In the foothills of a big climb

Twenty-seven months into a 10-year project, Nama boss Brendan McDonagh is confident the State will get back its €32bn investment

THE NATIONAL Asset Management Agency has named the meeting rooms on the third floor of its offices in Dublin after Irish mountains. Brendan McDonagh jokes that it reminds Nama’s 214 staff of the mountain they must climb at work every day.

Even though he has built Nama up from the ground to an agency holding loans with a face value of €74 billion purchased with €31.8 billion of State-backed borrowings, the chief executive of the State loans agency is still in the foothills of what is a big climb.

The challenges to ensure that the State at least breaks even on Nama by the time it ceases to exist in 2020 can be seen in the €1.3 billion impairment charge it took on loans for 2011, reported on Wednesday. This reflected further falls in the property market and the hit on the Irish loans. The charge brought total impairments to €2.75 billion and left Nama with a profit of €247 million for 2011 (including a tax credit of €235 million).

“I have always had the view that short-term profitability on an annual basis means nothing in the context of Nama,” says McDonagh, sitting in the Djouce meeting room. “What is important is that the €31.8 billion liability of the State is zero by 2020 and that we have recovered all that money and the State doesn’t have another hole to fill. That means trying to get the best price for the assets and use the cashflow surpluses that we are generating on overseas assets to help the Irish market.”

Impairments on loans account for declines of more than 20 per cent on commercial property values and more than 25 per cent on residential property values since the €74 billion in loans were valued in November 2009. “Nobody ever thought back in 2009 that we were heading for bailout territory and that has downstream consequences for the Irish economy,” he says.

Nama would be “quite confident” that it will remove the €31.8 billion contingent liability facing the State by the time the agency is shut down, he says. But people shouldn’t expect that the State agency will be able to recover the €74 billion the property developers on its books originally borrowed from five lenders.

There is “no crock of gold out there” by way of assets that debtors have not disclosed, he says. Nama has recovered more than €500 million in assets not previously pledged for borrowings by the agency’s 780 debtors.

Still, the optimism shown about Nama’s prospects has softened as the property prices have continued to fall in recent years. In 2009 Nama was expecting to make a profit of €5.5 billion by 2020. Last year, that forecast had fallen to €1 billion. McDonagh said earlier this month that it would at least break even.

“What we are going to have to realise at the end of the day is what we are going to sell the assets for plus any additional security or assets we can get off the debtors,” says McDonagh. “I wish it could be more but I have to be upfront with people and that is what we are going to get.

“If you’re going to get anything above it, then it is going to be on the back of very strong economic recovery. I don’t see anybody predicting anything other than a steady ship from 2014. It is going to be about 2 per cent annual growth on average until 2020.”

McDonagh says Nama’s loans have “better characteristics” than those of other banks, as more than 90 per cent of the €17.5 billion of loans in the Republic are “urban-centric” in Dublin and the commuter belt around the city, Cork, Limerick and Galway.

Nama has spent €400,000 searching for hidden assets and this has yielded €5 million in the likes of company shares, properties and racehorses that had not been disclosed. But value for money is not the issue, he says.

“It is basically sending the message out that you have to be upfront with us if you want to work with us,” he says.

McDonagh declines to say whether there would have been a better way of removing that €74 billion of the most toxic loans, relating to developers and land speculators, from the five financial institutions.

The prolonged transfer of assets through 2010 and the uncertainty around the final size of the hole the State had to fill in the banks didn’t help confidence in the Government’s ability to cope at a time of a budgetary crisis.

“The policy decision was the policy decision at the time. I am precluded from commenting on policy decisions,” says McDonagh.

Nama has been contacted by the Spanish authorities who are looking at how to purge their own banks of toxic assets. If he could advise them to do anything differently, it would be around how the loans were transferred from the banks. “The transfers did not happen as quickly as I would have hoped because the banks didn’t have the information to be able to get it together, to package it up to give it to us,” says McDonagh.

The banks transferred nominal loans of €27 billion of the most indebted debtors by September 2010 but the death-by-a-thousand-

haircuts and mounting banking losses aroused concerns about the Government’s ability to cover them. The European Commission insisted that the assets were valued loan-by-loan in a painfully protracted process.

“If there was one thing that might have been done quicker, maybe at the start, it would have been for the European Commission to allow the transfer of assets in bulk form, estimate the discount and do the adjustment afterwards. That wasn’t in the gift at the time,” says McDonagh.

After September 2010, the remaining loans were moved at an estimated discount of 58 per cent. The actual discount came in at 57 per cent because Nama could see how the loans were composed from earlier transfers.

