Bank recapitalization and NAMA

1. 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

2. 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 & unguaranteed Govt has made it clear this is not their intention But it could happen by accident if NAMA too optimistic in its pricing!

3. Recapitalization: Good and bad (1) Flow approach: wait for banks to make and retain profits over several years until they have recapitalized. But Banks are zombies while this happens Tie up all their resources keeping bad borrowers afloat May take reckless gambles May never be enough profits Evidence from 40 crises that this approach much more costly on average This is the “Do nothing” option. “Forbearance”. Wait-and-see

4. Recapitalization: Good and bad (2) Standard stock approach: (Decisive, once-for-all) • Insists on aggressive, realistic, asset valuations reflecting true recoverable value of assets. • Insist on banks raising new capital promptly from shareholders to meet regulatory minimum. • 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 But Is 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)

5. Recapitalization: Good and bad (2) NAMA purchase claims to do this Standard stock approach: • Insist on aggressive, realistic, asset valuations reflecting true recoverable value of assets. • Insist on banks raising new capital promptly from shareholders to meet regulatory minimum. • 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 But Is 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) Government may be the only willing buyer

6. Asset management company experience Rapid asset disposal type Success: 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 low Duration can be very long Monitoring: need to avoid a property empire

7. (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?

8. 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.)

9. NAMA: Improving the risk-sharing But how to get this right given ambiguities of accounting rules, broken market, etc. NAMA approach Straight 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)

10. NAMA: Improving the risk-sharing NAMA approach Straight asset purchase at “appropriate” value Bank gets safe marketable asset in return NAMA/Govt assumes the risk Better risk sharing (PH suggestion) Two-tier payment Bank gets safe marketable asset -- but less of it than in standard approach Shareholders get in addition an equity-type participation in NAMA Govt assumes less risk

11. 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

12. 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