MINISTER'S ADDRESS:The following is an edited version of the opening statement by Minister for Finance Brian Lenihan to the Joint Committee on Finance and the Public Service yesterday
I’M PLEASED to be here today to discuss the Government’s legislative proposal to establish a National Asset Management Agency (Nama) and to debate the draft consultative legislation with Deputies and Senators. I acknowledge the contributions received from both Fine Gael and Labour and indeed the comments received from other interested parties and I intend to deal in detail with some of the issues raised later on in my address.
Protecting the banking system and supporting economic recovery
The banking system is unique. Its proper functioning is critical to the smooth running of the economy and in supporting economic recovery and therefore must be protected by government.
To date, the Government has taken a number of successful measures to stabilise the system and protect depositors.
These include the guarantee of certain bank liabilities including deposits, the recapitalisation of AIB and Bank of Ireland, and the nationalisation of Anglo Irish Bank. This has allowed banks to raise the funds needed to support their operations and ensured that citizens and businesses could go about their daily business and in the knowledge their funds are secure. Through the above actions we have managed to stabilise the financial system here.
In addition to achieving the above objectives, financial benefits have accrued to the State from the annual fees related to the guarantee, and income from the 8 per cent preference shares in AIB and Bank of Ireland. The State also holds warrants for a 25 per cent shareholding in AIB and Bank of Ireland which are increasing in value.
However, we must do more. Concern about the impact of risky loans on the banking system continues to create funding difficulties for the banks and restrict the flow of credit as banks focus their resources on these troubled loans. Every euro lent by a bank to a customer must be drawn from deposits or borrowed by the bank from somewhere else. Irish banks rely heavily on financial institutions abroad for funding. Uncertainty about the scale of losses on banks’ balance sheets has made this liquidity more difficult and costly to attract.
In addition, if banks remain unsure about the losses that will eventually result from these loans, and nervous about the adequacy of their capital, they will not provide the credit necessary to support economic recovery. I think there is general consensus that a resolution is urgently needed, because our economy will be hampered unless we have a banking system capable of providing credit to viable businesses and households as that recovery kicks in.
Asset management agency approach
Following an assessment of the options available to deal with these risky assets, and the recommendations of skilled advisers, the Government decided that the establishment of an asset management agency was the best approach. The asset management model has been supported and recommended by banking experts across the globe and used successfully in many countries in the past as part of the work-out process of problem loans.
The proposal to establish a National Asset Management Agency has been widely supported internationally by bodies such as the IMF and the OECD and, tellingly, since the announcement of the establishment of Nama in April, bond spreads above the German benchmark for Irish sovereign debt have halved, from almost 3 per cent over 10- year German bonds to now just 1.5 per cent. Irish 10-year bond yields are now 4.8 per cent.
KEY PARTS OF THE LEGISLATION
I would now like to bring the committee through the key parts of the legislation.
Part 1sets out in detail the purposes of the Act and includes some general provisions such as the definitions used in the Act.
Part 2deals with the functions and powers of Nama. Nama will have all necessary commercial powers of a financial asset management company to establish subsidiaries, to operate through agents, to buy and sell assets, to manage loans and work with borrowers, and to take full and determined action in relation to debts owed. This part also provides for the establishment of the agency itself, the appointment of a board and CEO and related provisions.
Part 3sets out how the agency will be financed and includes detailed measures in relation to accountability. Nama must produce certain reports for me as Minister and these will be laid before the Oireachtas, it will be audited by the Comptroller and Auditor General, and the Bill provides for the appearance of the chair and CEO of Nama before Oireachtas committees. I note that the Opposition parties have made a number of comments on accountability and transparency and I am open to examining further proposals in that regard.
Part 4is an important part and provides for the designation of participating institutions eligible to have assets purchased by Nama and for the designation of assets eligible for transfer.
Part 5deals with asset valuation, which I will address in more detail later.
Part 6provides for the mechanics of the asset purchases by Nama. Assets will be listed on acquisition schedules drawn up by Nama and served on the institutions. This part also includes provisions to ensure Nama steps into the shoes of the banks in terms of the loans acquired.
Part 7sets out two appeal mechanisms – one, where an institution can appeal against the inclusion of certain assets in an acquisition schedule and, secondly, an institution can appeal against the total value paid by Nama for all assets it acquires from that institution.
Part 8gives certain powers to Nama to allow it to effectively deal with assets transferred to it. Nama will be provided with powers necessary to enforce the security on loans, including the appointment of statutory receivers, and Nama can be vested with ownership of the underlying asset where appropriate.
Part 9deals with legal proceedings. It includes provisions that will protect the operation of Nama where appropriate from disruption by excessive or obstructive legal challenges. The part also caters for the treatment of legal proceedings commenced before the publication of the draft Bill.
Part 10governs the use of information including confidential information by various parties.
