22. Credit Risk
Credit risk is the risk of incurring financial loss, taking account of collateral pledged as security that would arise from the failure of a debtor or market counterparty of the Group to fulfill its contractual obligations to the Group. NAMA’s main credit risk arises from the performance of its debtors, and related assets held as security.
The Group’s debtor-related exposures arose in the first place from the acquisition of a substantial portfolio of property related loans, mostly in the commercial and residential property sector in Ireland and the UK, and to a lesser extent in Europe, the USA and the rest of the world. Credit risk also arises in relation to the Group’s lending activities, which are undertaken in order to preserve or enhance value with the aim of achieving the maximum financial return for the State subject to acceptable risk. Financial instruments, such as undrawn loan commitments and guarantees, also create credit risk.
Credit risk is the most significant risk to the Group’s business. The Group therefore carefully manages its exposure to credit risk. The credit risk arising from the original acquisition of the loan portfolio was mitigated by the completion of an intensive property and legal due diligence process. This was designed to ensure that loans were properly valued in accordance with the statutory scheme that provided for their acquisition by the Group. The credit risk arising from the Group’s ongoing lending and credit risk management activities is mitigated by the Group’s Asset Recovery/Asset Management Policy and Procedures Framework.
The Asset Recovery division, has three primary functions: strategy delivery, management of debtors/receivers and maximising cash flow while minimising loss.
Asset Recovery is the principal interface with debtors/insolvency practitioners responsible for managing the majority of debtors both directly by NAMA and indirectly through the Participating Institutions/Primary Servicer. This responsibility requires intensive daily management, with an innovative and solutions based approach, employing a range of work-out methods including: setting and actively monitoring clear strategies, targets and milestones; minimising debtor and insolvency practitioner costs; securing and maximising income; optimising sales values through proactive asset management; providing additional capital expenditure where incremental value can be obtained or value protected; employing vendor finance and executing loan sales and portfolio sales, where appropriate; regularly reviewing asset sale versus asset hold options, employing inter alia a discounted cash flow analysis.
Asset Recovery Policy and Procedures Framework
The overall objective of the Asset Recovery Policy and Procedures Framework is to safeguard the Group by protecting and enhancing the value of loans acquired.
Ultimate responsibility for the management of credit risk in the Group rests with the Board. Credit risk management and control is centralised in the Asset Recovery function. Credit risk is reported to the Board and Credit Committee on a regular basis and the Framework is subject to a formal annual review.
The Group is responsible for managing loans, which were acquired under the provisions of the NAMA Act. Loans acquired from Participating Institutions have been grouped together and managed by debtor connection.
Debtors fall into two categories:
NAMA managed debtors: In this category key credit decisions, and relationship management, is undertaken by the Group. Loan administration is carried out by Participating Institutions and the Primary Servicer.
Participating Institution / Primary Servicer managed debtors: In this category debtor management and loan administration is carried out by the Participating Institutions and the Primary Servicer. Credit decisions are taken by Participating Institutions and the Primary Servicer under a Delegated Authority and are subject to a Policy and Procedures Framework mandated by the Group, together with ongoing ‘on the ground’ involvement from the NAMA Participating Institutions/Primary Servicer Teams and oversight by the Group’s Audit and Risk function. Capita, in its capacity as Master Servicer and Special and Primary Servicer, does not have delegated authority for credit decisions.
The Group is required to make various credit decisions, which may involve new lending, the restructuring of loans and receivables or the taking of enforcement action. Specifically, a credit decision can arise out of any event that could materially change the underlying risk profile of an exposure or debtor, including:
- An application for credit by a debtor;
- Approval of asset sales;
- A proposal by a debtor which may involve pragmatic/commercial compromises or incentives in order to maximise NAMA’s overall position;
- An application for finance;
- A proposed debtor or insolvency practitioner strategy;
- A proposed extension or amendment of terms for any or all of a debtor’s exposures;
- A proposal to initiate insolvency action;
- An action by a third party concerning a common debtor e.g. non participating institution.
Credit risk is measured, assessed and controlled for all transactions or credit events that arise from the Group’s acquisition of loans, and from the ongoing management of those loans.
22.1 Credit risk measurement
The Group applies the following measures of exposure:
- Par debt exposure - the gross amount owed by the debtor, i.e the total amounts due in accordance with the original contractual terms of acquired loans. The total Par debt acquired by the Group was €74bn. Total Par debt outstanding at the reporting date is €55.6bn.
- NAMA debt exposure - the acquisition amount paid by the Group (plus any new money lent by the Group and interest charge added, less cash payments received). The total consideration paid for loans and related derivatives acquired was €31.8bn. Total Gross NAMA debt outstanding at the reporting date is €16.9bn.
