The fact that NAMA is now set to leave loans under €20 million with the banks is debunking the justification for its original creation.

Yes, there were bigger loans with bigger problems, and they have been covered on every facet, and that will form the bulk of NAMA’s asset book, but what doesn’t go across will be handled by the banks (who incidentally already manage NAMA loans on behalf of the agency, only the legal ownership goes to the agency).

In Bank of Ireland’s case this will account for €2.1 billion of loans of which €1.6bn is already impaired! That’s a massive 76% impairment rate, of which €800m has been provisioned for – so about half of the expected loss is covered.

That tells us nothing about every other institution though, because BOI is likely to be one of the healthier ones, they neither lent as much to developers, nor are they going into full national control as a result of their lending decisions.

The NAMA discounts are not a valid proxy for the sub €20 million category -because many of the worst loans are in this strata of lending. There were no €200m deals for a field in Leitrim, rather that would be in the sub €20m category.

The other issue is how these loans were banked, I know from first hand experience that developers would use optimistic pricing when banking a deal. To actually do a deal you would need to demonstrate c. 15-18% of an end price profit, but the upward revision of a forward price is only part of the problem. The other issue is with the underlying collateral, the site.

Banks didn’t offer 100% finance on sites, not intentionally anyway, what would happen though, is that they would take a valuation and offer 75% of it while taking a cash down payment. So if you found a site for €6m and it was in an area that was set to be rezoned and you knew there was (for instance) a local area plan then it could be assumed that planning would come, and a developer with a proven track record could put together a proposal showing that they had obtained the deal but needed backing.

The business plan would go to the bank with a valuation (by an ‘independent’ valuer) of c €12m and normally a few non-developer equity investors would put in €1m. So the loan would go out for €5m which looks like it’s 41% LTV, but in reality – on the deal price – its 83% LTV. The important thing is though, that the bank is looking at the collateral as having been €12m and a peak to trough drop of 60% would put the current valuation at €4.8m so they figure that with a loan of around €5m and rolling interest things aren’t so bad.

But that belies the fact that the valuation was wrong to begin with, if you were to sell that site now you would probably get €3m for it so the actual drop is more in the region of 75% and the developer can no longer bank the deal because they don’t have a credit line and the end user price upon which the proposal stacked, both in terms of density and spec will no longer sell in 2010.

There are many cases like this, and the banks don’t realise the risk in the loan book because new valuations are not being carried out, in fact, in one case, the developer hasn’t paid anything in over a year and they haven’t gotten so much as a letter or a call, it’s a further factor of denial and of hoping that over time the bank can make the loan come good by waiting it out, in the hope that the market recovers on one hand, on on the other to the point that operational profit covers the losses.

This will in part happen due to higher interest rates, higher banking costs on all financial services users and an eventual bottoming out, but it won’t protect the banks in the mean time.

The other issue is that of investment property, there are literally thousands of landlords who are paying the mortgages on empty houses, for whom a further rate hike will force into arrears, this problem is a catch 22, banks need higher rates to cover losses and higher rates in turn create losses that were heretofore not happening. As joblessness continues and people eat up savings to stay afloat.

The NBER in the USA has argued that the ‘housing cycle is the business cycle‘ and recent work by O’Rourke/Eichengreen/Benetrix states that the quicker we reach a bottom in housing the quicker we recover, and yet all of our policy, from dealing with families in arrears to NAMA is about not letting the market resolve or hitting a bottom point fast, NAMA is there to prevent ‘firesales‘, but the Phoenix of Ireland is unlikely to resurrect until it burns a little.