THE HIGH COURT

COMMERCIAL
2010 No. 909 JR

BETWEEN:
DELLWAYINVESTMENTS LIMITED, METROSPA LIMITED, BERKLEY
PROPERTIES LIMITED, MAGINOTGRANGE LIMITED, MAY PROPERTY
HOLDINGS LIMITED, SCI 20 PLACE VENDOME, DIRECTDIVTDE TRADING
LIMITED, SUBMITQÜEST LIMITED, BELFAST OFFICE PROPERTIES
LIMITED, THE FORGE LIMITED PARTNERSHIP, FINBROOK
INVESTMENTS LIMITED, CONNIS PROPERTY SERVICES LIMITED,
FORMCREST CONSTRUCTION LIMITED, CHESTERFIELD (THE
PAVEMENTS) SUBSIDIARY LIMITED, ABBEY DEVELOPMENTS LIMITED
AND PATRICK McKTLLEN
APPLICANTS

AND

NATIONAL ASSET MANAGEMENT AGENCY, IRELAND AND THE ^

ATTORNEY GENERAL
RESPONDEN
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4S NO *N! O V/1

AFFIDAVIT OF DR. JOSEPH E. STIGLITZ

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I, Professor Joseph Stiglitz, residing a1258 Riverside Drive Apt 12 CÍD New York, NY 10025,
United States of America aged eighteen years and upwards Make Oath and say as follows:

I. INTRODUCTION

1. I make this affidavit at the request of the Applicants in the above entitled
proceedings, for the purpose of providing an expert opinion to the Court. I
understand that the duty and the role of an expert witness are to assist the court and
that experts have a duty to be impartial. I have abided to this duty and make this
affidavit from facts within my knowledge, save where otherwise appearing and where
so appearing I believe the same to be true.

A. QUALIFICATIONS

2. I am one of ten University Professors at Columbia University. I currently hold joint

appointments in the Department of Economics in the Faculty of Arts and Sciences,
the Department of Finance in the Gradúate School of Business, and in the School of
International and Public Affairs. Prior to assuming this position, I held professorships
at Stanford, Yale, Princeton, and Oxford where I taught a wide variety of gradúate
and undergraduate courses in economics and finance.

3. From 1993 to 1997, I served as a member of the President Clinton's Council of

Economic Advisers, and from 1995-1997, as Chairman of the Council and a member
of the President's Cabinet. As Chairman and Cabinet Member, I was the principie
person within the White House responsible for formulating fiscal policy, financial
sector regulation and banking policy, and coordinating policy with the U.S. Treasury.

4. From 1997 to 2000, I served as Chief Economist and Sénior Vice President of the
World Bank, in which capacity I had the responsibility of advising countries around
the world on the design of fiscal and monetary policies.

5. Relevant to the topics I discuss in this affidavit, I have published leading

undergraduate and gradúate textbooks, authored over 500 scholarly articles, written
numerous academic books and a variety of popular books.
6. In 2001, I was awarded the Nobel Prize in economics for work which is directly
relevant to this case. This work includes the study of how Information asymmetries
affect economic behavior, the determination of the conditions under which effícient
sharing of risk occur, and the economics of fínancial markets.

7. Additional qualifications can be found in my Curriculum Vitae attached and labeled

"JES1."

B . OVERVIEW AND SÜMMARY OF CONCLUSIONS

8. In preparing this affidavit, I have reviewed the witness statements regarding the role
and operations of the National Asset Management Agency ("ÑAMA") within the
Irish banking crisis, including its purported role in improving bank balance sheets and
enhancing economic performance. My review of these material s indi cates that there
is considerable confusion regarding how the banking sector works, the economically
appropriate process for addressing bank insolvency, and the role that ÑAMA can play
in addressing bank insolvency. I have also reviewed data and affidavits pertaining to
the performance of McKillen's portfolio and the extent to which his loans pose a
systemic risk to the Irish economy. Based on this review, the economic benefits to
moving the McKillen loans to ÑAMA are questionable at best. To the contrary,
McKillen, the banks and the taxpayer are likely to be injured by such a move.

9. I am aware, having been so advised by the legal advisors to Mr. McKillen, that this
Honourable Court is unlikely to rule upon the question as to whether the McKillen-
related loans are or are not suitable for transfer to ÑAMA. Rather, I understand it to
be the case that the Court is more likely to be concerned with the manner in which the
decisión to take a transfer of the McKillen-related loans was made. That being so, I
wish to note at the outset that from the perspective of Mr. McKillen there are
compelling arguments as to why his loans ought not to have been transferred to
ÑAMA, and it is my understanding that he was never given an opportunity to make
those arguments. Furthermore, from the perspective of the Irish economy and the
banking sector - including in particular the banks lending to Mr. McKillen - there are
several factors which strongly indicate strongly that there should not have been a
 transfer to ÑAMA. Based upon both what I have revíewed to date and also what I
have been told, I see no evidence that any consideration was given to these factors in
the taking of the relevant decisión. It is my own strong opinion that there should not
be a transfer of the McKillen loans to ÑAMA. Furthermore, in light of the incentives
associated with ÑAMA and its structure and powers, it is particularly important to
have procedural safeguards and due process, neither of which would be unduly
burdensome.

10. My affidavit proceeds as follows. First, I outline the role of long-term relationships
in the banking sector in addressing the asymmetric information problems that are
pervasive in this industry. Second, I discuss best practices for addressing bank
insolvency, highlighting economic considerations relevant to choosing which assets
should be purchased by ÑAMA. Third, I provide analysis of the Irish banking crisis
and the creation of ÑAMA, incíuding an economic analysis of NAMA's structure and
its statements to shareholders and taxpayers with respect to its performance. Fourth, I
explain why NAMA's structure and incentives - in particular its incentive and ability
to seize performing loans in the absence of due process - do not reflect best practices
for addressing bank insolvency. Fifth, I explain from an information economics
perspective why a transfer of the McKillen loans will likely have a negative impact on
McKillen. Sixth, I review evidence indicating that McKillen's loans are not impaired
and that his portfolio does not impose systemic risk on its lenders. Seventh, I discuss
how allowing for due process would improve NAMA's efficiency and reduce the
potential for injury to the banks, taxpayers, borrowers, and the Irish economy more
broadly. Eighth, I review the testimony of ÑAMA witnesses, Ms. Anne Nolan, Mr.
Brendan McDonagh, Ms. Aideen O'Reilly, and Professors McAleese and Lañe.

11. I will use several words íhroughout this affidavit with precise meaning:

a. Impaired loan - Means a loan where there is an explicit expectation by the bank
and its accountants that a loan loss will occur.1

See discussion of definitions in International Accounting Standards in affidavits of John Trench and
Michael Cragg.

3
 b. Technical default - Means that a loan covenant is breached but the loans are being
ftilly serviced.

c. Payment default - Means that the borrower's cash payment obligations to the
lender are not being met.

d. Performing loan - Means that the cash flow requirements of the loan (scheduled
interest and capital payments) are being met (see Affidavit of John Trench
paragraph 32).

12. The conclusions of my anaíysis can be summarized as follows:

a. There is a standard process for addressing bank insolvency that creates

appropriate incentives for borrowers and lenders. The Irish governmenfs
response to the banking crisis implements parts of this standard toolkit, though
some of the distinctive aspects of its response do represent deviations from best
practice and raise concerns that require particular attention with respect to the
acquisition of assets. In order for the governmenfs process to work well, it is
crucial that the government focus on identifying and acquiring those loans for
which: (i) principal and interest is not being repaid or (ii) there is a significant risk
of nonpayment.

b. Although NAMA's role should be confmed to paying for bad loans at fair market
valué, it has both the incentive and the ability to underpay banks for good assets.
ÑAMA has an incentive to seize bank assets that are performing well because this
strategy allows it to create short-term gains for shareholders and demónstrate
profitability to the public. ÑAMA is able to act in accordance with this
inappropriate incentive largely because of the extraordinary powers that it has
been granted to rewrite contracts and seize bank assets without consultation with
borrowers.

c. NAMA's incentive and ability to seize good loans is highly problematic. If

ÑAMA is allowed to underpay for performing loans, the banks will be leñ weaker
and the taxpayer will be leñ no better off - in fact, they may be worse off, both
because of the likely increase in public costs of bank recapitalization and because
 of the adverse effects on the economy. Further, NAMA's acquisition of good
loans (which it has an incentive to do) will hurt the banks, the economy, and -
most relevant to this case - good borrowers such as McKillen.2 This is because
ÑAMA does not have a bank's reputation, incentives, or information, ñor does it
have a bank's ability to issue or roll over credit. In the absence of these resources,
ÑAMA cannot recreate the valué generated in normal long-term banking
relationships.

d. In sum, the structure of ÑAMA (including its short time horizon and its inability
to issue credit) create the possibility of value-destroying loan transfers. NAMA's
incentives exacerbate this risk, making what would otherwise be a theoretical
possibility into a matter of serious matter of concern. Such value-destroying
transfers hurt the banks, the economy, and, most relevant to this case, good
borrowers such as McKillen. ÑAMA has disrupted and may well continué to
dísrupt McKillen's core long-term real estáte business and it will have an adverse
effect on the valué of his assets and his ability to refinance loans. This is because
McKillen's business - long-term investment in income-generating real estáte - is
a business that relies on predictable sources of credit and predictable tenant
behavior. Unlike speculative development, in which a developer builds to sell at
prices that he hopes are higher than the costs of acquiring the land and building
structures, businesses grounded in long-term real estáte investment are
particularly harmed by a transfer to ÑAMA. In more normal times, given enough
time, McKillen could presumably transfer his banking relationship to another
willing, long-term lender. But these are not normal times, and ÑAMA procedures
and timetables may not provide McKillen with the time that would normally be
required for a transfer of this scale.

e. Consistent with my discussion above, the affidavits provided by ÑAMA do not

provide any explanation of why moving McKillen's loans to ÑAMA is good for
the Bank of Ireland or Anglo Irish Bank. They also provide no explanation of

While many of these problems are inherent in any good bank-bad bank restructuring, Ireland's structure,
with partial prívate ownership of ÑAMA, represents particular risks, and is a structure not 1ike1y to be
followed elsewhere in the world.

