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The Perpetual Subordinated Bonds (formerly called PIBS) -
Revised 15/11/2010
Please go to the bottom of this page for the latest news.
Our
view is that the Government is not
treating the bondholders of the subordinated debt of Bradford and Bingley
bank equally to the bondholders of the subordinated debt of other banks
caught up in the British banking crisis.
Whereas the capital of all other bondholders in these banks is being
protected, the capital of the bondholders invested in the subordinated debt
of Bradford and Bingley bank may be wiped out under the present system of
ranking within the Treasury order relating to the nationalisation of
Bradford and Bingley bank. The
Government has arbitrarily ranked itself (the Treasury and the FSCS) ahead
of subordinated bondholders in settlement.
What is the “subordinated debt” of a bank?
The
subordinated debt of the bank is formed, in this case, by the bonds sold by
the bank to finance its operations. These bonds pay interest twice per year
in return for the use of the investors’ capital. The capital remains the
investors’ property and is only loaned to the bank in return for an income
in the form of the interest payments.
The
word “subordinated” means that in the event of the winding up of the bank
these bondholders will be ranked behind the existing senior debt of the bank
(for example “covered bonds”) and behind depositors, but before shareholders
(stockholders).
Significant changes to the operation of the bank (e.g. winding up) would,
under the terms of issue of these bonds, force an immediate repayment of the
bondholders’ capital at par (the face value of the bonds). As these bonds
normally trade at a premium to the issue price this would normally result in
a loss of some part of the investment capital.
Who bought these bonds and why?
The
subordinated
bonds of British banks and building societies have traditionally been seen
as a safe investment and are bought by investors requiring a stable long
term income. The bonds have been available for over 25 years and have formed
a significant part of the pension planning of most investors. Since the
issue of these bonds no bank (or building society) has defaulted on payment.
No bank (or building society) has ever forced repayment at par - for
example, in the event of takeover, demutualisation or winding up.
The
bonds have been readily tradable on the British bond market and market maker
Collins Stewart is a significant dealer in these bonds.
Although bond issues from the smaller building societies have traditionally
been at the higher end of the yield range, the credit crunch has led
investors to move towards the larger issuers such as Bradford and Bingley,
and Halifax, even though some of the smaller mutual societies have robust
finances.
What has happened to
the banks issuing these bonds?
Since
the financial crisis, when three of the largest banks who have issued these
bonds required refinancing, the bondholders’ circumstances have changed
significantly.
Halifax Bank of Scotland is to be merged into Lloyds bank and the
bondholders’ investments will become part of Lloyds financing, where it will
continue to pay interest. These bondholders’ investments are safe.
Northern Rock has been nationalised and refinanced by the Government and
continues its operations. Northern Rock was reducing its mortgage book prior
to eventual sale (the most probable outcome) when the financial crisis is
over. The Government has recently (March 2009) invested several billion in
the bank to provide liquidity to the mortgage market. Bondholders’
investments continue to pay interest as usual and will go with the bank to a
buyer in the future.
However, should the Government fail to find a buyer, the bank would be wound
up and creditors would be repaid their capital in order of ranking. The
subordinated bondholders would be repaid their capital at par, face value,
of their bonds.
Bradford and Bingley has been nationalised by the Government, which has
broken the bank up in the following manner:
1.
Deposits: The deposits of retail savers who bought products sold through the
branch offices have been sold to the Spanish owned bank, Santander, together
with the branch network.
2.
Lending: The Government has funded the outstanding loans in the form of
mortgages and personal loans, with a loan.
Terms of the Government
loan
Under
the terms of the loan the Government has provided a total £18bn of which
£14bn is to be provided by the Financial Services Compensation Scheme (FSCS),
which is industry funded. The £14bn equates to the amount of B&B savings
guaranteed by the £35,000 deposit protection scheme. A further 4 billion
loan has been provided by the Treasury.
The
Financial Services Authority triggered the FSCS immediately following the
Government (FSA) decision that B&B did not meet its requirements for a
deposit taker. NOTE The Government, both Treasury and FSA, have not yet
defined precisely which requirement of the FSA B&B did not meet despite
being questioned upon this matter many times.
The
Government (BOE) will provide the FSCS with a loan for the £14bn and
interest on the £14bn loan will be charged to the retail banking sector.
Thus the Government itself is only providing a loan of £4bn.
Interestingly, the first Treasury order issued on the Monday morning
following Nationalisation ranked the Government (FSCS and Treasury) ahead of
all bondholders for repayment. This would be the normal position for
depositors not shareholders.
However, after some swift legal objections from the lawyers representing the
covered bondholders (major financial institutions) the Treasury order was
immediately amended and reissued moving the covered bondholders up the
ranking, thereby securing their investment before the Government in
settlement but still placing the Government before the subordinated
bondholders and 100% shareholder, the Treasury.
In
this highly unusual and unique settlement ranking the Treasury is therefore
both above and below the subordinated bondholders while the FSCS is above
the subordinated bondholders.
NOTE
The legality of this settlement structure is questionable.
The Implications for Bondholders of B&B Subordinated Debt
arising from the current situation.
