Mr. Brendan McDonagh:

Good morning, Chairman, and inquiry members. In this brief opening statement you have asked me to address five topics in particular: the acquisition process of eligible assets from participating institutions; the quality of documentation underlying collateral of acquired assets; the governance models in place in respect of loan and asset acquisition and management; the asset valuation methodologies utilised by the participating institutions prior to acquisition as compared to that used by NAMA; and the extent of commercial diligence conducted by borrowers.

Before addressing these points directly, I wish to emphasise that my comments are informed largely by NAMA's experience of acquiring a management portfolio of loans with a face value of €74 billion acquired from the participating institutions in 2010 and 2011 for a consideration of €31.8 billion. Regarding some of the points on which you have asked me to comment, I do not and could not have the level of detailed knowledge or insight that would be available to senior lending managers or to the credit committees of the financial institutions or to staff of the Financial Regulator or the Central Bank.

By the time of NAMA's establishment, the property lending crisis and the losses created by poor lending decisions were already irreversible, and while in this statement I may draw certain inferences about the causes of these losses based on what we found when we acquired the loans, I do not claim to have access to the full picture. In particular, as I was outside the banking system, I do not have an insight into the motivation behind the poor lending decisions of the financial institutions or indeed the borrowing decisions of the debtors in the years up to the end of 2008. I trust Chairman and committee members, you will accept my comments in that spirit.

The acquisition process has been described in detail in the Comptroller and Auditor General's first special report on NAMA acquisition of bank assets, which was published in 2010. The key elements of the process are outlined below. The institutions were required to identify assets which were eligible for transfer by reference to criteria in the NAMA Act 2009 and in regulations made by the Minister of Finance in December 2009, and subsequently in March 2010. They were also requested to provide detailed information on their eligible loans, including legal due diligence reports and up-to-date valuations of the property and other assets which were placed as collateral for these loans. The reference date for the market valuation of property was 30 November 2009.

NAMA then went through a process of validating key information provided by the financial institutions. Legal due diligence reports submitted by the institutions were reviewed by NAMA's external legal panel. The reviews were required to highlight any issues which gave rise to legal difficulties for NAMA in managing the loans or engaging in enforcement actions in respect of them. Particular attention was paid to enforceability of security, any deficiencies in title to property and the implications of such deficiencies.

The valuation process also covered property valuations supplied by the institutions. A key element in the valuation of each loan was the current market value of the property or other collateral securing the loan. The valuation was, in the first place, provided by a professional property valuer commissioned by the financial institution but also owing a duty of care to NAMA. Each property valuation submitted by the financial institution was referred by NAMA to its own property valuation panel which reviewed it and provided an opinion as to whether it considered it to be correct or not. If the NAMA property panel disagreed with the valuation it was referred to an independent property valuer for adjudication. This third party property valuation was accepted by NAMA and used as part of the loan valuation.

The valuation methodology used to value bank assets, usually loans, but also including derivatives, had to receive the formal approval of the European Commission because there was an element of state aid incorporated into the transfer price. Bank assets were acquired at an acquisition value which is determined in line Part 5 of the NAMA Act and the valuation regulations made by the Minister and published in March 2010.

The acquisition value of each bank asset was its long-term economic value. Various factors were taken into account in the calculation of the long-term economic value, including the current market value of the security, typically property but also including non-property assets, such as shares etc., and in the case of property, its long-term economic value. The valuation regulations required that NAMA apply an uplift adjustment factor ranging from 0% to 25% to the current market value of property to reflect its long-term economic value.

Following completion of the property and legal due diligence processes, a loan-by-loan valuation was carried out by one of five loan valuation firms employed by NAMA. The loan valuation process was independently audited by KPMG, which acted as audit co-ordinator. The audit co-ordinator provided audit certification to the European Commission on the valuations ... that the valuations were in line with the methodology approved by them. By 2014, the Commission had confirmed its approval of the transfer of all nine loan tranches. Ultimately, of the €31.8 billion NAMA paid as consideration for the acquired loans, €5.6 billion was considered to be state aid, i.e. NAMA paid the financial institutions €5.6 billion more than the private sector market would have paid them at the time of acquisition.