5
 why such a move is good for taxpayers, save for the nebulous claim that McKillen
poses a systemic risk because he is a large borrower. In fact, the evidence shows
that McKillen loans are not impaired and pose no systemic risk.

f. Based on the foregoing analysis, it is my opinion that the Irish economy would
benefít most from leaving the McKillen loans with the banks in which they
currently reside. Given the breadth of McKillen's assets, the extent of
diversification in his portfolio, and the fact that McKillen's assets were assembled
and fmanced over a three decade period - a period in which McKillen
demonstrated himself to be a reliable, long-term borrower - it is in the country's,
the banks' and McKillen's best interests for his loan portfolio to remain with the
banks that originated the loans. ÑAMA would need to conduct an extensive
dialogue with McKillen in order to understand the economic support for this.
Instead of engaging in such conversations, however, ÑAMA has exercised its
broad powers to purchase assets it considers eligible, even in the face of
objections by banks or borrowers.

g. As a general matter, it is good policy for ÑAMA to gather information from

borrowers who wish to make a case for staying out of ÑAMA. If ÑAMA neglects
to gather such information, it will almost surely make economic mistakes that hurt
the state, the borrowers, and the banks. Thus, providing borrowers with the
opportunity to object to their loan transfer to ÑAMA is good economic policy that
generally makes borrowers, lenders and the state better off. Failing to provide
this opportunity creates the risk of a taking, as well as a situation in which the
state and the economy is made worse off.

II. THE ROLE OF LONG-TERM RELATIONSHIPS IN THE BANKING SECTOR

13. Financial institutions are primarily vehicles for facilitating transactions between those
who have capital and those who wish to borrow either: (i) to fmance investments or
(ii) to consume now at the expense of future consumption. While conceptually
straightforward, the complex real-world structure of financial institutions and markets

3
A taking is when the government acquires prívate property and fails to compénsate an owner fairly. A
taking can occur even without the actual physical seizure of property.

6
 is to a large extent a response to issues arising from differences in information
available to borrowers and lenders. These information differences - or asymmetries ~
give rise to problems of moral hazard and adverse selection.

14. Moral hazard in banking arises because key aspects of borrower behavior often cannot
be observed by the lender. As a result, once a borrower is insulated from the risks of
its actions, it can change its behavior in a way that is adverse to the interests of the
íender. For example, real estáte developers may have an incentive to undertake
excessively risky investments when they have a limited downside and an unlimited
upside when gambles pay off. The Irish real estáte frenzy increased the problems of
moral hazard, as developers raced to build and flip properties in the absence of
adequate bank supervisión. Similarly, in the aftermath of the Irish banking crisis,
banks themselves may have the incentive to take excessive risks. This is because they
may perceive themselves as insulated from the full cost of their decisions by the belief
that the Irish government will not let them fail.

15. Adverse selection in banking arises both because borrowers differ in the prohability
with which they will be able to repay their loans and because lenders are unable to
perfectly identify reliable borrowers. As a result, the pool of loan applicants may
change once the terms of provisión of credit change. For example, when a lender
increases the interest rate that it charges, borrowers with a high probability of
repayment may drop out of the pool, leaving only those borrowers with a low
probability of repayment. With these changes in the pool of lenders, it is difficult for
lenders to ensure that the terms they offer - e.g., the interest rates that they charge -
appropriately reflect the risks that they face.

16. Many practices have developed to address the moral hazard and adverse selection
problems discussed above. For example, banks typically require collateral from
borrowers. Because of concerns of moral hazard, banks making construction loans
often require borrowers to meet specifíc milestones before providing additional funds.
Banks also use consumer credit scoring to help differentiate potential customers who
are likely to repay their loans from those who are not. Banks can then offer better
interest rates to those customers who appear to be relatively credit-worthy.
 17. One of the most important ways in which adverse selection and moral hazard
problems are addressed in the banking sector is through long-term relationships
between bankers and borrowers. Long-term commercial banking relationships, such
as those that McKillen has with Anglo-Irish Bank and Bank of I reí and, help banks
differentiate borrowers who are good risks from those who are bad risks. As the
commercial borrower builds an ever-longer track record with a particular bank, the
underwriters gain confidence in the borrower and the bank is able to offer lower
interest rates. reduced collateral requirements, reduced information reporting
requirements, and greater loan amounts, al! at greater and safer profíts to the bank.4
Long-term relationships also help address the moral hazard problem. Given the
prospect of ongoing benefíts from the relationship, both the borrower and the lender
have strong incentives to behave well even under adverse, and often complex,
circumstances.5 Long-term "incentive compatible" relationships enable more flexible
contracting, based on trust. These relationships are an important part of the reason
that parties can agree to short or medium-term loans (such as those McKillen has)
even when financing a long-lived asset.6 Institutional practices and understandings
between the parties can substitute for explicit contract provisions, reducing
contracting costs and enhancing fíexibility and effíciency.

18. With no long-term relationship in place to mitígate concerns with respect to moral
hazard and adverse selection, organizations like ÑAMA are severely constrained in
their ability to recognize and support successful borrowers. Mo reo ver, NAMA's
incentive to develop such a mutually beneficial relationship with its borrowers is
limited, for two reasons. First, unlike traditional lenders that derive their profits from
a long-term relationship with a credit-worthy borrower, NAMA's goal is to discharge

See the affídavit of Joe Belanger for greater detail

5
This is because each party perceives the valué of its future reward to be greater than arty immediate valué
gaíned from engaging in opportunistic behavior today.
6
See the affídavit of Joe Belanger for greater detail
7
No contract is ever "complete " in the sense that ií could anticípate every contingency. ít would be
prohibitively expensive even to attempt to do so. Economists refer to the understandings that serve as
partial substitutes as "implicit contraéis." They not only provide for greater effíciency and fíexibility, they
also reduce litigation costs.

8
 its portfolio in a relatively short span of time.8 Second, ÑAMA lacks one of the
prímary means for effecting a long-term mutually beneficial reíationship with
performing borrowers, the ability to meaningfully extend credit. In a long-term
banking reíationship, credit facilities are rolled over upon expiration of a loan if both
the bank and the borrower have behaved well, thus providing profit incentives for
future good (non-opportunistic) behavior. However, ÑAMA is not a bank9 and does
not have the same ability to provide rollover credit on a long-term basis. Without the
promise of future rewards from a mutually benefícial long-term reíationship, both
ÑAMA and good borrowers such as McKillen have an increased incentive to behave
opportunistically. The response by ÑAMA seems to be rule-based procedures that
risk the destruction of valué by requiring relatively rapid sales of assets, even in
unfavorable markets. Potential buyers' knowledge that sellers may be under
compulsión to dispose of their assets would adversely affect sellers' bargaining
position even in more favorable market conditions. This concern is even more
pertinent in the current climate of high uncertainty and liquidity constraints.

19. Clearly, NAMA's structure and incentives present significant problems for McKillen
and other borrowers who run successful businesses that rely on loan refinancing.10
Given these considerations, ÑAMA should not be allowed to acquire and administer
loans that are currently performing well, without the full benefíts of due process.

See the affidavit of Joe Belanger for detail.

At some points, it seems to make a great deal of this, saying that it should therefore not be called a "bad
bank," and therefore cannot have the adverse reputation effects associated with a bad bank. The general
nomenclature in bank restructuring is to refer to asset management vehicles like ÑAMA as a bad bank,
even though they are really work-out vehicles. But this reinforces the point I am making: work out
vehicles are designed to work out bad loans, and the fact that they don't have the tools or long-term
horizon of a bank means that they are not suitable for managing performing assets.
In the language of economists, NAMA's purchase of McKillen will elimínate the economic benefíts that
have accrued to the banks and McKillen as a result of their participation in a repeated game. Through this
repeated game, McKillen and its banks have each built up the reputation for non-opportunistic behavior
that is needed to effect mutually benefícial transactions. NAMA's purchase of McKillen would replace
this repeated game with a one shot game that could well preven! such benefícial transactions from taking
place and thereby destroy market valué.

9
III. BEST PRACTICES FOR DEALING WITH LOAN INSOLVENCY ALLOW
GOOD LOANS TO CONTINUE TO BENEFIT FROM THEIR EXISTING LONG-TERM
RELATIONSHIPS

20. Lending is risky, even when banks do a good job of assessing creditworthiness and
monitoring loans. Bank regulations are designed to ensure that the bank has adequate
capital to meet its liabilities, i.e. money that it has "borrowed" from depositors. The
greater the amount of bank capital held by these shareholders, the less susceptible the
bank is to becoming insolvent, i.e. to have insufficient assets to meet its obligations.

21. Bank regulators are concerned about capital adequacy for a second reason: if banks
have insufficient capital, they have an incentive to undertake excessive risk (making
bad loans), and this is especially so if they are likely to be bailed out by the
government (if they are too big to fail). While bank supervisors are supposed to
mitigate this risk, they can do so only imperfectly.

22. In periods of turbulence, assessing whether banks are adequately capitalized may be
especially difficult. There may be problems of information asymmetries between
regulators/supervisors and banks. Banks often claim that they are illiquid meaning
that no one is willing to provide the banks the funds they need (at least at reasonable
terms) when in fact they are insolvent - i.e., they are unable to raise additional capital
because the valué of their liabilities exceed their assets. In the case of Ireland, the
offer of a very broad government guarantee of all bank liabilities meant that the banks
were neither illiquid ñor insolvent since they were effectively backed by the
government's fulí capacity to tax. If the guarantee is removed, the twin problems and
illiquidity and insolvency will immediately emerge.11

This has one further important impücation: There are two rationales put forward for stripping out the bad
loans. One is to reduce the uncertainty associated with the banks' balance sheet The second is
managerial—to allow one institution (the good bank) to focus on good loans, the other on working out bad
loans. But if the bank is essentially insolvent, the first objective becomes largely irrelevant The
government will, in any case, have to bear the risks. The government is currently doing so through the
guarantees it provides to those providing capital to the banks, and given the effective insolvency, it wí11
have to continué to do so. Moving the risk from one public body to another does not change the overall
risk to the economy or the public—something which the markets have already recognized. The
consequences depend only on the improved management of the assets that might result My analysis
suggests that, to the contrary, a move of a performing loan is likely to result in a worse management of the
asset.

10
23. Standard rules of capitalism díctate who will bear the losses associated with a bank
solvency problem. These rules require that shareholders lose all valué and that
bondholders become new shareholders. Only after bondholders have lost their capital
should government inject new capital, through deposit insurance and government
bailout funds. The bank, in such circumstances, will need to receive an infusión of
new funds (i.e., be recapitalized), typically first firom the government (to make it
viable), and then from the prívate sector through a public offering. In either case, the
bank can continué to exist and to provide funds.

24. Bank insolvency, if handled in accordance with these standard rules, will not entail a
serious interruption of the flow of credit to borrowers. This approach to addressing
bank insolvency has worked in very large banks, such as Continental Illinois, and in a
variety of countries, including Sweden and Norway. Indeed, as with bankruptcies in
other sectors, bankruptcies among banks can lead to better performance, as
uncertainty about the status of creditors is resolved and as the Corporation imdertakes
changes in management. In contrast, deviations from these standard rules result in
inequities, and going forward, can lead to large adverse incentive effects.

