As far as I understand it the basic funding model for NAMA is this. NAMA/Min for Finance will determine total spend for acquiring assets. Lets say for arguments sake €70bn. NAMA issues bonds with a par value of €70bn which are guaranteed by the Gov’t. The Banks take these bonds to the ECB and use them as security for borrowing from the ECB, the proceeds of which can be used for lending. This is a standard tool used by central banks to inject liquidity into a banking system - repurchase agreements or repo’ing securities. So far so good.
The Gov’t is suggesting that as a bonus, these (floating rate) bonds will pay a very low coupon (talk is about EURIBOR +1%) and therefore interest costs to the exchequer/NAMA will be minimised. I think its safe to assume that after we issue a further €70bn of (effectively) sovereign debt that the yield on Irish floating rate bonds will be significantly in excess of EURIBOR +1%.
The question is at what value will the ECB repo these bonds at (i.e. how much will the ECB lend banks in exchange for these bonds)?
If the ECB lends the par value of a bond to a borrower and the borrower defaults when the market value of the bond is less than the par value then the ECB is going to have to eat the loss. If it repo’s at market value than it protects itself from this loss. For this reason I can’t see the ECB repo at par value.
The market value of these bonds will only equate to the par value of €70bn IF the market demands a yield on them equal to the coupon rate of EURIBOR +1%. If the market demands a higher yield than the coupon rate the market value will be less than the par value. A simple example demonstrates this. For simplicity look at fixed rate bonds, the principle is the same for floating rate bonds.
NewCo issues a five year, 10%, €10,000 bond. Lets say the market demands a yield on these bonds of 20% (because of the level of risk free interest rates and the perceived default risk of NewCo). In this case the market value of the bonds will not be €10,000, it will be approx. €6,900. So an investor repo’ing this bond would receive a maximum of €6,900 (ignoring repo interest costs).
The implication of this is that banks repo’ing NAMA bonds will receive significantly less than the suggested €70bn unless the ECB has decided to completely abandon any sensible lending practises.
NOTE: I may be missing something obvious here which renders all of the above wrong.