Part 11deals with the conduct of participating institutions and allows the Financial Regulator with the approval of the Minister to direct participating institutions to take certain actions or provide certain reports. This part also includes provision for the drafting of restructuring plans consistent with EU commission guidance by the institutions that benefit from the Nama scheme.
Part 12covers miscellaneous matters including certain tax provisions.
Part 13relates to the review of Nama's operation. The Minister may at any time require Nama to report on the progress it has made in discharging its functions under the Act, and the Minister will assess after five years the extent to which Nama has achieved its objectives.
Part 14deals with amendments to certain other Acts, and Members will be aware that the draft legislation also incorporates a number of schedules.
VALUATION
I said I would return to the issue of valuation, which is the issue drawing most attention in the public discourse.
The draft legislation provides a framework for the valuation of loans which must be approved by the European Commission. The basic premise of the valuation framework is that Nama will pay significantly less than what the bank values a loan at. The value to be paid has been defined, with regard to EU guidance, as the long-term economic value and strikes a balance between providing support to the banking system on one hand while minimising any potential risk that Nama will make a loss.
Let me make it clear that the success of Nama is not based on any assumption of a return to the recent “bubble” prices for property. It is a myth that has gained some currency during the “silly season” that there is some intention that the amount Nama will pay will compensate the banks for a recovery in values back to the unsustainable peak property prices of 2007. This is not correct, is nowhere near correct, and has never been proposed by Government – perhaps it is a reflection of wishful thinking among interested parties.
To be clear, such an approach would not be countenanced by Government and would not pass muster with the EU commission, whose approval for the valuation process will have to be obtained. Furthermore, Nama will not be paying anything other than current market value for certain assets, where this is the appropriate approach.
I propose to run through the process for the valuation of an asset to assist the understanding of the Government’s proposals.
At the outset it is important to remember that, based on information supplied by the financial institutions, the borrower typically provided about 25 per cent of the purchase price for the underlying asset and borrowed the other 75 per cent. Thus, in the event of repossession, prices have to fall by more than 25 per cent from the peak of the market before the bank makes any loss at all. We are all aware that prices have fallen more than that but the first 25 per cent loss will be the borrower’s and this is being lost in the commentary by some contributors to the Nama debate.
The valuation process will operate as follows:
1.Independent valuers will value the security for the loan – and of course the security may often be more than the property purchased. Valuation will be in accordance with recognised red-book valuation standards, European valuation standards, or international valuation standards, as appropriate.
2.Following the valuation of the security, and in line with the commission's guidance, Nama will adjust the value to reflect the fact that the market for this security is currently illiquid but will not remain so. This recognises that these assets are at crisis values and that the fundamental long-term value having regard to cash flows and longer time horizons is appropriate.
3.The adjustment will be based on a detailed assessment of market indicators such as the Department of the Environment housing statistics bulletins, as well as broader macroeconomic statistics from sources such as the CSO and the Central Bank. It will also have regard to data in relation to property yields and capital value movements in the past.
4.This property valuation information as adjusted will then form the basis for the calculation of the loan value.
5.The loan will be valued based on current mark-to-market pricing to establish the loan's current market value.
6.The loan will then be priced by reference to Nama's cost of capital to calculate its long-term economic value. The overall value will be adjusted by reference to adjustment factors and expert reports set out in sections 58, 59 and 63 of the draft Bill.
RESPONSE TO THE KEY ISSUES RAISED BY OPPOSITION PARTIES
I would like to thank the Opposition parties for the detailed comments received on the draft legislation and I would like to deal upfront with a number of issues raised.
Much of the public debate in recent weeks has revolved around requiring losses to be distributed amongst shareholders and bondholders. First of all, I have stated on numerous occasions that, if after the introduction of Nama the banks require capital, this capital will be in the form of an equity stake. This will dilute the current ownership of shareholders – and as we are all aware the share prices of the Irish banks have fallen significantly from their peak prices of early 2007. So, many shareholders have already lost vast sums (over 90 per cent) and are likely to lose more if their shares are diluted further.
With regard to bondholders, a large amount of subordinated debt has been bought back by the banks in recent months at a significant discount – with the result that bondholders took substantial losses relative to the face value of the bonds. This was organised in such a way that no event of default arose – the bondholders were given a choice and they took it, and buybacks by the three largest banks have resulted in losses of almost €4 billion from face value for those bondholders already but resulted in accounting gains for the financial institutions, which has increased their core capital.
It is also important to note that the bulk of bonds in issue by Irish banks are not subordinated debt but are debt of a far more fundamental character. They are ordinary senior debt bonds entered into by the banks.
There is a perception in the media that even senior bondholders are natural risk-takers aiming to get high rewards for taking high risk: they are not, they are usually pension funds, insurance companies and other long-term providers of debt. They provide loans to viable entities on the basis that they are senior to other creditors and are secure. These same senior bond debt investors also buy Government debt and are an important source of funds to keep our economy funded. These senior bondholders are guaranteed under the Government guarantee scheme and any suggestion that those parties should be invited to consider a reduction in the amount repayable to them would have catastrophic effects for the banking system and the funding of the Irish State.