I understand that one of the earlier contributors to this inquiry made a comment to the effect that NAMA acquired loans at rock bottom prices. This suggestion, frankly, does not bear much scrutiny. I have mentioned already the overpayment of the state aid element of €5.6 billion in acquisition price. In addition, NAMA's acquired loans were valued by reference to a property collateral date of 30 November 2009 and, as a result, NAMA had to absorb losses from the impact of a 25% to 30% decline in Irish property values which took place subsequently right up to the end of 2013. No private investor would have transacted on this basis, i.e. a private investor would have paid only on the basis of the market price at close to the actual dates of the loan transfers in 2010 and 2011; thus if the participating institutions had to sell to private investors, I estimate that the acquisition price would probably be reduced by another €4.5 billion. Essentially, therefore, the institutions would have been paid about €22 billion by the market rather than the €32 billion that NAMA did pay for the loans.

Incidentally, I gather that the same contributor expressed the opinion that NAMA was acting more like a debt collection agency than as a property value maximising entity, and apparently questioning our ethos in that respect. I think this reflects a poorly informed view of NAMA although I understand that the contributor indicated that it was only an impression that he had. Of course NAMA collects debts, as would any similar entity. We collect on the loans due to us, indeed this is due to the taxpayers, but our role has been much broader and much more positive than that.

To give you a sense of the scale of NAMA’s role in the market since the end March 2010, NAMA has acted to stimulate market activity by disposing of close to €6 billion in Irish property since inception, involving over 20,000 individual property transactions. We have worked hard to bring foreign investors to the Irish market. We have injected €1 billion in capital to support the development of viable Irish projects which will continue to enhance the value of the underlying assets. We provided a vendor finance programme for commercial property lending at a time when the banks had stopped lending on Irish property. We set up a price protection scheme which addressed the concern about falling prices on the part of purchasers; the scheme involved a deferral of 20% of the cost of a residential purchase for five years. A further €3 billion is available in development funding, some of which will help fund the initiatives in the Dublin residential property market and also the docklands SDZ. We have worked assiduously to enhance planning permissions and to remove other obstacles to the development of assets so as to enhance their value and to ensure that they are shovel ready as soon as possible. By end 2015 we expect to have made 2,000 residential units available for social housing and we have supported businesses whose debt we acquired to employ about 15,000 people.

All of this work requires an intensive commitment by us in terms of time and resources involving experienced staff brought together from a wide range of disciplines for this unique asset management challenge. All in all, Chairman, I would suggest that well informed commentators would not regard these activities as those of an agency solely concerned with debt collection.

The legal due diligence process involved the submission by the participating institutions of comprehensive legal due diligence reports which included the disclosure of any matter which could materially affect the value of either the loan or the underlying security for the loan. NAMA retained the panel of legal advisers to review legal due diligence reports and report on the disclosures made and other matters not disclosed. In particular, their expertise was focused on highlighting any issues which would give rise to legal difficulties for NAMA in managing the loans or in engaging in enforcement actions in respect to them. As part of this acquisition process, the participating institutions provide the certificate and warranty to NAMA that, save as disclosed in the legal due diligence reports, the loan and security documentation are legal, valid and binding against the obligor, represents the entire agreement between the institution and the obligor and is fully enforceable against them.

Since the acquisition of loans commenced in 2010, NAMA has reviewed legal documentation of its acquired loans for the purposes of restructuring, sales, enforcement and providing new finance.

Each participating institution had different operating practices concerning its legal documentation which included the use of standard form facilities and security documents and general terms and conditions, the use of bespoke loan security documents drafted by their external lawyers and a combination of both standard and bespoke documents. Recurring issues which NAMA encountered with legal documentation included items of security not actually taken, guarantees not confirmed on the granting of a new facility and development loans with no security over work in progress or step-in rights. Other issues included defective Land Registry dealings and in a few cases missing original documents, such as title. Where a documentation issue was identified following acquisition, it was generally capable of remediation and remediation was carried out by NAMA. Where remediation was not possible, NAMA sought to revisit the acquisitionvalueof the loan in question and to claw back any amounts that may have been overpaid.

As regards the governance model in place in respect of loan and asset acquisition, NAMA dedicates substantial resources towards ensuring that the loan valuation and acquisition process was managed to highest professional standards. This was important not least to ensure that the process and the valuations which emerged received the approval of the European Commission. I have provided an outline earlier in the statement of the comprehensive rigorous approach that we adopted, particularly as regards the valuation of property collateral and the due legal diligence, both of which were key towards safeguarding the integrity of the whole process.

As regards the governance model in place in respect of post-acquisition loan management, the C&AG's second special report in NAMA - NAMA Management Loans since 2012 - provides a detailed account of the approach that we adopted to management loans and debtor relationships. NAMA decided that it would engage directly with its largest debtor connections, initially 189 NAMA-managed debtor connections with debt of €61 billion, that it would delegate the day-to-day relationship management of another 583 debtor connections with €13 billion in par debt within tight and specific delegated authority limits to the participant institutions, known as PI managed connections. We put in place a process to oversee the institutions and the performance of credit and operation of functions on our behalf.

