A legal challenge to Nama by developer Paddy McKillen could derail the engine designed to pull the banks out of crisis

IT IS 15 months since plans were announced for a State agency to take out the most toxic loans across the domestic banking sector. As of this week, the National Asset Management Agency (Nama) had acquired a quarter of the targeted loans linked to the 33 biggest borrowers.

Nama said this week it had acquired a further €5.2 billion in loans from four of the five participating lenders – Anglo Irish Bank is still working on its second batch of loan transfers – bringing to €20.5 billion the running total on Nama’s loan acquisitions – €60.5 billion to go.

But now a legal challenge to the constitutionality of the Nama legislation by one of those 33 borrowers threatens to derail the Government’s engine that is pulling the banking system out of its crisis.

Time is also against the State – Nama has to meet February’s deadline set by the European Commission to transfer all €81 billion in loans.

The Department of Finance didn’t mince its words when it stressed to the Commercial Court on Monday the importance of hearing the judicial review proceedings taken by businessman Paddy McKillen as soon as possible. It pushed the issue to fast-track the case so that Mr Justice Peter Kelly would give it the earliest date possible in the court’s busy list.

The stakes are high. McKillen’s challenge presents “a very real threat to the vital work of Nama that must continue, and be seen to continue, in order to increase and maintain confidence in the Irish banking sector and thereby strengthen and protect the economy of the State”, department official Ann Nolan, a key engineer of Nama, said in a court affidavit.

Both sides must prepare legal arguments and expert witness statements before the case begins on October 5th over an expected four days. A team of legal heavy-hitters has been recruited by McKillen to poke holes in the legislation that the attorney general Paul Gallagher SC had a crucial role in drafting last year.

At issue is whether Nama’s procedures trample over the property rights and business interests of good borrowers, and whether they are detrimental to the few businesses whose loans are performing, generating income and being taken over by the State agency.

Economist Peter Bacon designed Nama to buy both good and bad loans by acquiring whole land and development loan portfolios.

The reason for this was the Government had to remove uncertainty about the banks, proving to the financial markets which support them that the institutions had been cleansed of their most toxic assets and so that interest on good loans would pay for servicing the bad.

Some of the financial scaffolding around the Nama structure has collapsed somewhat since the revised draft plan was published earlier this month. It showed that while the price being paid by Nama for the loans had fallen dramatically – the average discount has shot up from 30 per cent to 50 per cent, reflecting the poor quality of the loans – the level of income-generating loans had also dropped, to 25 per cent from 40 per cent last October.

McKillen’s loans – if they are all eventually to transfer – would be among the 25 per cent. He says he is paying all the interest due, and has questioned how his loans at Anglo, Bank of Ireland and Irish Nationwide are “eligible bank assets” within the meaning of the National Asset Management Act, 2009. This is the kernel of his action.

The State argues that the Nama Act allows the agency to acquire non-impaired loans.

The transfer of his loans and those of his companies – totalling €800 million – from Anglo are on hold pending an expert review.

McKillen’s case centres around €80 million of loans owing by McKillen personally and 15 of his companies to Bank of Ireland. These loans were the focus of the action as they were among the ones earmarked to move in the second wave of transfers.

McKillen is probably the only person among the 33 biggest borrowers who could have taken such a challenge against Nama.

The other 32 are unlikely to be able to say, as he has, that they have not bought an Irish asset since 1998 and “have not engaged in speculative lending” or that their loans are all good.

So why is he so afraid of Nama?

Belfast-born McKillen (51), reclusively media shy and unassuming, has been in business and property investment in Ireland and internationally for 35 years. His investments – commercial offices, shopping centres and hotels – are almost exclusively held to generate income and have fared better than most through the economic crisis.

He is best known as the developer of the Jervis Shopping Centre in Dublin and a co-owner of the Maybourne Hotel Group, the company behind the five-star Connaught, Claridge’s and Berkeley hotels in London, and as a shareholder in Bono and The Edge’s Clarence Hotel in Dublin.

McKillen invests in prime commercial property and maximises the value of his assets and the income being generated from them over the long term. This is funded by “a sensible balance” of funding between debt and equity, he claims, “so as to maintain a low risk, comfortable, financial position over the long term though the economic cycles”.