In accordance with Section 10 of the Act, NAMA is required to obtain the best achievable financial return for the State having regard to Par debt, acquisition cost, any costs as a result of dealing with the assets, its cost of capital and other costs. These are the fundamental measures upon which credit and case strategy decisions will be made. They are also the basis for determining the appropriate Delegated Authority level for credit decisions made by the Group, Participating Institutions or the Primary Servicer. NAMA monitors Par and NAMA debt exposure in parallel and uses them in support of all credit decisions.
In addition to the loans that were acquired by the Group, a number of derivative financial instruments were acquired which were attached to debtors’ loans acquired from the Participating Institutions.
At any time, the Group’s credit risk exposure is limited to the positive fair value of these derivative instruments (i.e. assets with a positive mark-to-market value). This mark-to-market value is usually only a small fraction of the contract value (or notional value of the outstanding instruments).
22.2 Credit risk assessment
Credit risk assessment focuses on debtor repayment capacity and all credit enhancements available, including security. Loans and advances to debtors are collateralised principally by charges over real estate assets, other assets, liens on cash deposits, and are supplemented in many cases by personal and corporate guarantees.
The Group relies initially on the valuations placed on existing security and recourse attached to loans acquired as part of the acquisition process. However the Group seeks to ensure that an appropriate, up-to-date, valuation of any additional forms of security or recourse are included in any debtor’s new credit proposal. Existing security may also be revalued as part of that process.
A key consideration in advancing funding is whether or not the debtor’s or insolvency practitioner’s credit proposal is value enhancing. In advancing additional debt or undertaking any new credit decision, the Group will seek to obtain additional security or recourse from the debtor or insolvency practitioner where it is necessary to protect its interests.
In determining additional or alternative forms of security or recourse, the Group may commission personal asset assessments of a debtor to identify any security or recourse that may be available to protect the Group’s interests.
22.3 Credit risk control
Credit risk policy, as determined by the Group, applies to both NAMA managed, and Participating Institution/Primary Servicer managed loans. The Group has defined an Asset Recovery/Asset Management Policies and Procedures Framework for the Group and for Participating Institutions and the Primary Servicer. This sets out authority levels for permitted credit decisions and credit limits, as well as credit risk monitoring and reporting to be carried out by the Group, Participating Institutions and the Primary Servicer.
The Asset Recovery/Asset Management Policy and Procedures Framework sets out the permitted decision making and credit limits, for example relating to:
- The approval of Debtor Business Plans and Strategic Credit Reviews;
- The approval of new lending;
- Loan restructuring or renegotiation where no additional debt is provided;
- Enforcement action being taken by the Group;
- Sales of assets / loans;
- Property and asset management requirements.
The level of approval required for each of these credit decisions is determined by reference to the size of the debtor’s outstanding balance. Credit decisions are approved by one or more of the following within a cascading level of approved delegated authority:
- Asset Recovery/Asset Management Panel A or Panel B Delegated Authority Policy holders;
- Senior Divisional Manager Asset Recovery/ Asset Management;
- Head of (or Deputy Head of) Asset Recovery/ Head of Asset Management;
- CEO and Head of (or Deputy Head of) Asset Recovery/ Head of Asset Management;
- Credit Committee;
- Board.
All credit decisions relating to Participating Institution managed loans, within Group approved limits, are required to be approved by the Participating Institution Credit Committee and/or Head/Deputy Head/Senior Manager of Credit in the NAMA unit of the Participating Institution. All credit decisions relating to the Primary Servicer managed loans are required to be approved by the relevant delegated authority within the Group.
Oversight of the compliance with the Delegated Authority Policy is performed by the Quality Assurance Team, and by the Internal Audit function.
Specific control and mitigation measures adopted by the Group are outlined below:
Management of cash within a debtor connection is a key control with the aim of ensuring that overheads, working capital or development capital expenditure payments are appropriate and verified so that potential cash leakage is eliminated. The full visibility of all rental/trading income is also required.
The Group employs a range of policies and practices to mitigate credit risk. The most traditional of these is the taking of first fixed charge security for any working or development capital advanced.
The principal collateral types acceptable for credit risk mitigation of loans and receivables are:
- Mortgages over various land and properties;
- Floating charges over business assets such as premises, inventory and accounts receivable;
- Charges over financial instruments such as debt securities and equities;
- Charges over bank deposits.
The security for derivatives acquired is from the collateral acquired with the loan, and is reflected in the loan acquisition price paid. The Group also transacts derivatives with the NTMA to hedge interest rate and foreign currency exposures.
The credit exposure of derivatives acquired, together with potential exposures arising from market movements, is managed as part of the overall debtors exposure management.
