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Nama - The "real" Default Rate

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Our general criticisms of Nama's draft business plan are presented in Nama - A Flawed Business Plan.

This posting raises basic questions and concerns about the plan's underlying default rate and treatment of rolled up interest. These could have huge implications for the plan's credibility; the likely depth and duration of the banking/building crisis; and the cost of Nama to taxpayers.

In summary, detailed analysis of Nama's cashflow projections suggests that the "real" default rate is either an unrealistically low 6% or a catastrophically high 34% depending on the treatment of rolled up interest arising over the ten years to 2020. This compares with a 20% rate quoted in Nama's plan.

Instead of debating the Nama Bill, the Dail and Seanad should undertake a more indepth review of Nama's business plan. Bottom line: no taxpayers' money or support should be forthcoming until its plan has been fully researched and presented in final form for approval.

Our detailed assessment is presented in the five sections below. They review Nama's projections, highlight concerns, pose questions, explain implications and present general conclusions. 

1. Nama's Projections

Our attention is focused on two tables in Nama's plan showing (a) net present value cashflow projections (2010-20) and (b) budget projections (2010-2012).

This Excel spreadsheet  Nama-Cashflows 2.xls (Altern format: Nama-Cashflows 2.pdf) reproduces Nama's cashflow projections and adds seven columns which determine annual balances and interest rates and estimate rolled up interest. Everything in the spreadsheet has been derived from Nama's plan aside from an assumption that the interest rate on borrowers debt outstanding will be 6% p.a. for 2013-20.

Note that references to rolled up interest refer to interest rolled up during the ten years 2010-2020 - interest rolled up prior to this period is included in the €77 billion loans to be taken over by Nama.

2. Main Concerns

Based on the spreadsheet's calculations, our main concerns are as follows::

    1. Total Interest income from borrowers (col D) of €12 billion is lower than the Interest outflow on debt (col G) of €16 billion. One would have expected the opposite!

    2. The Minster for Finance has stated that the interest rate on Nama's bonds will start at 1.5% in 2010 but column M suggests that the projected rate will be 2.4% for that year and will rise to 5.7% in 2012.

       
    3. According to Nama's budget projections (table 7 of business plan), Interest income for 2010-2012 will total €9.46 billion as compared with cashflow-related Interest income from borrowers (col D in the cashflow projections) totaling €4.5 billion. Presumably the difference (€4.96 billion) is rolled up interest accumulating over these three years (see col R).

      For the following seven years, an estimated additional €5.94 billion of interest could be rolled up. On this basis, €10.9 billion of interest payable by borrowers will be rolled up over the ten years (col R).

Assuming that the cashflow projections in table 5 are complete, then there are only three ways to account for this rolled up interest:

  • It is included in the Principal repaid by borrowers (col E) which amounts to €62 billion. In this case, the "real" principal repaid is only €51.1 billion (62-10.9). This means that the "real" default rate is 34% [ (77-51.1)/77) ] rather than the 20% indicated in the plan.

  • Rolled up interest is included in the assumed €15 billion write-down. This would mean that the "real" write-down on borrowings would be only about €4 billion (15-10.9), to yield a "real" default rate of 6% on the total loans.

  • Rolled up interest is not being paid at all and written off at some point in unpublished, projected P&L accounts for 2013-2020. As a result it would not appear in the cashflow projections at any stage.

3. Unanswered Questions

The key questions arising from the above are:

    1. Why is the cumulative Interest income from borrowers (col D) of €12 billion lower than the Interest outflow on debt (col G) of €16 billion?

    2. What is the total rolled up interest arising over the ten years?

    3. When is this interest repaid and how is it accounted for in the cashflow projections (table 5)?

    4. After excluding rolled up interest, what is the default rate on the €77 billion of loans?

4. Profound Implications

Depending on the answers to the foregoing questions, the implications are profound:

  • The business plan states that "a 20% default rate assumption has been made", However, this analysis suggests that the "real" default rate on the €77 billion of loans taken on by Nama could be either 6% or 34% depending on the treatment of rolled up interest.

  • A projected "real" default rate of 6% would be extraordinarily low and viewed as absurd given the scale of write offs already incurred by banks and widespread expectations about the depth and duration of the banking/building crisis.

  • A "real" default rate of 34% (with write offs amounting to €26 billion before any recoveries) indicates that the crisis is far more serious than indicated in Nama's plan and could prove catastrophic for the economy in general and extremely costly for taxpayers.

    This could transform Nama's projected cash surplus into a deficit of at least €5 billion. Note that every additional five point increase in the default rate would increase losses by almost €4 billion. 

5. Conclusions

Given that it will be taking control of loans worth €77 billion (amounting to almost half Ireland's GDP), Nama's business plan should have included projected P&L statements and balance sheets as well as cashflow forecasts for all ten years. These would have given a fuller picture and facilitated ratio analyses which might help anticipate problems similar to those experienced by very same banks that Nama is trying to rescue. In view of the mind-blowing amounts involved, this omission can only be viewed as gross incompetence or willful concealment, or both.

All in all, Nama's draft business plan amounts to a extremely poor document (see Nama - A Flawed Business Plan) - but entirely appropriate to its poorly developed business concept.

Finally, instead of discussing the Nama Bill, the Dail and Seanad should undertake an indepth review of Nama's business plan and proposed Special Purpose Vehicles. No taxpayers' money  or support should be forthcoming until the plan has been fully researched, presented in final form and approved by the Dail.

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This page contains a single entry by Brian published on October 31, 2009 11:48 AM.

Nama - A Flawed Business Plan was the previous entry in this blog.

Nama - Horses, Carts and Stable Doors is the next entry in this blog.

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