McDonagh says it turned out that the banking problem ran deeper beyond the property loans Nama acquired. “People forget about the amount of losses incurred in the Irish banking system – about €40 billion of those losses had been as a result of Nama.

“Almost €80 billion of the losses have been in non-Nama banks but also in parts of their mortgage books or other parts of their books as well, which has nothing to do with Nama. The problem was much more pervasive than people had thought back in 2009.”

Responsibility for the crisis in the banks lies with their boards and the regulator, he says.

As for the claims of the last government that Nama would kick-start lending by the banks, McDonagh says there has been “a lot of revisionism around that”. Nama gave the banks liquidity of €30 billion by the issuing of State-backed bonds which they could swap for European Central Bank cash but the banks ended up losing €100 billion in liquidity through withdrawn deposits, he says.

“I don’t think it is a question that the banks don’t want to lend. I think they have to lend because otherwise there is no point in having banks,” says McDonagh. “The second issue is they lost much more liquidity and they are trying to save their liquidity the whole time. Obviously the economy has slowed down as well. There is a bit of an over-correction going on; they got so burned and are much more cautious about their lending policies. If they didn’t have the Nama €32 billion liquidity, they would be a lot worse.”

McDonagh says Nama is 18 months ahead of schedule in terms of meeting the target of repaying €7.5 billion of the €32 billion it has borrowed by the end of next year. The State agency has repaid €3.25 billion and has close to €3.4 billion in cash on its balance sheet.

But given that the agency has had to take €2.75 billion in impairments on its loan so far, will Nama, like the banks it was created to clean up, require a State bailout?

McDonagh says there is the €1.5 billion cushion in a subordinated bond issued to the banks and the agency will become more profitable, while impairments will only have to be taken on specific loans after this year.

“We are probably going to be producing pre-impairment profits of well over €1 billion a year so we would believe at this stage – with a cumulative impairment taken of €2.75 billion, absent anything that has taken place in the market – we are probably reasonably provided for at this stage,” he says.

McDonagh says Nama is sitting on about €2 billion of unrealised gains which it could take into its profit line if it wanted to under the strict IFRS accounting rules. The board has taken a conservative view – “we’ll take those gains when they are realised,” he says.

Nama has raised most of its cash from asset sales in the UK but McDonagh rejects accusations that it is picking low-hanging fruit in a functioning orchard with buyers. The agency’s view is that if an asset is yielding 5 per cent – the annual rental income as a percentage of the property’s value – then it’s time to get out and sell, and McDonagh says that there is more demand for foreign assets.

“People have to think that we are under obligation to repay €7.5 billion of our bonds by the end of 2013. If we can’t get the assets sold in the Irish market for all sorts of reasons, then we have to find the money somewhere else because it is part of the troika programme and the Government expects us to deliver on that,” says McDonagh.

Another issue being examined by the troika and the Government is how to remove bad or unprofitable loans such as tracker rate mortgages from the “live” banks. McDonagh says Nama could take them but it’s a policy decision on which he cannot comment.

“If you wanted to do it strategically, I think there is a lot of knowledge within Nama. It could be useful for [that purpose] but that is somebody else’s decision,” he says.

He also declines to comment on whether the State has to have two asset recovery vehicles in Nama and Irish Bank Resolution Corporation, formerly Anglo Irish Bank and Irish Nationwide, as merging them, or allowing one take over the other, is again a policy decision for the Government.

It could be done, he says, if that decision was made. “My view is, like anything, given the challenge to get on with it you do it and you do it within a reasonable timeframe. But that is a policy decision,” he says.

McDonagh says Nama has taken on board some recommendations made by former HSBC chief executive Michael Geoghegan, who reviewed the agency for Minister for Finance Michael Noonan and the board of the agency last year; others were rejected.

Nama decided against hiring 200 more staff to manage 583 of the less heavily indebted borrowers directly, leaving it to the banks to manage their loans. (The agency manages the top 189 debtors and their €61 billion of nominal value debts directly.)

McDonagh says Nama has staff sitting on the credit committees at the banks and is reviewing loan cases every week, and it is getting good value out of the understanding the banks have of the debtors locally.

He says Geoghegan’s proposal to outsource small batches of loans to a service provider to see if they can do a better job will be kept under review but he feels that such a provider was “not going to do much more than what Nama is doing working with the banks”.

As for the risk of Nama not becoming a more entrepreneurial and the threat that this could cost the agency billions of euro, as Geoghegan warned, McDonagh says they are “getting on with it”.

“Twenty-seven months ago we had zero cash and we have collected €8.3 billion – that is a massive achievement in anyone’s book.”