With respect to derivatives entered into by the Group, the sole counterparty is the NTMA and the counterparty risk is covered by a Collateral Posting Agreement.
22.4 Maximum exposure to credit risk - before collateral held or other credit enhancements
| Group | Note | Maximum exposure 2014 €’000 |
Maximum exposure 2013 €’000 |
|---|---|---|---|
| Cash and cash equivalents | 1,158,692 | 3,453,236 | |
| Cash placed as collateral with the NTMA | 690,000 | 802,000 | |
| Financial assets available for sale | - | 145,138 | |
| Amounts due from Participating Institutions | 84,810 | 78,447 | |
| Derivative financial instruments | 58,241 | 160,369 | |
| Loans and receivables - NAMA | |||
| Land and development | 5,290,320 | 5,943,029 | |
| Investment property | 11,590,489 | 17,780,341 | |
| Impairment | (3,520,775) | (4,125,260) | Loans and receivables (net of impairment) – NAMA | 13,360,034 | 19,598,110 |
| Loan facility deed – NARL | - | 11,715,589 | |
| Other assets | 12,164 | 23,755 | |
| Investments in equity instruments/td> | 36,181 | 6,373 | |
| Total assets | 15,400,122 | 35,983,017 | |
| Loan commitments | 23.4 | 660,303 | 765,320 |
| Total maximum exposure | 16,060,425 | 36,748,337 |
| Agency | Maximum exposure 2014 €’000 |
Maximum exposure 2013 €’000 |
|---|---|---|
| Cash | 101 | 1,152 |
| Investments in equity instruments | 49,000 | 49,000 |
| Other assets | 168,161 | 5,961 |
| Total maximum exposure | 217,262 | 56,113 |
22.5 Information regarding the credit quality of loans and receivables
The Group has implemented a grading policy to provide a risk profile of NAMA’s portfolio which applies to all debtors. NAMA’s credit grade scale seeks to assign a measure of the risk to the recovery of a financial asset and is based on two dimensions with nine possible grades expressed as a combination of a number and letter 1A, 3B etc.
- The first dimension (scale 1, 2, 3) measures the quality of the underlying assets acquired and the expectation for debt recovery relative to the NAMA debt. This first dimension ranges from instances where recovery is expected to exceed the NAMA debt to situations where a shortfall on NAMA debt is anticipated and an impairment provision has been marked against the exposure.
- The second dimension (scale A, B, C) rates the level of debtor performance and cooperation by measuring the achievement of financial and non-financial milestones that have been agreed through the debtor engagement process.
The 9 possible grade outcomes can be summarised into the following categories:
- Satisfactory: Capacity to meet financial commitments and low likelihood of expected loss.
- Watch: Requires closer monitoring but demonstrates capacity to meet financial commitments.
- Impaired: Exposures require varying degrees of close attention and active portfolio management and loss expectations is a concern.
| 2014 €’000 |
2013 €’000 |
|
|---|---|---|
| Satisfactory | 5,130,393 | 3,216,972 |
| Satisfactory (loan facility deed – NARL) | - | 11,715,589 |
| Watch | 866,163 | 968,991 |
| Loans and receivables neither past due nor impaired | 5,996,556 | 15,901,552 |
All the assets of the Agency are inter-group assets and are current.
The disclosure required by paragraph 37(a) of IFRS 7 regarding the aged analysis of loans and receivables that are ’past due but not impaired’ is not being provided. Current ageing analysis is based on the original contractual terms of loans acquired from Participating Institutions, and is not reflective of loan performance compared to loan acquisition value.
All of the Agency’s receivables are due from related entities and are current. None are past due or impaired.
Loans and associated derivatives which were determined to be impaired as a result of the individual impairment review had a carrying value of €10.6bn (2013: €15.8bn) (see following table).
The Group has availed of the exemption under IFRS 7 not to disclose the fair value of collateral held as security against the loans, as it would be impractical to do so.
Loans and receivables individually assessed for impairment| 2014 €’000 |
2013 €’000 |
|
|---|---|---|
| Gross loans and associated derivatives | 16,220,078 | 19,593,708 |
| Individually impaired loans and associated derivatives | (10,581,233) | (15,789,439) |
| Loans and associated derivatives not individually impaired | 5,638,845 | 3,804,269 |
Vendor finance arrangements were initiated subsequent to the initial transfer of loans and derivatives from covered institutions. These are assessed for indicators of impairment semi-annually in accordance with the impairment accounting policy 2.12. To date, no indicators of impairment for vendor finance connections have been identified and as such, they are not included in the individually assessed debtors category above. Vendor finance debtors had an outstanding loans and receivables balance of €358m at the reporting date.