25. To prevent banks under prívate control from throwing good money after bad in the
presence of a government guarantee and to reduce uncertainty about insolvency itself,
it may be desirable to take the bad loans away from the bank. In that case, it is
obviously appropriate for a government entity to pay the bank the expected valué of
the bad loans. Such payment forces recognition of the (expected) loss, and thereby
making clear the shortfall in capital. However, it is important to realize that the
governmenfs payment to the bank of fair market valué for its bad loans does not
cause the bank to become insolvent. It only makes apparent the insolvency that
accounting standards have allowed to be hidden - the bank was already insolvent. If
the bank is insolvent, such stripping out of the risky loans will not enable the bank to
retum to lending. It will not resolve the banks' financial position. It can only be seen
as a first step in the recapitalization process, which, as described above, should entail
first converting bondholders into new shareholders, and then, if necessary, further
injections of capital.

11
 26. While, in the "bad bank" approach to addressing banking crises, it may be necessary
or desirable for the government to purchase bad loans from banks in order to facilitate
recovery, economic logic clearly indicates that it is poor public policy for the
government to purchase good loans from the banks. This destroys the valué of long-
term banking relationships that facilitate profitable transactions in a sector pervaded
by asymmetric information problems and incentives for opportunistic behavior. With
the severance of such relationships, bank risks may actually be increased and access
to additional funds reduced, all with adverse effects on new potential borrowers and
other good borrowers. Further, and as discussed in detail below, there may be follow
on effects: risks to the taxpayer may increase, the interest rate government pays may
increase, and this may lead to further increases in the cost of capital to the banks, and
to borrowers.

IV. BANK INSOLVENCY IN IRELAND AND THE CREATION OF ÑAMA

27. Below, I describe the banking crisis in Ireland and discuss the Irish government' s
response to this crisis, including its creation of ÑAMA. I also explain that the role
accorded to ÑAMA by the EU is to forcé banks to realize their losses by purchasing
bad loans at an amount approximately equal to long run fair market valué. As noted
above, NAMA's role need not conflict with an economically consistent process for
addressing bank insolvency, though in the best of circumstances, the "bad bank
approach" reflected by ÑAMA is one fraught with challenges (see section V below).
However, NAMA's current structure provides it with incentives to underpay the
banks, seize good assets in order to offset losses from riskier loans on their books, and
create short term gains for the ÑAMA shareholders.12 Further, ÑAMA has the ability
to act on these incentives due to the extraordinary powers it has been granted to
rewrite contracts. NAMA's authority in this regard is well in excess of that afforded
to ordinary commercial lenders.

As I explain later, ÑAMA created a SPV for acquiring loans from banks, and it is more accurate to say
that the shareholders are shareholders in the SPV. Throughout this report I simplify by referring to the
shareholders in the SPV as "ÑAMA shareholders."

12
 A . DESCRIPTION OF THE IRISH BANKING CRISIS

28. As discussed in detail in Dr. Cragg's affidavit, Ireland's economy was hit especially
hard during the fínancial crisis of 2008, and those doldrums have continued until
today. Unlike the crisis in the United States, Ireland's economic problems were not
driven primarily by exotic fínancial instruments. Rather, they represented a "plain
vanilla property bubble"13 fueled by large concentrations of lending for property-
related purposes.

29. Ireland's economy was hugely dependent on building and construction; those sectors
made up 20% of the country's GDP in 2007. This figure was more than 5% higher
than in any other Western European country and more than double the share that
building and construction represented in the United States' GDP for 2007.14
Construction also employed over 13% of the workforce at its peak in the third quarter
of 2006, which amounted to nearly a doubling of the economy-wide employment
share before the property run-up.15

30. Furthermore, construction accounted for an ever-increasing proportion of Ireland's

GNP as the bubble became more inflated. As discussed in Dr. Cragg's affidavit,'6 4%
to 6% of Ireland's national income in the 1990s carne from homebuilding, the usual
level for a developed economy. By the peak of the boom in 2006-07, however, this
percentage had increased to 15%, and other construction endeavors represented
another 6% of GNP (€163 billion in 200717). This distortion in the economic
contribution from housing and other construction projects was driven by the
overvaluation of Irish real estáte and the excessive availability of credit to fínance
housing and commercial real estáte development.

13
Regling, Klaus and Max Watson, "A Preliminary Report on the Sources of Ireland's Banking Crisis,"
2010, p. 6 attached and labeled "JES2." Alternatively described as an "old-fashioned property bubble" in
Honohan, Patrick, "What Went Wrong in Ireland" May 2009, Prepared for the World Bank attached and
labeled "JES3."
M
Cragg Affidavit 1J27.
15
Cragg Affidavit 127.
16
Cragg Affidavit ^28
17
Central Statistics Office, "National Income and Expenditure: Annual Results for 2009," June 30, 2010, p.
3 attached and labeled "JES4."

13
 31. In the third quarter of 2006, the number and average size of approved mortgages
peaked. By the raiddle of 2007, unsold units were beginning to accumulate. This
property slowdown spelled bad news for the Irish banking system, which had "lent
heavily to builders and developers to fmance projects and to make speculative land
purchases."19

32. The collapse of the building boom left Irish banks facing large losses from builders
and developers, and as a result, the major Irish banks' share prices started to slide
steadily after March 2007.20 The crisis carne to a head on September 29, 2008, with
a run in wholesale markets on one of the largest banks, Anglo Irish. In light of the
global fmancial crisis and international concerns about Ireland's fmancial sector,
pressure mounted for the government to respond.21 The fear was that, without
government intervention, banks would continué to hoard capital, erasing all liquidity.
At tihte extreme*
they would become "zombie banks" , representing risks to the
economy and the public fiscal sector.
33. In September 30, 2008, in response to the run on Anglo Irish, the government
2.3

guaranteed all the deposits and the sénior debt of Irish banks. In January 2009, the
government nationalized Anglo Irish. On February 11, 2009, the Irish government
invested €3.5 billion in preference shares in two large retail banks: Allied Irish Banks
and Bank of Ireland.24

18
Cragg Affidavit f 2 9 .
19
Kelly, Morgan, "The Irish Credit Bubble," December 21, 2009, UCD Centre for Economic Research
Working Paper Series 2009, Working Paper WP09/32, p. 3 attached and labeled "JES5."
20
Kelly, Morgan, "The Irish Credit Bubble," December 21, 2009, UCD Centre for Economic Research
Working Paper Series 2009, Working Paper WP09/32, p. 15 attached and labeled "JES5.". See also Cragg
Affidavit 1fl¡32-33 and Figure 6.
21
Second Affidavit of Ann Nolan, July 30,2010, - 7.
22
Zombie banks are banks that should be dead (i.e. have inadequate capital) but remain among the living.
Such banks pose a risk to the public fin anees, because they have an incentive to engage in reckless (and
worse) forms of lending and other behavior, even with negative expected social returns, typically imposing
high future expected bailout costs.
23
Second Affidavit of Ann Nolan, July 30, 2010, - 7. See also "Government Decisión to Safeguard Irish
Banking System," Department of Finance of Ireland, September 30, 2008 attached and labeled "JES6" and
"Credit I n s t i t u t o s (Financial Support) Scheme 2008 (the "Scheme"): Market Notice ~ Confirmation of
Statutory Guarantee," Department of Finance of Ireland, October 22, 2008 attached and labeled "JES7."
24
"ÑAMA Business Plan," June 30, 2010, ÑAMA, p. 10 attached and labeled "JES8." Affidavit of Brendan
McDonagh, July 30, 2010, ^jlO.

14
 34. Dr. Cragg has esíimated that, when fmally realized, Irish bank losses will be líl cxccss
of €30 billion. For at least the three major banks participating in ÑAMA, the realized
* 25 *

losses will be well in excess of existing bank capital. Without a government

guarantee (which allows banks to boixow at the Irish sovereign rate), and the resultant
access to the European Central Bank (ECB) and other sources of credit, the Irish
banks would be illiquid. This is because the banks' wholesale borrowing costs (at
high interest rates representing their junk rating), would be well in cxccss of proceeds
from their retail and commercial lending (at lower interest rates reflecting borrower
credit quality). Under these circumstances, bank insolvency would immediately
emerge. The only reason that the Irish banks remain functioning is the presence of the
blanket government guarantee of bank liabilities. But providing liquidity to banks in
this way does not resolve the underlying problems of bank insolvency. Moreover, any
value-destroying transfers and/or transfers to ÑAMA at prices that reflect a payment
less than the valué of the asset - including the valué of the banks' long-term
relationships with borrowers that might be severed or impaired by any involuntary
transfer - increase the eventual cost to taxpayers. The market appears increasingly
sensitive to such costs, and there may accordingly be a large indirect cost through
increased borrowing costs.
B . THE ROLE OF Ñ A M A

35. As discussed in detail in Dr. Cragg's Affidavit,26 The National Asset Management
Agency ("ÑAMA") Act of 2009 (the "Act") provided for the creation of ÑAMA by
the Irish government in order to remove bad or impaired assets from the balance
sheets of participating Irish banks. This logic behind the decisión was to remove
uncertainty about the soundness of the banks' balance sheets and make it easier for
them to access funds in the fínancial markets. The Irish government, through ÑAMA,
would acquire the loans from the banks for a discount, paying for them with
government-guaranteed bonds. ÑAMA is expected to have a finite lifespan and

25
Cragg Affidavit <¡54.
26
Cragg Affidavit 1fl}44-47.

15
 requires that 25% of its loans be repaid or refínanced within three years.27 As I shall
discuss below, and as I have noted above, this rationale for creating ÑAMA has been
vitiated by events. It is now clear that the banks are undercapitalized; there is little
uncertainty associated with this. And henee moving the risky assets off the banks'
balance sheets will not allow these banks to access fmancial markets. It is only the
government guarantee that allows access; and only a substantial recapitalization
would allow a return to access without a government guarantee.

36. ÑAMA was given broad powers to complete this mission: "ÑAMA may acquire an
eligible bank asset of a participating institution if ÑAMA considers it necessary or
desirable to do so having regard tó the purposes of this Act and in particular the
resources available to the Minister [of Finance]...NAMA may acquire, from a
participating institution, performing or non-performing eligible bank assets."
Significantly, the Act gave ÑAMA the power to acquire eligible bank assets even if
the participating institution did not consider the loan to be eligible, and even if the
participating institution objected to its acquisition. ÑAMA had no obligation to
consult with the borrower.

