m in equity? 

If winding up occurs after 10 years this is a big risk, if it is after 20 then these guys will probably earn a decent return through coupons alone. 

I'd like to hear more about the reward sharing side of things. €100m of capital, €51m stumped up by private investors. Is there a possibility that these guys have a max exposure of €51m but stand to gain billions if we end up with a bit of house inflation over the term of NAMA?


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## ipxl (28 Oct 2009)

I think we are talking across purposes here.
I am pretty sure you are talking about the SPV (Special Purpose Vehicle) which  was only mooted in the last few days as a way of keeping NAMA liabilities off the government debt balance sheet. 

The assymetry in the risk in that is staggering but it is just a smoke and mirrors way of keeping Eurostat measured debt ignorant of NAMA liabilities.

The risk sharing I am talking about are the subordinated bonds being issued to the banks which were a concession added to NAMA after Patrick Honohan (prior to his appointment as Governor of central bank) expressed a strong view that NAMA should incorporate some risk sharing between taxpayer and the banks. The coupon on these bonds is now being revealed and to my untrained eye it looks murky.

http://www.thepropertypin.com/viewtopic.php?f=50&t=26107


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## DerKaiser (28 Oct 2009)

ipxl said:


> I think we are talking across purposes here.
> I am pretty sure you are talking about the SPV (Special Purpose Vehicle)


Apologies for going slightly off topic by introducing the SPV, but I am talking along the same lines as the property pin poster where I have said:



derkaiser said:


> I think the idea is that if NAMA is wound up as loss making the subordinated debt holders will be the next to get hit after the €100m in equity?
> 
> If winding up occurs after 10 years this is a big risk for subordinated debt holders, if it is after 20 then the subordinated debt holders will probably earn a decent return through coupons alone.


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## Sunny (29 Oct 2009)

DerKaiser said:


> I'd like to hear more about the reward sharing side of things. €100m of capital, €51m stumped up by private investors. Is there a possibility that these guys have a max exposure of €51m but stand to gain billions if we end up with a bit of house inflation over the term of NAMA?


 
The equity holders in the SPV get an annual dividend depending on the performance of the SPV. I haven't seen the level.
When the SPV is wound up, the equity holders will only get their capital back if the SPV has the ability to pay i.e. it is non-recourse. They also get a bonus of 10% of capital if the SPV makes a profit.
All other profits of the SPV will accrue to NAMA.

I have been watching some of the debate in the Dail and I have to say that it is very very irritating. To hear Joan Burton going on and on about this SPV when she doesn't understand it would drive anyone to despair. I am all for debate for something as important as this but there are much more important areas of NAMA than the setting up of a SPV.


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## ipxl (29 Oct 2009)

I assume the bonus of 10% of capital is 10% of the SPV capital amount (i.e 10% of 100Million Euro, not 10% of the "notional" NAMA profits ?

Actually my original question was not about the SPV at all.
I was asking about the 5% of NAMA bonds transferred to the banks as a token gesture to include "something along the lines" of what Patrick Honohan suggested in terms of risk sharing.

I'm trying to understand that arrangment and how the risk is being apportioned if NAMA breaks even, turns a profit or makes a big loss.
My understanding from it is that the banks have only a tiny exposure in the event that NAMA makes a loss under this arrangement.


On Joan Burton and the SPV - I personally think she does understand it. I take a more benign view in that she is trying to ensure that it is read into the public record exactly what the risks are for both counterparties in the arrangement. Of course there may be a certain amount of making political capital by adding more confusion to confusion but I think the SPV was omitted, for example, from the draft NAMA business plan and the whole presentation of NAMA has, to my mind, been littered with obfuscation so as to confuse the voting public.





Sunny said:


> The equity holders in the SPV get an annual dividend depending on the performance of the SPV. I haven't seen the level.
> When the SPV is wound up, the equity holders will only get their capital back if the SPV has the ability to pay i.e. it is non-recourse. They also get a bonus of 10% of capital if the SPV makes a profit.
> All other profits of the SPV will accrue to NAMA.
> 
> I have been watching some of the debate in the Dail and I have to say that it is very very irritating. To hear Joan Burton going on and on about this SPV when she doesn't understand it would drive anyone to despair. I am all for debate for something as important as this but there are much more important areas of NAMA than the setting up of a SPV.


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## Sunny (29 Oct 2009)

ipxl said:


> I assume the bonus of 10% of capital is 10% of the SPV capital amount (i.e 10% of 100Million Euro, not 10% of the "notional" NAMA profits ?
> 
> Actually my original question was not about the SPV at all.
> I was asking about the 5% of NAMA bonds transferred to the banks as a token gesture to include "something along the lines" of what Patrick Honohan suggested in terms of risk sharing.
> ...


 
Its on the share capital of the SPV so the private investors will get back an extra €5.1m if it is successful.
The banks have a greater exposure NAMA than you think since they are putting the provision of a banking levy on banks in the event of a loss into the legislation. 
It is completely unfeasible to issue 50% sub bonds to the banks. Defeats the whole purpose of the exercise.
The SPV was always likely to be used to keep NAMA off balance sheet. I am assuming it wasn't put in the initial plan because they were waiting for European Commission approval. There is nothing amazing or strange about the structure.