None of the assets exposed to credit risk in the Agency are individually impaired.
(d) Loans and advances renegotiated
Certain loans are being renegotiated and restructured through the debtor engagement process.
Restructuring activities may include extended payment arrangements, modification and/or deferral of payments. Restructuring polices are set out in the NAMA Pricing and Restructuring Policy included in the Asset Recovery/Asset Management Policy and Procedures Framework. Each loan is restructured based on the most appropriate strategy to achieve repayment of all outstanding debt obligations, taking into account structures, guarantees, tax issues and sales strategies. The details of each proposed restructuring plan including any deviations from policy are reviewed and approved by the Delegated Authority/Credit Committee and, where relevant, the Board.
The restructuring of debtors in 2014 involved in the majority of cases the restructuring of loans into a reduced number of interest bearing facilities for easier engagement and debtor management. The total carrying value of loans subject to restructure of this nature in 2014 was €0.1bn (2013: €1.5bn).
None of the assets exposed to credit risk of the Agency were renegotiated in the period.
22.6 Geographical sectors
The following table analyses the Group’s main credit exposures at their carrying amounts, based on the location of the collateral securing loans and receivables.
| Geographical sector 2014 €’000 |
Ireland excluding Northern Ireland €’000 |
UK including Northern Ireland €’000 |
Rest of World €’000 |
Loan impairment €’000 |
Total €’000 |
|---|---|---|---|---|---|
| Loans and receivables | |||||
| − Land and development | 3,690,497 | 1,334,763 | 265,060 | - | 5,290,320 |
| − Investment property | 8,917,666 | 1,777,539 | 895,284 | - | 11,590,489 |
| Impairment of loans and receivables | - | - | - | (3,520,775) | (3,520,775) |
| Total loans and receivables | 12,608,163 | 3,112,302 | 1,160,344 | (3,520,775) | 13,360,034 |
| Cash and cash equivalents | 1,158,692 | - | - | - | 1,158,692 |
| Cash placed as collateral with the NTMA | 690,000 | - | - | - | 690,000 |
| Derivative financial instruments | 32,642 | 24,275 | 1,324 | - | 58,241 |
| Amounts due from Participating Institutions | 84,810 | - | - | - | 84,810 |
| Deferred tax asset | 132,364 | - | - | - | 132,364 |
| Inventories – trading properties | 36,021 | - | 1,930 | - | 37,951 |
| Other assets | 12,164 | - | - | - | 12,164 |
| Investments in equity instruments | 28,735 | - | 7,446 | - | 36,181 |
| Property, plant and equipment | 1,935 | - | - | - | 1,935 |
| Total assets | 14,785,527 | 3,136,577 | 1,171,044 | (3,520,775) | 15,572,372 |
| Geographical sector 2013 €’000 |
Ireland excluding Northern Ireland €’000 |
UK including Northern Ireland €’000 |
Rest of World €’000 |
Loan impairment €’000 |
Total €’000 |
|---|---|---|---|---|---|
| Loans and receivables | |||||
| − NAMA Land and development | 4,128,097 | 1,365,778 | 449,154 | - | 5,943,029 |
| − Investment property – NAMA | 11,715,736 | 4,588,883 | 1,475,722 | - | 17,780,341 |
| − Loan facility deed – NARL | 11,715,589 | - | - | - | 11,715,589 |
| Impairment of loans and receivables | - | - | - | (4,125,260) | (4,125,260) |
| Total loans and receivables | 27,559,422 | 5,954,661 | 1,924,876 | (4,125,260) | 31,313,699 |
| Cash and cash equivalents | 3,453,236 | - | - | - | 3,453,236 |
| Cash placed as collateral with the NTMA | 802,000 | - | - | - | 802,000 |
| Financial assets available for sale | 145,138 | - | - | - | 145,138 |
| Derivative financial instruments | 85,611 | 72,936 | 1,822 | - | 160,369 |
| Amounts due from Participating Institutions | 78,447 | - | - | - | 78,447 |
| Deferred tax asset | 202,387 | - | - | - | 202,387 |
| Inventories – trading properties | 38,924 | - | - | - | 38,924 |
| Other assets | 23,755 | - | - | - | 23,755 |
| Investments in equity instruments | 6,373 | - | - | - | 6,373 |
| Property, plant and equipment | 1,071 | - | - | - | 1,071 |
| Total assets | 32,396,364 | 6,027,597 | 1,926,698 | (4,125,260) | 36,225,399 |
The Agency statement of financial position, comprises inter-group assets in respect of the reimbursement of administration expenses from the Group, therefore all of the assets exposed to credit risk in the Agency are located in Ireland.