37. With bank losses of over €30 billion and government capital injections into the banks
of over €25 billion,29 at least according to some observers, ÑAMA, as originaíly
envisaged, would have allowed the Irish government to cover the enormous additional
losses through a hidden recapitalization. In particular, the original plan for ÑAMA
would have required it to overpay for failing bank loans arising from credit extended
to developers.30 However, the EU balked at this original plan (as a form of state aid
that was not allowed) and has only allowed ÑAMA to exchange government backed
securities for development and associated loans, at long-term economic valué. The
extent of the state aid was limited to the difference between what ÑAMA pays to the

27
"ÑAMA Business Plan," June 30, 2010, ÑAMA, p. 10 attached and labeled "JES8 " Affídavit of Brendan
McDonagh, July 30, 2010, f l 0.
28
National Asset Management Agency Act of 2009 attached and labeled "JES9."
29
Cragg affídavit
30
Morgan Kelly, "The Irish Credit Bubble," UCD Centre for Economic Research, WP09/32, p. 16 attached
and labeled "JES5."

16
 banks for assets transferred to ÑAMA (at most the long-term economic valué) and
current liquidating valúes (current market valué, or CMV).

38. In its final design, ÑAMA merely increases certainty about the state of the Irish
banks' balance sheets by replacing illiquid and harder to valué assets with assets that
are, for the most part, easier to valué (government paper). The realized bank losses
due to the transfer of assets to the ÑAMA portfolio will be on the order of €40 billion,
as discussed by Dr. Cragg.32 Thus, ÑAMA will effectively make apparent the current
bank insolvency, in what should be seen only as a first step towards recapital ization.
But, ÑAMA itself cannot recapitalize the banks. Henee, ÑAMA is not and cannot be
the primary policy that saves the Irish banks ~ this role will belong to whatever policy
is chosen to replace the bank guarantees which are currently supporting the banks.

39. In fact, when ÑAMA acquires a good asset, it may increase uncertainty because 5%
of the payments are with a bond whose valué depends on NAMA's performance.
For reasons that will be clear, this bond could have little or no valué, so that even with
an accurate valuation, there would be a 5% haircut, increasing the risk and magnitude
of bank insolvency.

C . Ñ A M A PROJECTIONS OF PROFITABILITY HAVE BEEN DECLINTNG

40. ÑAMA has established a Special Purpose Vehicle (SPV) for the purposes of
acquiring loans from the banks. This SPV is 49% owned by the public and 51%
owned by prívate investors. The prívate investors in ÑAMA are restricted in the
amount of return they can receive on their investment34 These limitations include an
annual dividend of no more than the Irish Government 10 year bond yield at the time

Affidavit of John Mulcahy, July 30, 2010, 1 and Eurosystem, "Opinión of the European Central Bank
on the establishment of the National Asset Management Agency," August 31, 2009, p. 6 attached and
labeled "JES 10."
32
Cragg Affidavit H68.
33
"ÑAMA Business Plan," June 30, 2010, ÑAMA, pp. 4, 25 attached and labeled "JES8." "Draft ÑAMA
Business Plan," October 13, 2009, ÑAMA, p. 6 attached and labeled "JES11
34
"ÑAMA Business Plan," June 30, 2010, ÑAMA, pp. 15-16 attached and labeled "JES8." The fact that
current projections imply that profits will be below the cap implies that, at the margin, prívate investors
will be getting 51% of any incremental profit.

17
 of dividend declaration35 and when ÑAMA meets its objectives and is wound up, no
more than 10% of the total capital invested in ÑAMA can be paid out as a profit.36
The bulk of the fmancing for purchasing loans from the banks is derived from
government guaranteed bonds.

41. In its October 13, 2009 business plan, ÑAMA projected a total profit of €4.8 billion.37
38

In its June 30, 2010 business plan, projected profit had fallen to €1 billion. The
decline in NAMA's projected profits was much noted in the Irish press. Indeed
ÑAMA has been subject to serious criticism. For example. the Labour party finance
spokeswoman said that clearly the first ÑAMA draft plan had been "a fantasy."
Further, the public appears to be growing increasingly disenchanted with ÑAMA
itself.40 Given the decline in expected profits, tax payers and prívate investors are far
more likely to be equally splitíing profits from ÑAMA. Thus, ÑAMA appears to be
under serious political pressure to provide an improved return for its shareholders -
both public and prívate.41
42. These results should not be seen as a surprise. If ÑAMA does in fact pay ful! long-
term market valué, then it can only make a profit if: (a) it is superior to the bank in the
management of the assets; and/or (b) the market performs better than appraisers
generally believed to be the case when the valuations occurred. But given the

For reference, the current 10 year bond yield, as of 2010, is 5%. National Treasury Management Agency,
"Ireland: 5.00% Treasury Bond 2020," January 14, 2010 attached and labeled "JES 12."
36
"ÑAMA Business Plan," June 30 2010, ÑAMA, p 15 - 16 attached and labeled "JES8."
37
"Draft ÑAMA Business Plan," October 13, 2009, ÑAMA, p. 10 attached and labeled "JES 11" and
"ÑAMA Business Plan," June 30, 2010, ÑAMA, p. 4 attached and labeled "JES8."
38
"ÑAMA Business Plan," June 30, 2010, ÑAMA, pp. 4, 25 attached and labeled "JES8."
39
See, for example, Irish Times Reporters in The Irish Times, "Ñama 'to make profit of € l b n , ' " July 6, 2010
attached and labeled "JES 13."
40
For example: "Ñama is a macroeconomic three-card trick...." in Sean Barrett, "Ñama will distort market
and is economic nonsense," The Irish Times, September 2, 2009 attached and labeled "JES 14;" "ÑAMA
will recover €16bn for the taxpayer on the €40bn it intends to spend...." in Emmet Oliver, "ÑAMA to
'recover just €16bm out of €40 bn spend on loans,"' The Irish Times, August 26, 2010 attached and
labeled "JES 15;" "It appears many of the worries over ÑAMA ... are coming to fruiíion already." in
Gregory White, "Massive Commercial Real Estate Loans Now Blowing Up Tn Treland," Business lnsider,
August 24, 2010 attached and labeled "JES 16;" Geoff Percival, "ÑAMA board set to forecast modest
profit," Irish Examiner, July 6, 2010 attached and labeled "JES 17;" "ÑAMA is unlikely to ever get back
the full amount it is owed...." in Thomas Molloy, "ÑAMA won't recoup full amount owed for land
loans," Independent, August 4, 2010 attached and labeled "JES 18."
41
See, for example, Irish Times Reporters in The Irish Times, "Ñama 'to make profit of €1bn,'" July 6, 2010
attached and labeled "JES 13."

18
 deficiency in experience, the inherent disadvantages of being a short temí
organization (where valué is maximized with long-term relationships), and the
constraints imposed by public sector rules, it would be a surprise if ÑAMA were able
to squeeze additional valué out of these assets. Some of those advocating "bad bank"
strategies believed that the market was temporarily depressed, and that government -
with a longer time horizon than markets - could hold the assets until the market
recovered. However, ÑAMA has a relatively short time horizon, and within this short
time horizon, global fmancial markets have performed far more poorly than many
expected earlier on in the crisis. Indeed, increases in interest rates facing Ireland, if
translated into increased lending rates more generally (as is often the case) will act to
further depress real estáte prices, making losses (in the relevant time horizon) even
more likely.

43. NAMA's one effective strategy for increasing profits is to underpay for the loans, but
should ÑAMA be successful in doing so, it increases the costs to the public through
múltiple channels. Most importantly, if the banks are in fact insolvent, for every €1
of profits for ÑAMA, the public loses half, as half of the gain goes to private
investors, and all of the bank losses are likely to be borne by the government.42

44. There is another way of thinking about what is going on. This is cióse to a "zero
sum" outcome; assets are just being moved around. Gains by one party (say, as a
result of mispricing) are a loss to another. If private investors are to be compensated,
it has to be negative sum for government and the bank together, but if the public is
picking up the shortfall of banks at the margin (and it appears that it will be, since the
banks are likely insolvent) then any gains to the private investor mean a loss to the
public. I have also delineated a number of reasons why what is going on is likely to
diverge from "zero sum." Reasons that we might observe a negative sum outcome
include the fact that: (a) ÑAMA is less experienced than the banks from which it is
acquiring the loans; (b) ÑAMA is a short-term organization, which has adverse
effects on hiring, implicit contracts, etc. and which means that the benefits which
accrue from a long-term relationship cannot be reaped; (c) ÑAMA has adverse

42
This is, of course, only true if profits are below the capped level, which appears to be the likely case.

19
 incentives (given both its prívate ownership and short term focus), exacerbated by its
political positioning, and claims that it will be profitable; (d) the large haircuts,
including partial payment in the form of an asset of uncertain valué, combined with
the failure to solve the insolvency issues, may increase opportunistic incentives; (e)
incentives for borrowers are similarly adversely affected; and (f) the ability of the
bank to recruit good borrowers in the future is also likely to be adversely affected.43
Offsetting these negative effects is the possibility of some "positive" gains: (a)
preventing opportunistic behavior by banks and borrowers with respect to bad loans;
and (b) diseconomies of scope - allowing banks to focus on good lending. In the case
of any particular asset, one has to ask whether the overall adverse effect on the public
and the negative sum impacts are greater or less than the positive sum impacts. In the
case of performing assets, such as Mr. McKillen's, there is an overwhelming case that
the adverse effects dominate. Indeed, with such assets the problem of opportunistic
behavior is limited, and the transfer of such assets vitiates the purported benefits of
NAMA's specialization in bad assets.44

V. NAMA'S INCENTIVES AND ABILITY TO SEIZE PERFORMING LOANS ARE

INCONSISTENT WITH GOOD PUBLIC POLICY

45. As discussed above, it is bad public policy for a quasi-governmental agency such as
ÑAMA to purchase performing loans from the banks in which they reside because the
severance of long-term relationships between performing borrowers and their lenders
needlessíy destroys valué. There may also be long-term adverse reputation effects to
Irish banks and commerce, for reasons explained below.

46. However, even if - contrary to economic logic and evidence - there were no valué in
these existing long-term relationships, purchases of performing loans by ÑAMA

While ÑAMA only has the power to acquire loans made before December 31, 2008, borrowers are likely
aware that the banks' problems have not been fiilly resolved, and that there is therefore considerable risk
of further actions, e.g. a ÑAMA II. The compulsory transfer of performing assets to ÑAMA could well
have a chilling effect on any good borrower seeking to establish a long-term banking relationship with an
Irish bank.
In fact, internal correspondence that I have reviewed from ÑAMA would appear to reflect the potential
that the adverse effects dominate. E-mail from Michael Connolly, "Coroin/Maybourne," March 11, 2010,
20:59, p. 105 in produced materials and e-mail from Eilish Finan, "Coroin/Maybourne," March 12, 2010,
00:37, p. 122 in produced materials attached and labeled "JES 19."