This I think is the key criticism of the set of proposals of one of the Opposition parties. Fundamental to these proposals is a threat to default on significant levels of bank debt. This would have a severe detrimental effect on remaining banks and most importantly the State’s ability to fund itself. The Government does not believe the best interests of the State are served by allowing a culture of default or potential default to develop. This would undermine financial stability and result in the need for further action to rescue the banking system.
I have made it clear already that the Government believes the proposals are not workable and lack sufficient detail for serious examination. The Irish banking system, like all other banking systems, must continuously replenish its funding – deposits, short-term commercial paper, note issues, short- and long-term bonds must all be refinanced on a regular basis.
The ability to do so depends on a fundamental belief on the part of the investor in the viability of the investment and the stability of the institution concerned – who would invest at a rate of 5 per cent or 6 per cent if they felt there was any serious risk of default? Who would immediately re-invest in a system which had just defaulted on his or her debt?
BLANKET NATIONALISATION
A solution being put forward by the Labour Party involves the nationalisation of the entire banking system. Though not suggested by the party itself, many are under the illusion that nationalisation will address the problems facing Irish banks – this is clearly not the case as the troublesome assets would have to be dealt with either way. The shareholders in the two main banks would have to be compensated before the State sets about putting additional capital in to resolve the capital deficiencies from dealing with impaired assets.
A policy of blanket nationalisation contains other risks. It may impact negatively on financial institutions’ own funding and the sovereign’s funding, because it would affect market sentiment towards the banks and Ireland, or owing to the fact concentration risk would dictate that investors withdraw funds from certain banks if they are effectively owned by same owner.
In simple terms counterparties cut credit lines to nationalised banks. Anglo Irish Bank provides an example of the challenges faced by nationalisation – nationalisation did not fully address the bank’s funding difficulties and the Government was still forced to inject almost €4 billion to date in capital following serious losses on loans.
Nationalising the entire banking system would inevitably result in Ireland’s sovereign credit rating being downgraded from AA. This would result in increased debt service costs on the national debt which the country can ill afford when it has so many other pressing calls on its resources.
I would draw to your attention the words of President Obama last April, when explaining his opposition to blanket nationalisation. He said, and I quote: “Pre-emptive government takeovers are likely to end up costing taxpayers even more in the end and . . . are more likely to undermine than create confidence.” He went on to say: “Governments should practice the same principles as doctors: first, do no harm.”
So that is what President Obama thinks of the policy of blanket nationalisation. That view is shared by many countries around the world and that is strongly the view of this Government.
Furthermore, I believe strongly that, as far as possible, the banking sector should have a market presence and operate within market disciplines and constraints. Our objective is to ensure that the lending needs of the real economy are met and undoubtedly the best way to achieve that is a commercially focused banking system.
Of course, as I have already noted, some institutions may need capital after they have transferred loans to Nama. This will increase the State’s ownership in these banks and in some cases that may result in a majority shareholding – but I believe this is a more discriminate and effective policy than blanket nationalisation.
RISK SHARING
It has always been the Government’s policy that some form of risk-sharing mechanism would be included in the Nama process and I have from the outset said that, down the line, should Nama be faced with losses, consideration would be given to the imposition of a levy or some equivalent measure.
I expect Nama to make gains over its life but I am open to examining other risk-sharing mechanisms. Proposals made to date include giving the banks equity in Nama. This proposal has difficulties of its own – including how it would be valued on bank balance sheets – which could indirectly necessitate the further injection of State capital. This proposal would also give the banks access to the upside at the expense of the taxpayer but the risk-sharing proposals do merit further consideration. All of these aspects are currently subject to review.
But in the final analysis, Nama must lead to cleaner, less risky bank balance sheets – if it does not do this, it will not achieve any of its key objectives.
BORROWERS AND DEVELOPERS
A final point I would like to make before I conclude is to address the constant inaccurate commentary proposing Nama as a bailout for borrowers and developers. It is far from that. In fact, as Nama will have acquired the loans at a significant discount from the bank’s book value, Nama will be in a position to be more aggressive with borrowers if it deems it necessary. The draft legislation also contains a number of provisions which will assist Nama in its dealings with developers and ensure that every last cent due to the taxpayer is pursued vigorously.
CONCLUSION
The proposal for a National Asset Management Agency is designed to cleanse the balance sheets of Irish banks allowing them to focus their resources on discharging their essential role in the economy – the provision of credit. This is essential for economic recovery and the generation of employment.
The draft legislation reflects detailed consideration of how Nama will need to operate to protect its investment and generate a return for the taxpayer. As I noted earlier, I am keen to hear all views on this significant policy proposal and I believe the draft legislation will benefit from today’s engagement with this committee.