Mr. Brendan McDonagh:

We welcome this opportunity to set out NAMA's response to the Comptroller and Auditor General's section 9 special report on the sale of the Project Eagle loan portfolio. It is remarkable that the Comptroller and Auditor General does not form any view on the value for money but comments that the decision to sell the loans at a minimum of £1.3 billion involved "a significant probable loss of value" to the State.

In the time available to me, I will focus my remarks on this comment which NAMA very emphatically rejects. The Comptroller and Auditor General’s view is that a discount rate of 5.5% would have been appropriate to derive the market value of this portfolio. Not only does the report fail to provide any market or expert support for this view, but it inexplicably ignores strong market evidence from international loan sales experts which would have supported the use of a discount in the 10% to 15% range. This report has adopted a position which would not be accepted by anyone engaged in actual loan sales in Ireland or anywhere else. The Comptroller and Auditor General position holds that there should have been no divergence between the end-2013 proxy accounting value of the portfolio of £1.465 billion, based on a 5.5% discount rate, and a market value of approximately £1.3 billion, based on a 10% discount rate, and that, therefore, NAMA should not have accepted anything less than its accounting value.

The accounting value of the portfolio was derived using effective interest rate, EIR, discount rates, which are based on the IFRS accounting rules that NAMA has been required to follow since inception. They were not market rates and no potential purchaser would have applied them to value the portfolio. Valuation of the portfolio at EIR rates may be appropriate for ongoing NAMA accounting purposes but clearly not appropriate when determining a market sales value. NAMA's view, which is supported by expert market evidence from four internationally recognised loan sales experts and which we provided to the committee last week, is that a discount rate in the 10% to 15% range was appropriate to apply to the cash flows associated with the Project Eagle portfolio. This reflects the cost of capital that bidders would have incurred in early 2014. It is also very much in line with the range of discount rates - 10% to 15% - which were applied in a number of our other loan sales that NAMA conducted. It also reflects the inherent risk associated with a loan portfolio which was secured, for the most part, by a granular portfolio of non-prime assets, located mainly in Northern Ireland and in northern parts of Britain. The positions on this issue are very stark: NAMA and the loan sales market have one view on the appropriate discount rate; the Comptroller and Auditor General report appears to be alone in its view. It would not have been difficult for the report’s authors to have consulted market experts on this crucial point, something the NAMA board requested them to do. For some reason, however, this was not done.

A second major difficulty with the report’s understanding of the valuation issue is that it assumes that cash flow projections are fixed and certain. In reality, cash flow projections are no more than estimates of the income and disposal proceeds that assets may generate in the future. They are a point-in-time exercise. NAMA carries out a formal impairment review each 30 June and 31 December. There can be no certainty attached to the timing of cash flows or that they will remain constant. This uncertainty is compounded in the case of granular, secondary portfolio assets. For instance, cash flow projections associated with Dundrum Town Centre have a reasonable level of certainty attached to them because of the attractiveness of the asset to shoppers, to tenants and to potential purchasers. This is a strong income-producing asset with strong tenants. On the other hand, the cash flows attaching to small assets in Northern Ireland and certain parts of northern England and Scotland are much less certain both in terms of projected disposal proceeds and projected income. Some assets had no income stream. A total of 31% of the Northern Ireland portfolio comprised land and development assets. The top 55 assets in Project Eagle accounted for almost two thirds of the portfolio’s value. That left the rest of the portfolio with about 870 assets which had an average value of £600,000 each. It made sense, through a loan sale, to bundle poorer quality assets with the better quality and higher value assets. In general, the less attractive the assets and the income stream securing a loan portfolio and the less certain that the associated cash flows will actually be received, the higher the risk premium and, therefore, the discount rate that will be applied by buyers.