20
 would provide no benefit to the public, even though they could provide benefíts to
ÑAMA. To see this, it is helpful to consider the impact of such purchases on the bank,
on ÑAMA and on society as a whole.

47, As previously discussed, EU requirements prevent ÑAMA from overpaying for the
loans that it purchases.45 Henee, when ÑAMA seeks to purchase a loan, it can either
pay an amount cióse to fair market valué46 or it can confíscate the loan for a valué
below that amount. If ÑAMA pays fair market valué for a good loan, the bank is
compensated for its loss and ÑAMA has a good loan on its books. Thus, neither the
bank ñor ÑAMA is materially better off and ÑAMA has no incentive to undertake
such a transaction. On the other hand, if ÑAMA seizes a performing asset, paying
less than that asset is worth, it transfers money from the banks to itself Underpaying
banks for their assets exacerbates the banks' insolvency problem. Indeed, the
condition under which a bank would not voluntarily transfer a risky loan at long-term
fair market valué - a transaction that would provide liquidity without diminution of
asset valué - is if it planned to engage in some risky activity that would expose the
government to further losses without commensurate benefíts. Unless ÑAMA
believed that the bank's supervisors could not monitor/circumscribe such behavior,
there should be a presumption that the unwülingness of a bank to relinquish a loan
arises because the bank believes it is not being paid fair market valué for the asset.

48. There is no societal benefít to NAMA's confiscation of performing loans. (Recall the
rationale for confiscation of loans: reducing risk and reducing the scope for moral
hazard; both are problems only with risky loans.) Indeed, for reasons I have already
stated and discuss further below, there may be large societal costs. Given these

45
If ÑAMA were to overpay banks for bad assets, its payments would represent a hidden recapitalization of
the banking system. A government might conceivably want to engage in such a hidden subsidy,
recapitalizing the banking system in a way that taxpayers would not see as a direct appropriation. While
this is bad public policy and contrary to EU rules against subsidies, it is a course that has been taken or
proposed in several countries. For the EU's opinion on subsidies and the desire for the minimum level of
state aid see, for example, Eurosystem, "Opinion of the European Central Bank on the establishment of the
National Asset Management Agency," August 31, 2009, p. 6 and "Information from European Union
Institutions and Bodies," Commission, Official Journal of the European Union, C 72/1, Annex IV, pp. 20-
21 attached and labeled "JES20."
46
As noted above, the extent of the state aid was limited to the difference between what ÑAMA pays to the
banks for assets transferred to ÑAMA (at most the long-term economic valué) and current liquidating
valúes (current market valué, or CMV).

21
 concerns, why might ÑAMA want to seize performing assets? Coníiscation of
performing loans is the most certain way for ÑAMA to make money and thereby
fiilfill its previously mentioned promises to shareholders and tax payers. But it should
be clear that giving ÑAMA the right to confíscate performing assets provides
incentives and opportunities that are adverse to the interests of the overall fmancial
system and the economy. Moreover, because there is signifícant prívate ownership in
ÑAMA, transfers that take place between ÑAMA and the banks are not just transfers
between the taxpayers' pockets. Instead, they constitute, at least to some extent,
transfers from taxpayers to private shareholders in ÑAMA.

49. I have seen certain documentation provided by the Respondents on discovery which
indicates that ÑAMA is in fact approaching the McKillen loan portfolio on the basis
of an incentive to make a profit for itself.47

50. Ironically, those confiscations that make NAMA's performance look good (Le. yield a
positive return, as a result of underpaying) weaken banks. Moreover, the performing
assets that are most attractive to ÑAMA - i.e., the assets for which eventual disposal
is likely to be easiest, because uncertainty is the least ~ are likely to result in the
greatest loss of social valué as a result of their confiscation, precisely because these
are loans with the highest long-term valué. Further, these seizures do not just
represent an unjustified transfer of wealth; their adverse effects run counter to the
stated objectives of ÑAMA.

51. In summary, stated taxpayer and shareholder gains on ÑAMA are unlikely to be
realized unless the banks are underpaid for their assets. Gains to taxpayers and
shareholders that would result if ÑAMA paid banks less than bank assets were worth
would be offset by losses to the government, which would simply have to pay more in
bank recapitalization. One should be skeptical about the more sweeping claims about
the ability of ÑAMA to generate profits - they are not only unproven, but, given its
structure, unlikely.

47
E-mail from Michael Connolly, "Coroin/Maybourne," March 11, 2010, 20:59, p. 105 in produced
materials and e-mail from Eilish Finan, "Coroin/Maybourne," March 12, 2010, 00:37, p. 122 in produced
materials attached and labeled "JES 19."

22
 52. ÑAMA has limited resources, and it is important that it use those resources carefully.
Given these considerations, economic logic indicates that ÑAMA should focus its
attention of nonperforming loans, development properties that are not income-
generating and that are not likely to become so, and generally borrowers that are
illiquid and insolvent, and where the transfer would arguably increase the valué that
could be extracted from the asset and not decrease it (because of moral hazard issues
arising from "throwing good money after bad" due to bank guarantees and bank
insolvency). This specificaíly means that ÑAMA should focus its purchases on loans
for property development and not for income-generating assets like housing and
¿IR
tenant-occupied commercial real estáte.

53. ÑAMA could also play a particular role in helping stabilize the real estáte market in
Ireland, by avoiding a rash of liquidity induced fire sales, which are often part of the
propagation mechanism of fmancial crises. This suggests that, other things being
equal, ÑAMA should focus on loans for development in Ireland, and plan to retain the
assets for a long period of time given the leve! of overbuilding in Ireland.

VI. MCKILLEN WILL LIKELY BE INJURED FURTHER THROUGH A TRANSFER

54. NAMA's incentives for dealing with performing assets Hke the McKillen loans are
fundamentally different than those of a commercial bank. Thus, while it may be in
the interest of ÑAMA, the banks and the government to transfer poor quality real
estáte development loans to ÑAMA,49 there is no good economic reason to transfer
good assets to ÑAMA, especially in light of the likely harm. As discussed above,
there are several sources of harm that arise from the basic information economics and
theories of incomplete contracting outlined at the beginning of my affídavit.

a. First, ÑAMA does not have the resources, knowledge, or relationships to service
and negotiate with borrowers like McKillen.

48
There may be cases of income generating assets that are "developmental," in the sense that, for instance,
49
they are currently loss making, but with sufficient increased investment, they might be made profitable.
1 emphasize "may" because this conclusión requires (i) inability of supervisors to prevent bad lendíng
decisions; (ii) an assumption that ÑAMA has a superior ability to manage the resolution of bad loans; and
(tii) the benefits of the long-term credit relationship associated with a bank loan are more than offset by
the losses associated with opportunitistic behavior by bad borrowers that cannot be constrained by
adequate supervisión. The second hypothesis is particularly questionable.

23
b. Second, unlike traditional lenders that derive their profits from a long-term
reíationship with a credit-worthy borrower, NAMA's business model has a
relatively short time horizon and accelerated workout objectives,

c. Third, NAMA's stated business model - reducing total loans outstanding by 25%
within three years - exacerbates the problem because of the need for asset sales,
ín normal times, if an isolated asset were for sale, one would find several willing
buyers vying for the purchase, and the buyer would be able to find a source of
finance, Indeed, that is what one means by "long-term economic valué," the price
that an asset could achieve in the long-term, and the long-term economic valué of
a loan is related to the underlying assets. But these are not normal times, and the
market is not likely to return to anywhere near normal in 3 years, especially given
the scale of the property bubble and the weaknesses in the banking system. Thus,
if large numbers of assets are simultaneously put in the market in the ncxt tiuroG
years, the market price of these assets would, even in more normal times, likely
be depressed; but that is especially so now.

d. Fourth, reworking the terms for performing loans whereby total debt repayment
is accelerated by 25 percent is even more problematic. When financing income
generating properties with long lives, as an economic matter it is simply not
possible to generate sufficient income to pay down such loans by 25 percent
within 3 years. Competition in the long run will only allow landlords to charge
rental income that will cover principal payments, interest payments and normal
profits associated with the typically very long lifespan of the asset.

e. Fifth, under the ÑAMA plan, McKillen will be required to submit a Business
Plan within 30 days outlining how he will radically reduce his debt within a 3-5
year cycle. This is a very short time period for reducing debt exposure on a long-
lived performing asset. This is a radical restructuring requirement and likely to be
unobtainable, given the severing of McKillen's long-term lending reíationship, a
move that other potential lenders will interpret negatively. Therefore, given that
there is no evidence of McKillen's not being able to service his debt, such a
reduction in his debt would not make economic sense. Moreover, rapidly
 disposing of assets in the midst of a fmancial crisis is more than likely to result in
a capital loss.50

f Sixth, without the promise of future rewards from a mutually beneficial long-term
relationship, both ÑAMA and the once-performing borrower have an increased
incentive to behave opportunistically. For example, ÑAMA would have an
increased incentive to make onerous demands on McKillen, even going so far as
to unilaterally rewrite his loan contract Similarly, without the promise of profits
from a long-term relationship, it could become economically rational for the
ÑAMA borrower to walk away from property in which it no longer had an equity
interest 51 Further, both parties have the incentive to engage in a game of chicken.
If a borrower sees his equity being wiped out, he could simply stop managing his
assets, which would have a devastating affect on their valué to ÑAMA.

g. Seventh, with McKillen's loans transferred to ÑAMA, it could become rational

for McKillen's tenants - especially those in fínancial trouble - to stop paying rent
since ÑAMA may have a limited ability to find replacement tenants.

h. Eighthy given NAMA's purpose, if ÑAMA acquires good loans, the reputation of
good borrowers would suffer. For instance, parties who might consider
refínancing the McKillen loans could rationally infer that, like other ÑAMA
borrowers, McKillen is a bad credit risk.

i. Ninth, because ÑAMA increases the uncertainty about the net worth of any
ÑAMA borrower (and rationally would be expected to decrease the expected
valué of that borrower), good ÑAMA borrowers - which may entail some of the

In some countries, forced disposition of assets has played a central role in corruptíon, as the assets were
subsequently acquired at greatly discounted prices by those with access to funds or who were qualifíed in
rigged auctions, where relatively few buyers were qualified.
Even a firm with positive equity might undertake riskier actions, given the reduced likelihood of access to
credit in the future; in a sense, the valué of the on-going ftrrn has been reduced. The perverse structure of
ÑAMA (its short term horizon, the large role played by private equity investors) and the associated
incentives to which it gives rise, as well as NAMA's capacity limitations, exacerbate these problems. And
these problems are further exacerbated by the global fínancial crisis, which presents great difficulties in
getting access to alternative sources of finance.