As part of our initial engagement with debtors, we asked them to prepare business plans which set out how they propose to repay their liabilities.Following review of each connection's draft business plan, we adopted strategies which involved one or other of the following - debtor support, earlier asset disposal or enforcement. In return for support from NAMA, including funding of commercially-viable development projects, debtors were expected to agree a number of conditions, including asset sales disposals, reversing asset transfers to third parties, ceding unencumbered assets to NAMA as additional security, giving NAMA control over rental income from investments assets and agreeing to cuts in overhead costs. NAMA retained control of credit decisions to a cascading system of credit limits and delegated authority ranging from the NAMA board down successively to the credit committee to NAMA senior management and to NAMA units in the participating institutions.

As regard the loans acquired by NAMA from the participating institutions, banks would not have been required to measure them at fair value while they were still on their books. An asset valuation would only be carried out on a loan portfolio if it was mooted for sale or transfer. The participating institutions would have measured their loan books in accordance with the International Financial Reports and Standards, IFRS, specifically IAS 39. This accounting mechanism requires loans originally arranged in advance of them to be measured on an amortised cost basis. This was done on an assumption that the loans remain on the financial institutions books until maturity. At least once a year, banks would have had to perform an impairment exercise in respect ... in accordance with contra rules of IAS 39. This requires the banks to recognise an impairment provision against the book value loans where there is a reduction in the amount likely to be received or a change in the timing of future loan cash flows, commonly referred to as objective evidence of impairment.IAS 39 uses an incurred loss basis as opposed to an expected loss basis.Under IAS 39, banks cannot provide for expected future credit losses. As the impairment methodology operates on an incurred loss model, there can often be a time delay until those losses are identified, known as "the emergence period". During the duration of such emergence periods, it may be some time before the losses and loan portfolio are actually identified and have to be recognised as losses by the financial institutions. Following the banking crisis in 2008 and 2009, it was widely accepted among accounting practitioners that IAS 39 impairment methodology did not appropriately reflect potential losses in a loan portfolio or did not do so on a timely basis. As a result, the International Accounting Standards Board has redrafted IAS 39 and the new standard IFRS 9, which will be implemented later in this decade, changed impairment methodology to allow for future expected credit losses to be reported on a more timely basis. In summary there were significant differences between the valuation methodology used by NAMA and that used by the banks give the latter did not have to apply fair value methods to their loan portfolios.

Because they originated loans, they could deal with them on a non-amortised basis. NAMA by contrast did not originate the loans and had to value them at acquisition at fair value basis in accordance with IAS 39 rules, i.e., recognising on NAMA's balance sheet on day one that €31.8 billion was the fair value of the loans, not €74 billion.

I should point out that the valuation methodology used by the Irish financial institutions was no different to that used internationally and that they were in no way departing from conventional accounting standards in the approach they adopted. If anything the accounting standard lagged the market reality whenever IFRS was used. One of the misguided comments directed at NAMA in the early days was that it crystallised a massive loss in the banking system through an overly stringent valuation approach. It acquired loan balances of €74 billion for €31.8 billion, equivalent to a discount of 57%. By contrast, it was argued the banks, left to their own devices, would eventually have recovered much of the €74 billion par debt. I strongly disagree with this contention and would suggest that much of the €74 billion was never going to be seen again.

The NAMA acquisition process forced institutions to recognise their losses earlier than their own IAS 39 accounting valuation methodology would have required of them. In the absence of NAMA, you would have probably seen a phased unveiling of losses over a three, four, five, or perhaps even more years, with a consequent drip-drip effect in terms of the needs for capital replenishment and the corrosive impact of the creditworthiness of the sovereign. The NAMA process enabled the Irish banking system to recognise and address upfront the loan loss difficulties that it had created for itself long before NAMA was ever conceived. The fact that the asset management company model is now being copied in other countries suggests that, belatedly, it is recognised that the impaired banking systems do not tend to rectify themselves. An external body is needed to bring a fresh independent approach to resolution.

I do not have direct knowledge of the extent of commercial due diligence conducted by borrowers or, indeed, conducted by the institutions at the time the loans were advanced. However, based on our own experience of the loans which we acquired and which we have since sought to manage, I am in a position to make some observations on the lending environment which prevailed prior to 2007. In that context I would like to draw the committee's attention to table 1 below which in my view provides an eloquent summary into the insight of some of the issues which are the subject of your inquiry. The table presents a distribution of NAMA's acquired portfolio by size of the debtor connection aggregate of loans acquired from five participating institutions.