The report’s valuation approach involved in our view a mechanistic and rigid application of a spuriously precise and abnormally low discount rate to cash flows which are assumed, unrealistically, to be fixed and certain. In both respects, the level of certainty attached to cash flows and the discount rate, are seriously at odds with how distressed debt portfolios such as Project Eagle are actually valued by investors and purchasers in reality. The minimum sales price set by the NAMA board was £1.3 billion. That falls within the mid-point range of sale values generated by the 10% to 15% range of market discount rates that would have applied to a portfolio such as Project Eagle during the first half of 2014. A 10% buyer discount rate produces a value of £1.35 billion; a 15% discount rate produces a value of £1.25 billion. The £1.322 billion achieved on the sale, which was above the minimum price of £1.3 billion, was, therefore, well within the expected range of expected market values.

The only evidence offered in the report to support the use of a 5.5% discount rate is a NAMA board decision of June 2013. However, for some reason, the report ignores important caveats which were applied by the board in the case of its approved discount rate methodology and which were clearly set out in the paper on which that decision was based. The board decision of June 2013 noted that a 5.5% rate should not be used as an overarching discount rate to evaluate all potential transactions and that flexibility should be maintained. In particular, the board approved the position that "care should be taken to ensure that both (a) alternative NPV scenarios are generated using alternative discount rates and (b) that qualitative information would be considered as part of the decision-making process".

A discount rate of 5.5% may have been appropriate for overall portfolio accounting purposes and, indeed, for some individual transaction evaluations but would not have been appropriate for all segments or assets within the portfolio. The flexible approach approved by the board in June 2013 was clearly designed to deal with the evaluation of transactions and lower quality assets such as Project Eagle which was not typical of the NAMA portfolio as a whole. As I indicated, discount rates in the 10% to 15% range were applied to cash flows in later loan portfolio sales. There was very good reason the Project Eagle portfolio would have been subject to a higher discount rate, including the relatively poor quality of the underlying assets and the underlying weak economic conditions in Northern Ireland and in parts of northern England and Scotland. The discount rate would also have reflected the inherent macro risk associated with a high concentration of assets located in the small Northern Ireland economy. The Northern Ireland property market did not have the capacity to absorb a large volume of asset sales over a short time; this lack of market liquidity was evidenced by the fact that in the four years from 2010 to the end of 2013, sales of NAMA-secured assets in Northern Ireland realised a total of only £100 million. This consideration would not have applied to the Dublin or London markets.

Project Tower, a better quality portfolio than Project Eagle and to which it has been compared in the report, was launched to market at the same time in quarter 1 of 2014. UBS, our loan sale adviser for Project Tower, advised that a 10% discount rate was appropriate. In Project Arrow, a portfolio with similar characteristics to Eagle, Cushman and Wakefield, our adviser, advised us in mid-2015 that a 15% discount rate was appropriate. This demonstrates that NAMA’s position on discount rates reflects the market reality of loan sale pricing. The Comptroller and Auditor General’s claim that Project Eagle involved a significant "probable loss" of value to the State rests on its mistaken view that the board adopted a "standard" discount rate of 5.5% in June 2013 to be used subsequently for all future evaluations. The board firmly rejects this Comptroller and Auditor General interpretation of its own decision. It is clear from the June 2013 decision itself, as quoted earlier, that the board did not intend that 5.5% should be a one-size-fits-all discount rate. When it became clear to the board that the Comptroller and Auditor General’s examination team was unwilling to accept the board’s understanding of its own decision on the £1.3 billion minimum price, it offered to meet the Comptroller and Auditor General directly to discuss this issue and to discuss the key points. The board’s offer, however, was refused by the Comptroller and Auditor General.