25
 better entrepreneurs and property managers - will fínd it more difficult to get
access to credit.

j. Tenth, the diversión of attention to dealing with ÑAMA and its short-sighted
demands would rationally lead lenders to curtail funds to such borrowers.

k. Eleventh, when performing assets are being transferred to ÑAMA, they are being
transferred to a less competent party than a bank. In discussing global banking
crises, I often ask, "Do we really believe that the government has an advantage in
garbage disposal?"52 The main rationale for the creation of a bad bank (ÑAMA)
is that it might develop competence in the disposition of bad assets. However,
given the constraints, it would be naive to expect that a bad bank could develop
competence in managing performing assets.53

55. In sum, the only way that one could be confident that ÑAMA would not injure
McKillen is if it had superior capacities at managing bank relationships, which by
necessity requires the ability to extend credit. But ÑAMA is a new institution,
without experience. Moreover, without a bank charter, it cannot meaningfully extend
credit for long periods of time in an incentive compatible lending relationship. The
structure of ÑAMA thus creates the incentive for ÑAMA to underpay the banks, seize
good assets in order to offset losses from riskier loans on their books, and create short
term gains for the ÑAMA shareholders. This potential problem is compounded by the
powers granted to ÑAMA to rewrite contracts, well in excess of those afforded to
ordinary commercial lenders.

52
Joseph Stiglitz, Free Fall: America, Free Markets, and the Sínking of the World Economy (New York:
W.W. Norton and Company, Inc., 2010), 122.
53
The best thing for ÑAMA to manage is nonperforming loans and only nonperforming loans. Indeed, that
is one of the key rationales for creating a specialized institution like ÑAMA in the first place. (Given the
likely insolvency of the banks, the other rationale, moving risk off the banks" balance sheets, is of limited
valué, as 1 have already explained.) It is straightforward for ÑAMA to culi the nonperforming loans from
the bank balance sheets, especially if it allows for bank and borrower input in the event of a dispute about
how the loan is performing.

26
VII. THE MCKILLEN LOANS ARE NOT CURRENTLY IMPAIRED ÑOR DO THEY
POSE SYSTEMIC RISK

56. The key questions which ÑAMA should consider in determining whether or not to
acquire a loan portfolio are: (i) is the loan portfolio impaired? And, (ii) does the loan
portfolio pose a systemic risk i.e., could the failure of this loan portfolio cause a chain
of subsequent failures that could potentially bankrupt the entire system? My review
of the evidence in this matter indicates that for McKillen's loans, the answer to both
questions is no.

A . THE MCKILLEN LOANS ARE NOT CIJRRENTLY IMPAIRED

57. That the McKillen loans are not impaired is demonstrated by evidence presented in
the affidavits of Mr. John Trench and Mr. Patrick McKillen. These affidavits show
that the McKillen properties are meeting all of the loan servicing requirements and
that the portfolio is generating income in excess of its fínancing costs with an average
interest cover of 1.7 which in my experience is well in excess of typical interest
coverage for well performing loans.

58. In contrast, NAMA's measure of McKillen's impairment and payment default risk is
far less reliable. To assess McKillen's portfolio, ÑAMA compares the amount of
McKillen's loans to a valuation of the commercial real estáte financed by those loan.
The reason that NAMA's measure is unreliable is that commercial real estáte
valuations obtained during a period of extreme illiquidity in the real estáte market can
fluctuate dramatically.

59. Indeed, that is the reason that most countries do not forcé mark to market accounting
on commercial banks that have a practice of retaining (and rolling over) mortgages.
In the United States, even impaired assets - where the borrower may be delinquent in
payments - do not have to be written down in the midst of the crisis.

60. In order to obtain a reasonable approximation of long-term property valuation for use
in NAMA's loan to valué ratios, ÑAMA would need to undertake extensive
consultation with the property owners and managers. I understand that ÑAMA
appraisers did not pursue such consultations with respect to McKillen's portfolio.

27
 However, I further understand that appraisals in which such consultations were
pursued showed that the valué of McKillen's properties is well in excess of his loans.

B . THE MCKILLEN LOANS DO NOT POSE SYSTEMIC RISK

1. The Size of the McKillen Loan Portfolio does not Imply that it Poses a
Systemic Risk

61. According to Ms. O'Reilly, ÑAMA decided to acquire McKillen's loans "...because
of our belief that the extent of aggregate exposure of relevant participating institutions
to Mr. McKillen and his companies ... under credit facilities granted by those
institutions being the sum of approximately €2 billion was such as to create a
systemic risk....The risk to the banking system of any potential impairment in an
exposure of €2 billion and the potential losses hat would be suffered by the
participating institutions, which were already in receipt of substantial State support
due to their individual systemic importance was such that ÑAMA considered the
acquisition of Mr. McKillen's credit facilities was necessary to further the purposes of
the Act."54

62. In fact, however, ÑAMA is mistaken in its basic assumption that the size of
McKillen's loan portfolio provides a good measure of the degree of systemic risk that
it imposes. To see this, consider an owner of several, separately incorporated assets
who faces a series of value-impairing events (shocks). As long as these shocks are
uncorrelated with common ownership, there is no reason to believe that the single
owner would be more likely to go into default than individual owners of similar
assets. In order for the large single owner to face greater default risk, it would have to
be the case that common ownership causes correlation in shocks.

63. Common ownership could produce some increase in correlation among the shocks
that a business experiences - e.g., correlated judgment errors and/or correlated
liquidity problems, with the "owners" being unable to provide additional capital as
required. But, with a macro-economic shock, and a well capitalized owner, that
correlation could actually be less than the average correlation.

54
Affidavit of Aideen O'Reilly, July 30, 2010 %43.

28
64. Moreover, one owner who se loans contain cross default clauses (i.e. contractual
clauses that, in the event of a default on one loan, precipítate default on all loans) may
even lower systemic risk. This is because the strong incentives that the borrower
faces not to default are viewed as outweighing the risks imposed.55

65. In any case, an economic analysis of systemic risk needs to take into account the
magnitude of the losses that might be incurred, if loans were not repaid. Given the
lower loan to valué ratios and the high income generation of the McKillen assets,
there is in fact little risk, let alone systemic risk. In fact, there is little risk that banks
would not be able to generate enough income from the assets to pay interest
obligations to depositors, or even less risk still that the bank would breach (because of
a non-payment) capital adequacy standards.

66. On the contrary, acquiring the assets at too low a price could increase systemic risk
for the banking system, and rapid disposition of the underlying assets could contribute
to capital losses to be experienced by ÑAMA. In fact, was ÑAMA to systematically
pursue this policy of acquiring good loans, it could lead to broader systemic risk for
the country as ÑAMA underpays for the loans and destroys valué. Pursuit of such a
policy would raise the amount required for recapitalizing the banks, increase the costs
associated with the guarantees to the banks and increase the cost of the ÑAMA debt,
all three of which place additional costs on the state at a time when sovereign risks
associated with the Irish government are rising.

2. Review of Evidence on Systemic Risk Posed By McKillen Portfolio

67. Mr. John Trench's affidavit pro vides further evidence reftiting the notion that the
McKillen loans impose systemic risk just because they are large. A review of the
McKillen loans quickly fmds that the McKillen loans are diversifíed across many
countries, with approximately one half in the UK, one quarter in Ireland and the
remainder throughout Europe and North America. Further, the McKillen loans are
diversifíed across the various Irish banks and McKillen has extensive holdings at each
of Bank of Ireland, Anglo Irish and Allied Irish.

Of course, if lenders worried about the systemic effects of the simultaneous operation of such cross default
clauses, the different assets could be separated, and cross default clauses eliminated.

29
 68. While the majority of McKillen's loans are with Anglo Irish, in terms of systemic risk
this is hardly a problem since Anglo Irish has already been nationalized. Indeed, once
we take this fact into account, McKillen's loans make up far less than even one
percent any one bank's total loans.56 Therefore, the argument that any bank is
overexposed to risk via the McKillen loans is incorrect.

69. Dr. Cragg' s affidavit also shows that the banks in which the McKillen loans reside are
already suffering massive amounts of impaired loans relative to their Tier 1 capital
and are effectively insolvent,57 However, even if one were to cali all of the McKillen
loans impaired it would not appreciably worsen the situation at any of these banks.
To illustrate, 1 refer to the following figure from Dr. Cragg's affidavit.

Figure 1: Impaired Loans as a Percentage of Tier 1 Capital, by Bank¡58

800%

700%

a 600% -
«
U
S 500%

w 400%
re
S
4>
£<x 3 0 0 %
«
Vi
I 200%

100% -

0%
BOÍ Anglo AÍB

! ü w / o McKillen Bw/McKillen

56
C r a g g Affidavit f 7 1 .
57
Cragg Affidavit 1154-57.
58
Cragg Affidavit Figure 12.

30
 70. As Figure 1 shows, the difference in impaired loans relative to bank capital with and
without the McKillen loans is hardly noticeable in the case of AIB and Bank of
Ireland. Therefore, there Is no question that McKillen's BOI and AIB loans do not
represent a further systemic risk to the banks. Further it is irrelevant if the Anglo Irish
loans are impaired since, as the figure shows, this bank has already failed.

VIII. A L L O W I N G FOR DUE PROCESS WILL ENHANCE NAMA'S ECONOMIC

EFFICIENCY

A . ECONOMIC STANDARDS FOR DETERMINING COMPENSATION ÍN A TAKING BV

THE STATE

71. Economists have recognized that it may be important that the State seize private
assets for public use. However, two due process safeguards are typically put in place
in recognition of the importance of the rule of law and private property. These two
due process safeguards are as follows:

a. First, it must be possible to show that the acquisition is for public benefit (and
implicitly, that there are reasons that the acquisition cannot be effected through
voluntary transactions). For example, when land is acquired for a road, there is a
well-defined public purpose, where the refusal of a single party to sell could
impose large costs. In such case, it is clear why socially benefícial voluntary
transactions may not be possible. However, there are many other cases in which
the justifícation for a taking may not be as apparent. The main benefits may
accrue to other private parties. When there are private beneficiaries (like
developers abutting the new roads), one needs to be especially sensitive to
prospects for abuse, and one has to look particularly closely at the putative public
benefits.

b. Second, the private owner must receive fair compensation for his property. This
compensation should be based on the valué of the existing valué of the asset, not
the valué of the asset after, say, the public investment. Further, valuation of the
existing asset must take into account reasonable future prospects. For example,
the compensation for a vacant lot should not be based on its current use (zero), but
on the fact that on that lot a building could be built. If there is a high valué public

31
 use of the asset, then the valué after acquisition should be greater than the valué
before acquisition, and the owner should receive compensation based on the
asset's pre-acquisition valué.