He complains that barstool criticism about Nama not moving fast enough may be coming from “the same people who thought it was a great idea that a loan decision was made in 12 or 24 hours and ended up with this mess in the first place. That might be the reason why they are sitting on the barstool”.

Rejecting the low-balling bidders from distressed buyers knocking on Nama’s door, McDonagh says he is accountable to the Oireachtas and cannot sell an asset that, based on rental income, is worth more than a bidder might be willing to offer Nama.

“I can’t stand over that kind of decision; that’s basically robbing the taxpayer,” he says.

The agency also plans to extend the 20 per cent payment deferral scheme to a further 250 houses at the start of September to encourage buyers into the market. “We are not doing anything which no one else can do in the market. It is quite a limited scheme. It is to aid price transparency,” he says.

Nama has said it will invest €2 billion in completing projects up to 2016 and offer €2 billion in vendor finance to assist buyers of its properties who cannot secure loans.

McDonagh says Nama is “not afraid to recycle our money” and to hold and rent out finished apartments, or raise cash from selling properties via Qualifying Investor Funds, a potential €2 trillion market in the IFSC alone.

Transparency is another subject on which Nama receives much criticism. McDonagh says the two things people most want to know is which developers and what assets are in Nama. He is precluded from revealing either under the Nama legislation, he says.

McDonagh says that none of the debtors produced business plans with which Nama fully agreed. The agency looked at 791 plans in total. Most were rejected because debtors wanted to hold on to assets as long as possible and wait for a recovery in the market. One debtor even wanted Nama to loan a further €1 billion to complete existing projects.

In many cases, debtors were even reluctant to rent out completed apartments so that they could sell them. Nama has rented about 4,500 residential units and is planning to rent another 4,500. All told, Nama is generating cashflow of about €100 million a month.

“There is a human condition that things will be okay in the future. Most debtors don’t want to sell any assets. That’s what it was like at the start. All those tough conversations happened over many months. We had regular meetings with them and assets are being put in the market. Psychologically it is very difficult for them,” he says.

McDonagh jokes about the excuses he hears from debtors about asset transfers to spouses or assets they claim to have forgotten to tell Nama about. “It’s amazing how the mind plays tricks with people,” he says.

Reversals in asset transfers to connected banks has generated €160 million for Nama.

Litigation taken by big debtors is a fact of life for Nama – some of the borrowers didn’t like being told what to do as this had not happened to them before, he says.

“Some people swallow hard and accept it and other people just can’t do that and you end up in litigation. It is unfortunate. It is not what we want. If we are litigated against, we will rigorously defend ourselves,” he says.

The payment of up to €200,000 in annual salaries to developers is another area which has generated much criticism of Nama recently. About 160 debtors are paid €15.5 million a year, or an average of €97,000, on Nama-approved salaries, says McDonagh.

Appointing receivers and property managers to do the job those developers are doing would cost considerably more, he says.

“You draw a deep breath sometimes and ask yourself do you really have to do this, but you have to say this is not personal but what is the best commercial outcome.”

As for his own pay, McDonagh has no plans to take a further reduction towards the €200,000 cap for top civil servants following the pay cut he agreed to take last year to €365,000 on his €430,000 salary in 2011.

“I have taken a 15 per cent pay cut when the Minister requested it. I am not going to say any more than that. I have given up my bonuses. I was one of the first to give up my bonus before being asked to do so. I believe that I have played my part in this,” he said.

McDonagh accepts that trying to get money back from people doesn’t make him popular but he doesn’t take criticism personally or run Nama “as a vengeance vehicle”.

“It is a great role – not many people get this opportunity. I am very pragmatic about it. It is a job and you have got to get on with it to the best of your ability and do it so you can hold your head high and say you have done the best for the taxpayer,” he says.

FRIDAY INTERVIEW

Name: Brendan McDonagh.

Age: 44.

Position: Chief executive, National Asset Management Agency.

Family: Married with two children.

Hobbies: Sport.

Education: He studied business studies at Dublin Institute of Technology and qualified as a Chartered Management Accountant one year later.

Career: He joined the National Treasury Management Agency in 1994 from power company ESB where he worked in accounting, internal audit and treasury. He was the financial controller of the agency from 1998 to 2002 when he became director of finance, technology and risk. He was appointed chief executive of Nama in December 2009 by the then minister for finance Brian Lenihan.

Something you might expect: He is not making any plans for the fourth Sunday in September when he is hoping to be in Croke Park to support his native Kerry.

Something that might surprise: He recently had to buy a Dublin shirt and kit for his son; it was the hardest decision he claims he ever made.