Wednesday 9 September 2009

Ad Hoc Rules for In-Hock Banks

If stabilising bank finance is important, how near are we to restoration of stable regulatory conditions ? Last week revealed some of the reality of the current vogue for micro-management by European regulators, in ways that are affecting holders of bank bonds, preference shares and other 'hybrids' or forms of subordinated debt.

First the really basic stuff - payment of coupons.
Northern Crock had already 'deferred' some coupon payments (in order to conserve capital), but that wasn't technically default, it was because the Crock actually doesn't have sufficient funds (the wonders of Brown's bail-out) and the bonds in question were subordinate.

there was a sudden flurry when KBC, a bailed-out Belgian institution, said the EU was 'pressuring it' not to honour some of its coupons - even though they were able to, and in the event actually did, notwithstanding the 'pressure'. What's to be the next development on this front, I wonder ?

Then, the FSA instructed RBS and Lloyds not to redeem some of their bonds on the usual date. Again, this isn't default, but it's not what bond holders have come to expect after many years of custom and practice. It may give rise to some (modest) cash flow issues and adds to the overall levels of confusion and financial friction (though
it's fair to note that some recent buyers of hybrids may be the adventurous type anyway).

There are of course many who advocate equity-for-debt swaps but the crisis has been rolling for two years now and that strategy hasn't been formally instituted. Not all bond-holders are going to enjoy an ad hoc regime of will-they, won't they? In consequence, credit ratings on hybrids issued by banks like RBS have been downgraded and yields - which had been slowly creeping down in the right direction - have once more shot up to around 16%. We've looked at RBS prefs before (when yields exceeded 30%) and here's the latest chart.

With base rate at almost zero, 16% is what the market thinks of nationalised UK banks' subordinated debt in these supposedly improving conditions. Does any of this help the UK government unload its unwanted bank shares ? There's a long way to go before it's business-as-usual in the banking sector.



Old BE said...

Question from the ignorant: does that mean that some people who have lent money to the banks are not getting re-paid when they were promised? If so, what comeback do they have?

Electro-Kevin said...

Great title for this post.

Nick Drew said...

not promised, BE; but it has been the near-universal practice of many years for some of these instruments to be redeemed at the 'call' date (often e.g. 5 years after issue) and the bank to re-finance that slice of debt in some way or other, and (with base rate so low) investors could have had rational expectations this would continue**

so it's more what they expected than what they were promised

if the issuer chooses instead not to redeem, the buyer (lender) still holds the bond, and the bank must still keep paying the coupon (unless ... see the other part of the post)

but either way it was always at the issuer's (i.e. the borrower's) option - so the only comeback is that pissed-off investors^^ demand more coupon / interest next time around (hence falling bond prices / rising yields)

= = = = =
** to be fair, really clued-up investors may have seen this coming - see those bond prices back in March
- - - -
^^if you as a private investor have good reason to expect such a product to be redeemed at a particular date and it wasn't, you might be seriously inconvenienced if you had a need for the £££ on that date - of course in theory you could borrow against the security of the said product, but even if this were possible in practice, you'd still be ought of pocket by the amount of the interest-rate differential

Nick Drew said...

EK - it's the only thing about this post that isn't too wordy !
mea culpa

Old BE said...

Thanks for explaining, so it's not the same as a bond, then? I'm surprised that people would invest in such an uncertain deal, but perhaps there are advantages which I am not seeing.

Nick Drew said...

BE - they yield more than secured debt (for the very reason that the small print says what it says) as well as being easily traded

one way of explaining the whole current mess is that after years of stability and low yields, investors (of all kinds, in all classes of assets) were chasing higher yields and ignoring the greater risks in so doing