72. Given the principies outlined above, it is clear that the valué to be paid for McKillen's
portfolio should be based on the portfolio's pre-acquisition valué; and this valué
should include the benefíts associated with an ongoing bank reíationship (which the
transfer of the assets to ÑAMA would terminate). In contrast, the asset's post-
acquisition valué is likely to be less than the pre-transfer valué, since the valué of the
ongoing bank reíationship will be lost upon acquisition. Thus, if the price to be paid
for the McKillen loans is justifíed, it must be justifíed by external benefíts, such as
increased economic stability. Such benefíts will offset the fact that the asset is worth
less in NAMA's hands than it is in the hands of McKillen's long-term bankers. It goes
without saying that to justify the involuntary acquisition the social benefíts of the
acquisition must exceed the prívate costs.

73. In McKillen's case, I have shown that the transfer is more likely to be associated with
no social benefíts, possibly even social costs. If that is the case, it is unlikely that the
social benefíts suffíce to offset the prívate costs experienced in the transfer.

74. Further, the transfer of the loan to ÑAMA involves no compensation to the borrower
for his lost long-term relationships with his lenders, and resulting collateral damage.
Indeed, no provision was made for such compensation, perhaps because it was never
contemplated that good assets (where there was a positive valué to the
lender/borrower reíationship) would be transferred.

B . THE IMPORTANCE OF DUE PROCESS

75. I have long argued over the course of my career that there are grounds for
circumscribing unfettered property rights. Firms should not, for instance, be allowed
to engage in anti-competitive behavior, and compulsory licenses have an important
role to play in access to medicines. However, my concern in the current matter is that
ÑAMA has not made a compelling case for a breach of McKillen's basic property
rights.

32
 76. A closer examination of ÑAMA shows that it is structured with incentives that go
against the purported public interest of helping the economy revive in this moment of
crisis. Worse still, while some private entities (including possibly the fmancial
system itself) may bear substantial costs, other private entities (including NAMA's
private shareholders) may be the benefíciaries of the powers granted to ÑAMA.

77. Public policy structures that allow - or even worse, provide incentives - for this kind
of transfer of wealth should be particularly suspect. The fact that NAMA's conduct in
transferring performing assets to itself is consistent with its incentives should be even
more troubíing.

78. Governments always have an incentive to underpay for assets, and even more so
when there are private benefíciaries (e.g. when the assets are sold to private
developers). This is why systems of checks and balances, judicial scrutiny and the
like, are importan! These longstanding legal doctrines are grounded in concerns of
equity; but they also are motivated by economics; security of property rights and the
"sanctity" of contracts - both explicit and implicit - are foundational to a market
economy. Involuntary transfers of assets represent a "taking" which should be
undertaken only when there is a compelling public interest. Even then, it is important
that there be full and adequate compensation. So too for the breaching of long-term
relationships.

79. If these basic principies are not followed, there is a serious risk to Ireland's reputation
as a country respecting the rule of law, with consequent adverse short-term and long-
term effects on its economy. It is striking that NAMA's only defenses are the
argument regarding systemic risks and the more troubling argument that transparency
and due process in a democratic society can be ignored because they may complícate
the implementation of the policy objectives embodied in ÑAMA.59

80. A relatively straightforward and expeditious model of due process that includes
borrowers can be easily designed for ÑAMA and applied broadly on a voluntary
basis, or, more narrowly just to borrowers that are deemed to be potential systemic

59
Affidavit of Brendan McDonagh, July 30, 2010, T|17.

33
 risks. Recall that the magnitude of risk is a ñinction of the potential size of a loss, the
likelihood this loss will occur, and the correlation with other risks faced by the bank.
If systemic risk is a consideration, it is crucial to understand that the magnitude of risk
is a function of the potential size of a loss and the likelihood this loss will occur. For
systemic risk, the magnitude of risk is further extended to not only include the
potential size of the losses from an individual owner, but the potential losses must
then be suffíciently large and interconnected that it will lead a cascade of effects that
threatens the entire fmancial system. (A further element of systemic risk is presented
when a quick seíl-off of large numbers of assets exacerbates further asset price
declines, especially in the presence of more widespread lxquidity problems, leading
again to cascade effects. The appropriate response to such problems is to keep them
off the market until there can be time for an orderly disposal and/or until the liquidity
crisis has been resolved. As I have noted, however, NAMA's business model risks
exacerbating this form of systemic risk. And this aspect of systemic risk is likely to
be most relevant to properties within Ireland and not the McKillen properties.)

81. Therefore, the due process I imagine must allow for borrowers to present, ínter alia:
(1) the strengths and sources of their credit-worthiness; (2) the quality of the income-
generating capacity of the financed property; (3) the valué of any collateral and other
properties; (4) the nature and likelihood of potential threats to servicing the loans; (5)
any factors that mitígate these risks including, the geographic and industry
diversifícation, the centrality and importance of the properties, and the experience and
track record of the borrowers; and, (6) likely correlation with other losses that might
be experienced by the bank in the aftermath of the breaking of the Irish property
bubble. Without consideration of these factors it is simply not possible to assess the
systemic risk. In addition, recall that one of the basic rationales for ÑAMA taking
over the assets and their management is to enhance the valué that can be extracted
from those assets, given the moral hazard risks that have been identifíed. But I have
also raised a concern that, at least in some instances, there is a substantial risk that
such a transfer will actually reduce the valué of the assets. Therefore, both economic
fairness and economic effíciency require that both the lender and the borrower be able
to present evidence relating to the magnitude and nature of the moral hazard risks and

34
 the extent to which those risks have been, or could be, mitigated, and the risks that a
transfer be valué decreasing rather than valué enhancing. In designing a process, the
following points might be borne in mind: (1) the number of borrowers that might
conceivably present systemic risk is very limited, and therefore the resources and time
required to implement an appropriate procedure would be limited; (2) even if there
was an opportunity for all borrowers to make representations the overwhelming
probability is that many, perhaps most, borrowers will not avail of the opportunity
because as a matter of fact relatively few borrowers are likely to have a real incentive
to make representations because their loans are chronically impaired. If there were
concerns of excess burden be posed by such a process, it might be permissible from
a policy objective to limit the entitlement to representation depending upon the level
of impairment of borrowers' loans and incorpórate strict but nonarbitrary time limits
that do not negatively impair the borrower.

IX. R E B U T T A L

A . REBTJTTAL OF ATDEEN O'REÍLLY

82. In 1 11 of her affidavit, Aideen O'Reílly suggests that McKillen's statements of

choosing the Bank of Ireland based on trust and a strong relationship are fallacious
due to the fact that there exists covenants in the loans at issue that would have enabled
the loans to be transferred to another fínancial institution or a third party without
McKillen's consent. This completely ignores the well estabíished principies of
relationship banking, as detailed in Mr. Belanger's affidavit. Further, her claim that a
transfer of the McKillen loans to ÑAMA is not inconsistent with the original contract
is completely baseless since before ÑAMA was created, no one could have
reasonably foreseen that such an entity would exist. Further still, Ms. O'Reilly
attempts to portray ÑAMA as a lender, even though ÑAMA freely admits it is a
workout vehicle and not a bank. This last point is evident since ÑAMA is not even
licensed as a bank in Ireland.

83. In % 17 Ms. O'Reilly describes how ÑAMA may not seize an eligible bank asset when
the "land or development exposure is incidental to the main business." Ms. O'Reilly
provides no standard for determining whether or not a particular degree of exposure

35
 meets here definition of the incidental. However, in f 30 and % 32 Ms. O'Reilly states
that the Maybourne Loan is a development loan due to some GBP 30 million of the
GBP 472 million total loan being development-related. It would seem that such a
small fraction, just over 6%, would be considered incidental by most.

84. In % 35 I note that Ms. O'Reilly suggests that ÑAMA was always intended to acquire
loans secured on investment properties and not just land and development loans.
However, it would seem clear that ÑAMA never intended to acquire investment
properties unless they were tied to some larger problem. Certainly, this is what was
contemplated by the EU when it stated that "assets that cannot presently be
considered impaired should not be covered by a relief programme. Asset relief
should not provide an open-ended insurance against future consequences of
recession. «60

85. As noted above, in f 43 of her affidavit, Ms. O'Reilly gives the sheer size of the
McKillen asset portfolio as the rationale for NAMA's decisión to acquire the assets
since the €2 billion total posed a systemic risk is compared to a total of €50 billion for
the 100 largest borrowers. Such a comparison has no meaning in determining
systemic risk because it takes no account of the likelihood of loss and the potential
magnitude of losses regarding either the €2 billion or the €50 billion. What Ms.
O'Reilly apparently fails to realize is that the McKillen loans are small relative to the
total Irish banking sector, and in particular are diverse across geography, across
funding sources and the loans are generating cashflow well in excess of financing
costs (recall the 1.7 interest coverage). Indeed, due to the tenancy agreements that
others have reviewed many of the rent rolls are locked in at quite favorable rates and
it would take a very large increase in financing costs for the McKillen portfolio to
even begin to have cashflow difficulties.61 The strong fiscal position and
diversification of the portfolio shows that individually McKillen poses a minimal risk
and certainly not a systemic risk.

60
"Information from European Union Institutions and Bodies," Commission, Official Journal of the
European Union, C 72/1, 35 attached and labeled "JES20."
61
See % 24 in Mr. John Trench's affidavit.

36
86. In f 55 of her affidavit Ms. O'Reilly again plainly ignores basic banking practice
when she says that NAMA's 7-10 year view is not really short since many of the
credit facilities would expire by then anyway. As Mr. Belanger's affidavit describes
in detail, renewal of credit facilities rather than full repayment of principal is the
norm. Ms. O'Reilly instead focuses on the strict wording of the contract and ignores
the real-Iife applications of relationship banking would clearly be in play here absent
ÑAMA. While I agree there may not be a "right" to extend the loan, as she implies
McKillen suggested, it is the normal pattern and practice of the banking industry and
there would be no rationale reason to think a respected individual like McKillen
would not have that option available. As I noted earlier, a well functioning economy
requires implicit understandings (what are called implicit contracts) - not just explicit
contracts. It is not possible to deal in any contract all possible contingencies, and a
well functioning economy requires the flexibility provided by implicit contracts. But
their proper functioning is based on long-term relationships, based in turn on the
incentive compatibility provided by the reputations of the borrower and lender alike.