1. Subordinated Bondholder’s capital:
In
practice, the current Treasury order positions the bondholders of
subordinated debt lower in the settlement rankings than the Government
(Treasury and FSCS) meaning that the Government would seize the subordinated
bondholders’ capital to pay itself for funding the operations of B&B in the
event of any shortfall.
There
is a possibility of there being no capital left in the bank following the
Government’s charges for any shortfall in capital repayments and any
interest which would arise over many years of funding B&B. This would mean
that subordinated bondholders would be wiped out as are the shareholders of
B&B.
However, in the unlikely event that there should be any capital available to
repay bondholders, then the subordinated bondholders would be repaid their
capital at par (the face value of £1 per bond) which for most investors
would mean a loss as they bought their bonds at a premium to face value.
2.
Subordinated Bondholder’s interest payments:
Under
the terms of the current Treasury order there may be little hope of the
money being made available to make interest payments in the long term and
this is reflected in the current price of the bonds. In January, the
Government issued a notice to subordinated bondholders advising them that
interest payments were not guaranteed and each payment would be subject to
the availability of money.
In
March the Government arbitrarily cancelled the repayment of dated
bondholders’ bonds and reiterated its earlier warning with regard to
interest payments.
NOTE
This means that no contract with a British bank is safe in the event of
Nationalisation as the terms may be changed arbitrarily and applied
retrospectively by the Government. The net effect of the Government’s
action was to raise the cost of lending to British banks immediately by 100
basis points and reduce the availability of lending as potential lenders are
now being offered bondholder levels of interest for taking on equity levels
of risk. Who would buy the subordinated bonds of a British bank now?
N.B. See the postscript
at the end of this document for subsequent news on the interest payments
after the above was written.
The Issue for Bradford and Bingley bondholders
Following an examination of the current situation of each of the three banks
described above it is clear that the bondholders of subordinated debt of
Bradford and Bingley are not being treated equally to the bondholders of
subordinated debt in Northern Rock or HBOS.
The
bondholders of subordinated debt within Bradford and Bingley are being
treated extremely harshly when compared to the bondholders of subordinated
debt of the other two banks. The bondholders of subordinated debt within
Bradford and Bingley are the only group among all of the bondholders caught
up in the whole of the British banking crisis who are being treated in this
manner.
In
200 years of British banking history no previous Government has seized the
capital of the bondholders of the subordinated debt of a British bank! In
part, this cautious and protective behaviour of previous British Governments
is how Britain gained its international reputation for reliability and
probity in banking, alas all this has now gone.
The
current situation of bondholders of Bradford and Bingley subordinated debt
raises several questions:
1. Why is the
Government placing itself above the Bradford and Bingley bondholders in the
rankings for settlement?
2. Why is the
Government not treating all bondholders involved in these banks
equally?
3. Why is the
Government not acting consistently in the application of the rules
dealing with the winding up of these banks?
4. Why is the
Government proposing to seize the capital of the bondholders invested in the
subordinated debt of Bradford and Bingley? This does not form part of the
banks capital, but was loaned to the bank by the bondholders in return for
interest.
5. Is
the Government aware that in seizing the bondholders’ funds contained in
this subordinated debt, it is taking the life savings of pensioners and
small savers who rely upon this money for income and will in many cases
never be able to replace it?
The Way Forward
The
Primary Objective must be to convince the Government to amend its Treasury
order for Bradford and Bingley to move the subordinated bondholders up in
the ranking for settlement and place them before the Government claim
(Treasury and FSCS claim).
This single change will
at least guarantee the subordinated bondholders a repayment of £1 per bond.
However transferring
these bondholders to another Government controlled bank, HBOS or Northern
Rock, would bring the treatment of bondholders of the permanent subordinated
debt of Bradford and Bingley into line with all other bondholders caught up
in the British banking crisis.
WE RECOMMEND YOU WRITE TO YOUR LOCAL MEMBER OF PARLIAMENT ON
THIS ISSUE. This web site gives MPs and their contact details:
www.parliament.uk/directories/directories.cfm
N.
Williamson 15/11/2008 (Revised 19/4/2009)
Postscript. In May 2009 the company announced that it would
not be paying interest on some of its subordinated debt when the next
payments were due in June and July, and there is no apparent prospect of
payments being resumed. This is of course exceedingly bad news for all the
subordinated bond holders and it is not at all clear why the company has
chosen to cease payment. Is it a case of can’t pay or won’t p ay?
Press comment seems to suggest that the Government is trying to ensure it
gets its money back as a priority over all other debtors and hence is
prejudicing the bondholders. Anyway the end result was that the announcement
caused a collapse in the market price of the subordinated bonds, which are
still trading of course.
As we have previously
pointed out, the terms of the former PIBS, now called perpetual subordinated
bonds, did permit the company discretion to suspend payment of the interest
on them if ordinary dividends were ceased. So legally there is possibly no
technical “default”. But in essence as the company is now owned entirely by
the Government, it is in essence an arm of the Government defaulting on its
debt.
A summary of the then current
position was issued in May 2010 in this note:
Update_1
A further note on the
position of bondholders after the announcement by the Independent Valuer of
the valuation of the ordinary shares (which disclosed much additional
information) was issued in this note: Update_3
This note was issued about the tender
offer in November 2010 for the Subordinated Bonds:
Update_9.
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