The Comptroller and Auditor General’s office has not been consistent in the application and guidance it has provided in writing to the NAMA audit committee and board. In his end-2013 management letter issued after an unqualified sign-off of the 2013 financial statements, the Comptroller and Auditor General acknowledged that NAMA’s strategy was evolving from individual asset-by-asset sales to a greater focus on bulk loan portfolio sales. In that context, both NAMA and Comptroller and Auditor General staff agreed in 2013 and 2014 that we could not have maintained the previous carrying value of the portfolio once the strategy changed from individual asset sales to a loan sale of full debtor connections. This is evident from the end-2013 management letter, which was issued in mid-2014, in which the following is stated: "Where a change in strategy is effected which results in either (i) a change in the sale of underlying collateral to a loan sale/portfolio sale or (ii) a change in the sale of a loan/loan portfolio to the sale of the underlying collateral, cash flows should be updated to reflect the most up to date position to mitigate the risk of an incorrect impairment provision being recognised." Two things are clear from this. One is that senior Comptroller and Auditor General staff in 2013 took the view that the carrying value of assets included in a loan sale could differ from their carrying value as individual items of collateral. Second, it shows that senior Comptroller and Auditor General staff in 2013 would have expected NAMA to update the portfolio’s carrying value in response to a change in strategy and to the emergence of up-to-date information relevant to judgments on impairment.

Ultimately, the value of any loan portfolio, including the Project Eagle portfolio, is what credible bidders are willing to pay for it at a point in time taking account of demand-supply and economic conditions.

If we had halted the Eagle loan sale, we would have had to adjust our carrying value to bring it into line with the market price indications we had received from potential bidders. This is absolutely consistent with the IAS 39 IFRS accounting guidance and in line with NAMA's own understanding. Indeed, it is very much in line with the Comptroller and Auditor General’s 2013 management letter recommendation, although not apparently in line with the view adopted in this report. What this means in layman's terms is that if the best bid for Eagle had been £1.1 billion and NAMA had therefore decided not to sell, the Comptroller and Auditor General's office would have insisted - rightly, in my view - based on the end-2013 management letter that NAMA write down the portfolio to £1.1 billion. NAMA could then have sold the portfolio later in 2014, perhaps for £1.1 billion, and there would have been no talk of a probable loss to the taxpayer, merely because the accounting adjustment with a higher impairment would already have been made at that stage. Ironically, because NAMA was guided by its section 10 of the NAMA Act objective of getting the best price achievable, it set the minimum price at a more aggressive £1.3 billion. It achieved in excess of that price target. As a result, we are now being accused of losing £190 million because of the Comptroller and Auditor General report's misplaced attachment to an accounting value rather than the real world market value, which is ultimately what matters. It would be absurd if NAMA's commercial activity was driven by accounting valuations rather than by real world values. In effect, the practical consequence of the position now adopted by this report is that NAMA would never have sold the Eagle portfolio or any other similar loan portfolio if the market value failed to match NAMA's accounting value. It is worth bearing in mind that an accounting value is no more than a provisional estimate of value until confirmed or otherwise amended by evidence of market value, that is when it is sold.

NAMA, under legislation enacted by the Oireachtas, has to operate by reference to commercial principles. Acceptance of the Comptroller and Auditor General's unrealistic and uncommercial position would make commercial decision-making impossible. That is why this issue goes to the heart of NAMA's commercial mandate and why we have no alternative but to contest the stance as evident in this report.

The issue of valuation and the appropriate discount rate is closely bound up with the procedure adopted by the Comptroller and Auditor General in preparing this report. Prior to commencing his examination of Project Eagle, the Comptroller and Auditor General sought external specialist expert advice to assist him in his examination. This was, in effect, an acknowledgement of the reality that he needed expert advice if he was to conduct the examination in a properly informed manner. Ultimately, the fact that no external advisers were commissioned to advise the examination means that the report's conclusions are based entirely on opinions formed by staff who, to our knowledge, have no market experience and no expertise in loan sales. By contrast, when the Comptroller and Auditor General's office was preparing an earlier report on NAMA's management of loans in 2012, the then Comptroller and Auditor General, Mr. John Buckley, commissioned external advice on the property valuation process and on legal issues. Mr. Buckley stated that he did so "in order to gain assurance" about two elements of the process on which his office had no expertise, namely the valuation of properties and legal due diligence. Mr. Buckley relied heavily on expert evidence in arriving at his conclusions. We are aware of at least one other instance in which Mr. Buckley sought external expert advice from property consultants. Contrary to recent press reports, NAMA is not the first State body to contest the Comptroller and Auditor General's findings on matters which are outside its expertise. In December 2010, during a discussion at the Committee of Public Accounts on the OPW Vote, where the OPW disagreed with the Comptroller and Auditor General's position, Mr. Buckley stated the following:

Normally when we carry out assessments, we operate on the basis of our own work. Here, however, we are dealing with an area of expertise that is outside of our comfort zone. As a result, we employed consultants.

