Bank recapitalization and NAMA

Patrick Honohan

Professor, Department of Economics and

Institute for International Integration Studies

Trinity College Dublin

Prepared for the Joint Oireachtas Committee on Finance and the Public Service

6th May 2009

Recapitalization and asset purchase

They are separate

Goal of recap: Make bank financially self-sufficient with a cushion of shareholder’s funds available to absorb future risks

Goal of asset purchase (NAMA): Remove distraction of trying to recover on problem loans; Separate loan recovery from the team that made them; Replace assets of uncertain value with safe and marketable assets

Sometimes asset purchase at too-high prices is used as a covert way of recapitalizing A bad idea – non transparent subsidy for shareholders & unguaranteedGovt has made it clear this is not their intentionBut it could happen by accident if NAMA too optimistic in its pricing!

Recapitalization: Good and bad (1)

Flow approach: wait for banks to make and retain profits over several years until they have recapitalized.

ButBanks are zombies while this happens

Tie up all their resources keeping bad borrowers afloatMay take reckless gambles

May never be enough profitsEvidence from 40 crises that this approach much more costly on

average

This is the “Do nothing” option. “Forbearance”. Wait-and-see

Recapitalization: Good and bad (2)

Standard stock approach: (Decisive, once-for-all)a) Insists on aggressive, realistic, asset valuations reflecting true

recoverable value of assets. b) Insist on banks raising new capital promptly from shareholders to meet

regulatory minimum. c) Failing that, regulator seizes control and finds buyer for viable parts of

business. Puts remainder into wind down/bankruptcy

This the standard approach used by US in the past and recommended by experts all over the world

ButIs resisted by shareholders (they lose everything if unable to raise

sufficient capital)And by big debtors (as they will likely be dealt with more aggressively)

Recapitalization: Good and bad (2)

Standard stock approach: a) Insist on aggressive, realistic, asset valuations reflecting true

recoverable value of assets. b) Insist on banks raising new capital promptly from shareholders to meet

regulatory minimum. c) Failing that, regulator seizes control and finds buyer for viable parts of

business. Puts remainder into wind down/bankruptcy

This the standard approach used by US in the past and recommended by experts all over the world

ButIs resisted by shareholders (they lose everything if unable to raise

sufficient capital)And by big debtors (as they will likely be dealt with more aggressively)

NAMA purchase claims to do this

Government may be the only willing buyer

Asset management company experience

Rapid asset disposal typeSuccess: USA; Spain; Failure: Mexico, Philippines,

Corporate restructuring type Success: Sweden; Mixed: Finland, China; Failure: Senegal, Ghana

Sounds like NAMA is the latter; but if so would need its own capital

% Recoveries can be very lowDuration can be very longMonitoring: need to avoid a property empire

(Obvious) requirements for an effective AMCs

Clear objectives (including Rapid asset disposal vs corporate restructuring)

Robust governance (ideal private sector type) & external monitoring

Operational independence from Government/politics

Transparency of operations (more than banks)

Potential role of private managers

Strict cost control

Etc.

Can these be delivered for NAMA?

Distinctive features of NAMA

Will take on performing loans as well (why?)But ignores non-property sectors

Size is unprecedented worldwide(relative to economy)

(May be) buying from going-concern private banks(this has been done before – Thailand, Malaysia etc.)

NAMA: Improving the risk-sharing

NAMA approachStraight asset purchase at “appropriate” value

Bank gets safe marketable asset in return

NAMA/Govt assumes the risk

avoids the illiquid long-term low coupon bond trap!(though mention was

made of a possible levy)

But how to get this right given ambiguities of accounting rules, broken market, etc.

NAMA: Improving the risk-sharing

NAMA approachStraight asset purchase at “appropriate” valueBank gets safe marketable asset in returnNAMA/Govt assumes the risk

Better risk sharing (PH suggestion)Two-tier paymentBank gets safe marketable asset -- but less of it than in

standard approachShareholders get in addition an equity-type participation

in NAMAGovt assumes less risk

If valuation results in negative shareholders’ funds…

Capitalist logic implies ownership control passes to creditors

If existing shareholders cannot raise new capital, they have little basis for any residual claim(Banking license is a valuable privilege granted by State, conditional on

injecting sufficient capital)

If bank is to continue, government must inject necessary capital(May then sell to new shareholders)

In this way, NAMA process could well involve temporary nationalization unless additional private equity injections can be found

State ownership

Large majority state share is certain; 100% a possible consequence of NAMA process?Temporary control by regulators?Temporary ownership (in current market years rather than months)?Permanent nationalization

Objectives of nationalized banks:Maximize shareholder value?Seek national economic and social goals?

How soon to sell to private sector (foreigners?)Even 5% or 10% private shareholding could help maintain the dialectic

between government and banks

Most economists agree with this

Not at the cost of a huge additional taxpayer liability