In summary, we acquired the loans of 772 debtor connections who borrowed €74 billion from the institutions. This excludes any additional amounts borrowed by these same debtors from institutions not covered by NAMA. I do not know how much additional borrowing from non-NAMA banks was involved, but I conservatively estimate it to be at least €10 billion. There are 12 debtor connections with debt in excess of €1 billion each, aggregating to a par debt of €22.2 billion, an average of €1.85 billion per connection. Another 133 debtor connections have debt between €100 million and €999 million, aggregating to €35.7 billion par debt, an average of €269 million per connection. And finally, there are 627 so-called smaller debtor connections with a debt of less than €100 million, aggregated to €16 billion debt, an average of €26 million per connection. As mentioned the table does not include lending advanced by institutions such as Ulster Bank, Bank of Scotland Ireland and a number of institutions which were aside of the NAMA process. It does not include loans advanced by AIB and Bank of Ireland to borrowers whose aggregate borrowing was less than €20 million and it also excludes property loans which remained with the participating institutions on the basis that they were not eligible for transfer to us.

NAMA observations and concentration risk: You will note from table 1 above that some €34 billion par debt has been advanced to the largest 29 debtor connections. Lending on this scale to a relatively few debtors suggests that the banks consider property lending to be almost a one-way bet, not withstanding the well-established cyclical behaviour of property markets and the steep rise in prices from 2002 onwards. It is clear that financial institutions and debtors shared a groupthink view that prices would remain on an upward trajectory and that there was limited downside associated with property lending. The view was presumably supported by favourable medium-term economic and demographic projections produced by economists and commentators and by the expectations that any setback in the property market would be temporary and minor, in line with an expected soft landing of the Irish economy. There was an obvious mismatch that few economists or commentators called into question when, on the one hand, lending was growing at over 30% on average per annum in institutions, and, on the other, the economy was growing at rates at between 6% and 9% over the period 2003 to 2007.

The impact of greater competition amongst lenders was to increase risky and imprudent lending. In particular, lending on the basis of it providing very high levels of project funding, sometimes at 100%, appears to have been quite common. The equity pledged by the debtor, when required, often took the form of unrealised paper equity from other transactions. Few, if any, financial institutions wanted to be left out of what was seen as a profitable business due to the larger lender margins and the relatively low operating costs. In normal market conditions, a finite number of viable development projects would be able to secure finance from a finite pool of the bank funding available for property development. In perverse conditions, which held sway in the Irish market up to 2007, there was far too much bank funding available and, ultimately, it found its way not only to a finite number of development projects which were viable, but also to many other projects which could be viable only on very heroic and often mistaken assumptions. The sheer weight of debt funding that was available caused an overflow effect into riskier projects which could not have been entertained in normal market conditions.

It was difficult to avoid the impression that the institutions perceived lending as a sales activity and that, in the rush to expand bank balance sheets, a rigorous focus on lending quality was lost. Some bank balance sheets doubled between 2003 and 2008. In one case, the size of the bank balance sheet quadrupled. Based on our experience of managing acquired loans, it is difficult to fathom a robust rationale for a significant portion of the property lending and, at the very least, it raises the question of whether lenders' remuneration was based on lending volume rather than on the quality of such lending. It is unclear to what extent there was analysis by bank strategists, by the Financial Regulator or by economists of the relationship between the volume of lending, by region or by sector, and the projected demand for property assets, by region and by sector. Nor is it clear to what extent did the institutions subject their lending to vigorous stress testing or, indeed, were required to do so by the Financial Regulator.

Net worth: In advancing additional funding during the years up to 2007, the lending institutions appear to have relied heavily on assessments of debtors' perceived net worth – the difference between a debtor's valuation of his assets and liabilities. Statements of affairs – a list of assets, liabilities and value – were relied upon to provide comfort that a debtor's financial position could support new lending and that he could service his liabilities. However, these documents were not always audited and were often self-certified with asset values assessed by the debtors themselves.

Compounding the weakness was the fact that, for most debtors, assets comprised mainly or exclusively property assets so that when the market collapsed, the value of the asset side of balance sheets plummeted and the net worth evaporated rapidly. As market prices rose in the years up to 2007, so the self-assessed net worth of debtors also appeared to rise, thereby giving rise to ... giving the lending institutions a sense of false comfort over additional security that did not exist.