In his evidence to the banking inquiry, the current Comptroller and Auditor General stated that external experts were engaged on four occasions between 2010 and 2014 to provide specialist assistance on issues relating to NAMA. He stated:

Matters which are taken into account in the decision to engage an expert include the competence, capability and objectivity of the expert; the significance of the accounting area or nature of the matter to which the expert’s work relates; and the significance of that expert’s work in the context of the audit or reporting work.

Therefore, it is all the more extraordinary that the external expert advice was not utilised on this review given that loan sales are new to the Irish market and are certainly more esoteric than property or other matters on which external expert advice has been utilised in the past.

During the same discussion in December 2010, Mr. Buckley went on to point out that "when one is examining the performance of the OPW, there is no point in using the way it operates as a yardstick to judge that performance". In other words, good practice requires that you judge performance by reference to some objective external benchmark. In that context, we note that the current Comptroller and Auditor General report on Project Eagle reviews the Eagle sales process by reference to later NAMA loan sales processes, not by reference to the numerous non-NAMA sales processes which took place in Ireland and elsewhere in 2014. In effect, the Comptroller and Auditor General benchmarks NAMA against itself, not against the wider market. It would have been instructive to have compared the due diligence information in the Eagle data room with the quality of information available to bidders for the IBRC loan portfolios which were sold by the liquidator at the same time in 2014. That would have been a very relevant and useful comparison. It would also have been instructive to compare the targeted loan sales process applied in Eagle with the more targeted sales processes adopted by RBS and Lloyds loan sales in the UK. It could have shown that the targeting of major investors is a regular feature of the loan sales market. Unfortunately the relevant comparisons, which would have placed the Eagle sales process in a proper market perspective, were not carried out. Why not? It would not have required a huge amount of effort. Are these not obvious comparators which one would expect to find in any major review, like that of Project Eagle, which purports to be authoritative?

It is difficult to understand why the well-established Comptroller and Auditor General precedent of using external expertise was not utilised in the review of Project Eagle. The area of loan sales is very much a specialist area and is not one on which the Comptroller and Auditor General's staff could reasonably be expected to have detailed expertise. There would have been nothing wrong in acknowledging this. The view of the NAMA board is that if the Comptroller and Auditor General's examination had been informed by external market expertise and expertise in loan sale valuation and sales processes, its comment on this key valuation issue would have been very different. Given that this very unsound comment stems directly from what we regard as the inadequate examination process that was adopted, it would be entirely unsatisfactory if it was the last word on the matter. A report which is prepared to make such a resounding and serious comment must be properly supported by convincing, formidable and sufficient evidence - evidence that is based on accepted market valuation methodology, evidence that would be accepted by market experts and evidence based on market comparators. Unfortunately, the evidence produced in this report falls well short on all of these counts.

I will add one more point which is not in my speech but which arose this morning from the Comptroller and Auditor General's opening statement. As an additional point, the Comptroller and Auditor General advised in his opening statement that his office consulted two officials in the UK National Audit Office who reviewed the Northern Rock loan sale in the UK. I have looked at the National Audit Office report and it should be noted that in its description of the audit it undertook, it said it used semi-structured interviews with the following: Credit Suisse and Moelis, which advised both UK asset recovery and UK financial investments; the bidders in the process including Cerberus, which won that loan sale portfolio; KPMG, which helped out with the due diligence involved in putting that portfolio on the market; the financial conduct authority in the UK; UK treasury; UKFI; and UKAR. The Comptroller and Auditor General did not do this with any of the equivalent bodies in respect of Project Eagle. Why not, if it had consulted the National Audit Office?

Deputy Catherine Connolly:Can we have a copy of Mr. McDonagh's additional comments?