He borrows to a level that, even in a recession, the value of the property is still in excess of the debt, and the rent coming in on those properties remains sufficient to meet interest repayments even in an economic downturn or over a period of increasing interest rates.

McKillen believes being a customer of Nama will run counter to his tried-and-tested business strategy, destroying his long-holding investment plan.

He argues that the agency is, citing Nama chairman Frank Daly, “a workout vehicle” and “not a replacement bank”. As a result, Nama will take a shorter view than a bank would and will seek to maximise returns by selling off or by calling in loans and realising the properties supporting the loans and other security.

This would have “a devastating effect” on his businesses and on him personally given that he has guaranteed the loans of his companies.

The objectives of “a workout vehicle” are the “very antithesis” of the successful business model pursued by his companies.

He claims normally being managed by a workout section of a commercial bank would mean that a borrower is “seen as pressured and higher bank margins and/or fees are likely to arise”. Refinancing loans would be “much more costly and inimical to the current business model”. This would “greatly diminish” the short and long-term value of his investments.

The difficulty for McKillen is that – like many long-holding Irish investors in property – most of his assets are held for the long term but financed with short-term borrowings.

This leaves him exposed as his loans come up for regular refinancing, raising fears that being a Nama customer will make refinancing difficult and allow the agency to move against him and his take control of his assets.

McKillen argues the Nama legislation prevents him from making representations that his loans are not “eligible bank assets” under the meaning of the Act so that he can argue against them being transferred.

Section 221 of the Nama Act prohibits lobbying of Nama and carries with it a fine of up €1,000 and six months’ imprisonment or both.

He says he should be given a reasonable opportunity to refinance his loans, presumably with foreign, non-Nama banks, as well as an opportunity to make representations to Nama on the value the agency assigns to his loans.

He has been told by Nama that the agency only discloses the valuation of a loan to a participating institution, not to the borrower.

McKillen has argued that the transfer of his loans to what is perceived by international financial institutions as a “toxic bank” would damage his reputation and have implications for his ability to raise further loans.

Painting the Nama Act as some kind of draconian, wartime legislation, McKillen says it represents “an unjust and disproportionate attack” on his property rights and a breach of the European Convention on Human Rights.

His counsel said it is “not a full front attack on Nama” but the State’s response suggests the Department of Finance thinks very differently.

The Government’s claim last year that it drafted a piece of legislation that could withstand legal challenge will be tested in October.

THE FIGHT SO FAR

THE NEW management team at State-owned Anglo Irish Bank has come to the assistance of Paddy McKillen in his fight to keep his loans out of Nama, objecting to the transfer of his loans. The so-called McKillen “connection” accounts for loans of about ¤800 million at Anglo.

In June 2009 Anglo submitted a list of the top 100 “land and development” (L&D) borrowers to Nama but the list did not include McKillen. The first time his name emerged was during a telephone call on November 12th, 2009, when the agency asked Anglo for the bank’s lending exposure to a list of 20 individuals – McKillen was among them. Anglo objected to his inclusion in Nama on December 4th, 2009, because McKillen had minimal L&D debt – just €5 million of the €800 million in loans was to development projects in California and Budapest.

On December 19th, Nama gave a list of names where Anglo had successfully objected to the transfer of their loans. It did not include McKillen. Then, on January 9th, 2010, Nama told Anglo that McKillen’s loans would be included in the second tranche of loan transfers.

Anglo resubmitted its objection to the transfer of his loans on February 15th, but three days later Nama emailed Anglo a list of objections it had accepted; McKillen was not listed. Most recently, the bank wrote to Nama on June 11th, restating its objection to the transfer of his loans.

McKillen has also challenged how Nama has valued his investments. The agency valued the Maybourne Hotel Group at £725.9 million, but he objected to this, having had it valued at £994.8 million last month. Nama’s type of valuations could drive down the realisable value of his assets, which would make it likely that his companies would breach loan-to-value clauses, he claims. This would enable Nama or a bank to call in the loan and demand immediate repayment.

He also claims he has been refused loans to open Captain Americas and Wagamama restaurants in Blanchardstown shopping Centre in Dublin, showing the possible effect of being linked to Nama on his credit rating and reputation. In one case, Bank of Ireland told him it would not be happy to lend to him as the loan could end up in Nama.