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## ipxl (29 Oct 2009)

Yes, that makes sense. 
I read the analysis piece in the Irish Times later this evening and I see the risk profile for the SPV [broken link removed] and it tallies with what you have said.

Also I see there that an SPV was also used recently in some financial rescue scheme put in place in France. Mind you I imagine , as usual, that might be in a substantially different context to ours with NAMA.

How the clawback levy is addressed in legal terms in the final NAMA legislation is going to be [broken link removed]. I agree that 50% proportion of sub bonds in the mix would be negate the effectiveness of whole NAMA scheme.
It does make me wonder, though , why someone as eminent as Mr Honohan had suggested it if it was always going to be unworkable. It seems odd to me that they would go to the bother of mixing in this very weakly effective mix of sub bonds at all given that imposition of terms of a performance levy/penalty will be enacted in the legislation as part of the agreed programme for government ....







Sunny said:


> Its on the share capital of the SPV so the private investors will get back an extra €5.1m if it is successful.
> The banks have a greater exposure NAMA than you think since they are putting the provision of a banking levy on banks in the event of a loss into the legislation.
> It is completely unfeasible to issue 50% sub bonds to the banks. Defeats the whole purpose of the exercise.
> The SPV was always likely to be used to keep NAMA off balance sheet. I am assuming it wasn't put in the initial plan because they were waiting for European Commission approval. There is nothing amazing or strange about the structure.


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## DerKaiser (29 Oct 2009)

Thanks for the clear explanations Sunny


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## darag (29 Oct 2009)

If the banks hold subordinated bonds issued by NAMA, in theory they will feel some pain if NAMA is in the red when wound up.

Remember how it is claimed that this going to work.  Lets say they go for the 5% ratio.  NAMA will give the banks roughly 52 billion of floating rate bonds (there is still no clarity on the structure of these bonds) and 2.5 billion of subordinated bonds (presumably fixed rate) in exchange for the toxic loans.

Each year, NAMA will have to pay the banks coupons (say 750 million initially on the floaters and 200 million on the subordinated bonds).

At the end of the ten years, NAMA will have magically converted the toxic loans into a war chest of cash - over 55 billion according to the "business plan".  It will then hand over this cash pile to the banks to honor the bonds it has issued.

If - surprise, surprise - NAMA somehow fails to be able to sweat the equivalent of the combined net worth of Bill Gates and Warren Buffet out of toxic loans to Irish builders in the 10 years (all the while paying the banks 1 billion a year in coupons which is likely to double that if interest rates rise even 2% or so), then NAMA won't have enough to pay off the bonds (i.e. the banks).

However, any shortfall under 52.5 billion will be made up by the exchequer.  So the banks are guaranteed to get 52.5 billion.  Were NAMA not to have amassed the full amount (55 billion) then the banks would stand to not get paid the last 2.5 billion (of subordinated debt).  This is chicken feed in terms of "risk sharing".

Of course, deferring the pain suits most of the main players involved in this mess at the moment particularly politicians, bankers and developers.  Ten years is a long time in politics and it's only then that the bill for NAMA (likely to be 10 or 20 billion, I suspect) will be presented.  In the mean time, the banks will have been paid between 10 and 20 billion worth of coupons, 2.5 billion will have gone on accountants, solicitors and consultants and there will be endless opportunity for political meddling (social housing, etc.).  

The bill will be paid by tax payers.  The final sick joke is that it is unlikely that NAMA will improve credit conditions in the country.

What is interesting is that in admitting that subordinated NAMA bonds would have to pay junk-bond like coupons, the minister is telling us what he really thinks of NAMA's chances of success.


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## ipxl (29 Oct 2009)

You are hitting the nail on the head here DaraG.

I had a rude awakening this morning hearing Frank Fahey effusively cheerleading NAMA and the profits it would generate for the state.

Karl Whelan has just started a blog post on the risk sharing mirage
on www.irisheconomy.ie.

I noticed he was looking for feedback on the issue of whether the banks would have to mark down the sub bonds from par if they were issued a larger proportion compared to the 5% they have capped them at.




darag said:


> If the banks hold subordinated bonds issued by NAMA, in theory they will feel some pain if NAMA is in the red when wound up.
> 
> Remember how it is claimed that this going to work.  Lets say they go for the 5% ratio.  NAMA will give the banks roughly 52 billion of floating rate bonds (there is still no clarity on the structure of these bonds) and 2.5 billion of subordinated bonds (presumably fixed rate) in exchange for the toxic loans.
> 
> ...


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## ipxl (30 Oct 2009)

Looks like the levy is heading towards being transmogrified into a corporation tax surcharge to

 "avoid any complications that could arise for bank balance sheets or capital from the explicit legal contingency of the levy"

Only can be paid out if the banks are profitable (after they come out of their post-NAMA cryogenic zombified state ...)

http://www.thepropertypin.com/viewtopic.php?f=50&t=26144





Sunny said:


> The banks have a greater exposure NAMA than you think since they are putting the provision of a banking levy on banks in the event of a loss into the legislation.


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