Land and development assets: This issue was particularly acute in cases where a debtor's property portfolio had significant exposure to land and development assets. A fall ... A rise or fall in market prices has a multiplier effect on the value ... on the price of land indeed for residential or commercial development. The price of development land is a residual value after costs and developer's profit margin are deducted from projected sales proceeds. If projected sales proceeds based on market prices fall significantly, there may be little or no residual value. The land goes back to agricultural value or less. This is illustrated in table 2 below. This would explain the steep fall, in some cases of up to 90%, in the value of development land in the years after 2007. Much of the land had been bought speculatively. That is also why NAMA acquired some loans for only 10% or less of their face value. The fact that a substantial proportion of lending was secured by riskier land and development assets also explains why bank balance sheets suffered such extensive damage to their solvency. Unlike investment assets, there was no income flow associated with land and development assets and, in the absence of demand and liquidity, there was nothing to arrest the fall in prices as it gathered downward momentum.

Liquidity in the land market dried up completely. There were no buyers because residential prices had fallen to such a level that the construction of new houses was unprofitable. This point should be borne in mind whenever you hear the contention that NAMA or, indeed, any other market participant should have been funding the construction of houses in 2010 and 2011. It simply would have not made commercial sense by reference to market prices then prevailing and neither debt or equity providers would have made a compelling case for funding speculative development at that stage.

Smaller debtor connections: While the concentration of lending among the larger debtor connections was clearly excessive, our experience has been that the quality of such lending tended to be better quality than the lending to some of the smaller debtor connections. As set out in table 1 above, a total of €16 billion was advanced to 627 borrowers who had aggregate debts of less than €100 million each. Generally speaking, the initial discounts on these smaller debtor connection loans were higher and NAMA has to take even higher impairment provisions on them in the interim.

While some of the lending was to professional, well-managed entities, much of it was to individuals or syndicates whose primary business was not property developments, or who became involved in property developments relatively late in the cycle. Much of the lending related to potential development projects in or near towns, or in rural areas, rather than main urban centres. In some cases, one can see how an individual project may have made commercial sense to a bank, if assessed in isolation. The problem was that similar projects were receiving funding from other financial institutions and clearly not all those projects could have ever been simultaneously viable.

Corporate infrastructure: some of the debtor connections who received this funding did not have adequate support in corporate infrastructure. In particular, some of the property businesses which built up ... quickly built up balance sheets of €1 billion or more, did not have the financial expertise required to manage bank balance sheets of that size and it does not appear that the institutions made much of an effort to push for improved governance of the debtor's businesses. By contrast with our situation, property lending in the UK is largely advanced to publically quoted companies, which are suitably resourced to manage their bank balance sheets and the risks; for instance, British Land, a listed UK development company, which has debt levels comparable to some of NAMA's larger debtors, have more than 200 employees. As the crisis emerged in 2008, 2009, UK property plcs accessed the equity market and used that funding to pay down debt. That option was not available here, given the majority of debtors were, in effect, sole traders and they were totally reliant on bank debt. A debtor's track record and reputation appear to be paramount consideration for the lenders. There appeared to be a highly accommodating attitude among financial institutions towards the more prominent debtors and a concern that, if that institution was not particularly amenable, the debtor would look elsewhere for the funding of future projects. Clearly debtors were not slow to exploit the unusual lending market. Some of the more professional debtor connections tended to focus on particular sectors in which they had developed a particular expertise. This is particularly the case for debtor connections whose main asset base was outside of Ireland. However, one of the more notable features of the acquired loan portfolio by NAMA was that many debtor connections had borrowed against a diverse range of assets. It was not unusual to find, when all the loan information was collated, that a connection had exposure to a number of jurisdictions and to a number of sectors, including office, retail, residential, in addition to ownership of one or more hotels, as well as undeveloped land. After NAMA acquired the loans, it was not always apparent to us what the debtor's strategy might have been in assembling such a range of assets which was so diverse, by reference to a sector and location. The obvious conclusion, in some cases, was that the compulsion to purchase more and more uncorrelated assets was entirely related to the almost unlimited availability of debt funding. Many of these asset sectors require specialist business skills which do not appear to have been available to some of the debtor connections involved. The fact that many of them had only small supporting teams means they could have found it difficult to devote the requisite skill sets to the range and scale of projects covered by their borrowings. A debtor who was a successful house builder will not necessarily have the expertise to manage a group of hotels, or run a shopping centre, but this does not appear to have inhibited the lenders involved.

I hope that these comments are helpful in terms of assisting the committee to obtain a fuller understanding of some of the issues which you have been asked to address. Following the Chairman's statement, I will be happy to respond to any particular questions you may wish to raise. Thank you, Chairman.