87. Ms. O'Reilly's statements in % 58 of her affidavit are patently false. If the McKillen
loans were acquired by ÑAMA it is in no way similar to just "step[ing] into the shoes
of the transferring bank." Normal ly, the acquirer would be a bank; the party willing to
pay the most for such a contract would be someone who would take into account the
valué of the long-term relationship ~ something that I have already argued is
destroyed by ÑAMA. Moreover, normally the acquirer would have competency in
both banking and real estáte; such competency and agreed understandings of common
practices, motivated by good will and long-term relationships, are essential for the
conduct of business and reaching mutually beneficial agreements. The structure,
conduct and plans of ÑAMA give good reason for concern on the part of the
borrower. At the very least, there is a comprehensive business plan required within 30
days that has to highlight plans for massive debt-restructuring that may otherwise not
be a part of the business' plans. Even if ÑAMA were to accept this and never bother
the borrower that is an immediate difference. Secondly, ÑAMA admits that its goal is
reduce its total debt load by 25% by 2013. To assume that every borrower has such a
plan for such a quick debt reduction is simply ridiculous as a matter of economics -

37
 and especially in the context of a financial crisis, where long run disposition makes
more sense. Finally, if the loan were still held by the transferring bank there would be
the possibility of the option to refinance it since the lender would still be the bank.
By NAMA's own admission it is not a bank. To try and suggest that there would be
no difference is absolutely untrue.

B . REBUTTAL OF BRENDAN MCDONAGH

88. In f 7 of bis affídavit, Mr. McDonagh suggests that ÑAMA has the capacity to take
long-term perspectives on loans and debtors "as it makes commercial sense to do."
Its structure and conduct seem inconsistent with such a claim, as I have already noted.
As an example, debtors are required to make significant reductions in loans
outstanding in a brief time period. Indeed, in aggregate ÑAMA has promised a 25%
reduction by 2013 (as he himself discusses in % 10). What Mr. McDonagh is
implicitly assuming to make the statement he does, is that for each debtor and each
loan ÑAMA will acquire it makes commercial sense to have them meet NAMA's
guidelines and large goals for reductions in outstanding loans. While there may be
individual loans for which this is true, it is not the case for all loans and almost
certainly not the case for performing loans the McKillen loans. Indeed, the
willingness to make such a sweeping goal in the current circumstances by itself raises
questions.

89. In K 9 of his affídavit Mr. McDonagh states that one of the statutory purposes of
ÑAMA is to "obtain the best achievable financial return for the State." This goal is
incompatible with many of the claims made by Mr. McDonagh and other ÑAMA
representatives, such as Mr. McDonagh's statements m\l where he talks of ÑAMA
doing what makes "commercial sense" since that as sumes that achieving the best
financial returns for the State and the commercially sensible business practice are one
and the same. Indeed, there is a more troubling aspect of this approach: if there were
merely a commercial transaction, there would be little rationale for government
action, and little justification for the powers given to ÑAMA. It is because of the
externalities associated with the management of the financial crisis (including via
bank lending) that government intervention is justified. The "best achievable

38
 fínancial return to the State" focusing narrowly on ÑAMA, could be achieved by
underpaying for the assets. But that would be very bad from the broader perspective
of Ireland, or even from the perspective of Irish public finances. For by achieving
better returns to ÑAMA, the need for public funds for filling the hole in the banks'
balance sheet would be more than commensurately increased, and the adverse effects
on the public finances as a result of increasing bond rates faced by government would
present further costs.

90. In f 10 of his affidavit Mr. McDonagh states "ÑAMA invites each debtor to submit a
business plan and reviews the debtors' immediate working capital requirements." But
what is entailed is more than a kindly invitation to submit a business plan. ÑAMA
clearly states that business plans have to be submitted within 30 days, and the
business plan is entails not just "immediate capital requirements" but also detailed
forecasts of debt reduction and property over the next three years (plus a plethora of
other details which are more trivial, though certainly no less burdensome to produce).
Indeed, he describes that requirement in f 30 of his affidavit, though this time saying
that it is a "request" rather than a requirement. However, he highlights that ÑAMA
may reject whatever plan is submitted or have it referred back to the borrower for
amendment. This highlights the fact that these plans must be exhaustive to pass
ÑAMA muster. NAMA's powers are large, making its requests not just invitations.
It can revise loan contracts.

91. In 1 16 of his affidavit, Mr. McDonagh states that the banks selling their loans to
ÑAMA is no different than the banks selling their loans to other third parties which
happens in the normal course of business. While this certainly does happen in normal
commercial operations, what Mr. McDonagh fails to recognize is the role of
relationship banking in normal commercial operations, as discussed in the affidavit of
Mr. Joseph Belanger. What Mr. McDonagh does is ignore the fact that there is real
valué in the bank preserving its good relationship with borrowers. I do not mean to
suggest that banks would never sell loans to other banks, or assign the loans to SPVs
in order to prudently manage risks and finance their loans portfolios. However, they
would certainly consider the impact on their reputation in general and on the

39
 reíationship with that borrower in particular; the valué of both may be considerable,
and especially in the case of the McKillen loans, is non-trivial. And the acquirer —
e.g. the party willing to pay the highest price for the contract - in most cases would be
a party who too would valué the long-term reíationship.

92. In 17 of his affidavit, Mr. McDonagh states that any consultation between ÑAMA
and the borrowers would be costly and wasteful, and henee it does not happen. What
is implicit in his statement is his assumption that every borrower would appeal to
ÑAMA about seizing their loans, rather than just those with real concerns and valid
objections about the seizure. As I have discussed, it is simple to design a due process
that allows all borrowers to make representations since in this instance, only the good
borrowers have an incentive to engage in such discourse.

93. In 31 of his affidavit Mr. McDonagh describes ÑAMA as having "the same rights as
the Participating Institution would have had to pursue debts, and follow the same
legal procedures as a bank would, where necessary." This is patently false due to
NAMA's ability to change terms and conditions of a loan agreement if ÑAMA
believes that a certain term or provision "is no longer reasonably practicable," as he
describes in the very same paragraph. This is certainly not a right that the bank had
prior to transfer, ñor is it one that exists in general.

C . REBUTTAL OF ANN NOLAN

94. In % 9 of her affidavit, Ms. Nolan states that loan impairment was the key concern to
the Irish fínancial systems recovery and a policy was needed to remove doubts about
banks' capital adequacy and ability to manage their loan books. While dealing with
impaired loans is certainly a necessary step in recovery, as has been clearly shown the
McKillen loans are not impaired. Indeed, given the strong fínancial position of the
McKillen properties they are not likely to be become impaired. Thus, the McKillen
loans should not be subject to the policy discussed by Ms. Nolan.

95. In K 20 of her affidavit, Ms. Nolan describes how if a loan is in technical default and
the loans of a large entity are interlinked through cross default and/or cross guarantee
clauses it would cause all related loans to be in technical default. Like her colleagues,

40
 Ms. Nolan completely ignores the pattern and practice of the banking industry, as
discussed in Mr. Joseph Belanger's affidavit, of treating payment and technical
default very differently. Further, she incorrectly states that being in breach of a loan-
to-value covenant would cause this massive default by the borrower "unless waived."
As Mr. Belanger discussed, the opposite is actually true. Indeed, unless the bank
serves a notice of default the borrower is not considered in default. As I explained
earlier, written contracts are inevitably incomplete, and drawn up on the basis of
understandings and industry practices, in ways that maintain flexibility, but with an
appreciation of reputation effects and incentive compatibility.

D . REBUTTAL OF PROFESSOR MCALEESE

96. In 20, 21, 24, 29 and 31, Professor McAleese asserts that McKillen is mistaken in
his argument for avoiding ÑAMA because McKillen assumes his banking
relationships would remain unchanged. There is no doubt that Irish banks are
imposing stricter loan terms and that lending standards have increased,62 but
McKillen acknowledges this in his second affidavit and is finding this in his ongoing
banking relationships. However, as Mr. John Trench found in his portfolio review,
McKillen has very strong interest coverage, a fact that Professor McAleese does not
acknowledge. Therefore, Professor McAleese is making the same error of which he
accuses McKillen, namely not considering the relevant economic reality in analyzing
the confíguration of alternative lending relationships.

97. It is, however, reassuring that Professor McAleese acknowledges that there are no
justifícations of overwhelming importance as to why ÑAMA was set up to take on
performing as well as non-performing loans (f 38). Flowever, the fact that ÑAMA
was set up this way does not provide an economic justification for ÑAMA to use this
right when it can meet its objectives without taking on performing loans.

Central Bank & Financial Services Authority of Ireland, "Irish Responses to the Euro Area Bank Lending
Survey," July 2010 attached and labeled "JES21
 E . REBÜTTAL OF PROFESSOR LAÑE

98. There is no economic basis for Professor Lane's claim that since McKillen's loans are
performing, even when he goes to ÑAMA he can still get financing elsewhere (f 12).
Even if there were no adverse reputation effect and even if it were possible for
McKillen to get financing elsewhere in normal times, these are not normal times. In
particular, lenders are constantly making inferences about the credit quality of
borrowers, and the only rational inference for potential lenders to make in seeing a
borrower moved to ÑAMA is negative.

99. At fl 9-10, Professor Lañe claims McKillen's reputation will not be hurt because
ÑAMA is not a bad bank and it has adopted a universal acquisition approach that does
not taint property developers whose loans its acquires. As I have articulated earlier,
ÑAMA is principally designed to acquire bad loans (and best practices indícate it
should do so, in accordance with EU expectations). As such, the principies of
information economics indícate that any borrower improperly moved to ÑAMA will
suffer a reputationaí loss, and certainly a loss of any benefits from a trusting banking
relationship. While ÑAMA may claim it is not a bad bank, it looks like what
everyone else in the world calis a bad bank and the rationale for its existence is
precisely that of a bad bank's. And, whether ÑAMA considers itself a bad bank or
not is not the issue. The issue is, do others? The Financial Times, for instance, is
unequivocal in referring to ÑAMA as Ireland's "bad bank" that was purchasing "toxic
assets."63 While there were alternative ways of restructuring Ireland's banking system
that might have resulted in the creation of a good bank, Ireland chose the "bad bank"
approach and now has to deal with the consequences. One of these consequences is
that moving borrowers to ÑAMA will certainly affect their reputations negatively.
Therefore, any claim that being moved to ÑAMA is benign is simply false.

63
Editorial in The Financial Times, "Pluck of the Irish," August 26, 2010, accessed August 31, 2010
(http://www.ft.eom/cms/s/0/ef7fbe7c-bl54-l Idf-b899-00144feabdc0.html) attached and labeled "JES22."

42
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ibscríbed and to befo re me ott the ^ day of September 2010, by Dr. Joseph £.
fóglitz.

Notary Public for the State of

Residing at
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My Cornmission Expires:
¿Y v t AR y \ \ v ' . m j R i C E HALUVIS
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^ ^íít: No. 01HA8007604
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i / '• Commlsskxi Expires May 28,2014
^p^-A:ífidavit isfíledby Eugene F. Coüins, Soíicitors, Temple Chambers, 3 Burlington
"R'oad, Dubiin 4» soíicitors on bebalf of the Applicants* this dav of
day of September
Sentember 2010,
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