I’ve been looking into the AIB debt buyback program, details of which were announced on Monday (Irish Times story here.) Why in God’s name would I be doing that during a rare sunny week in this country? Well, between the state guarantee and NAMA, pretty much everything the banks do these days has implications for the taxpayer, so it’s worth taking a look at. That and the fact that I’m a nerd. Wonky corporate financey post below the fold.
On the face of it, the announcement looks like good news. AIB get to replace €2.4 billion of one type of debt with €1.3 billion of a different kind of debt. (Full gory details here.) This reduces AIB’s liabilities by €1.1 billion and boosts the core (shareholder) equity capital of the banks. To the extent that this gives the shareholders a greater cushion it’s good news for them. From the point of view of radical nationalisation advocates like me and, um, the IMF, it also means more equity capital can be used to absorb losses before the call on making up the rest of the capital shortfall moves onto the State.
However, when you dig a bit deeper, there is less to be enthusiastic about:
The new bonds are “10 year bullet dated subordinated Lower Tier 2” – the key is that they are dated, so now they count under the guarantee (See page 5). So while technically, the loss-sharing burden on the state is reduced by the €1.1 billion profit that AIB booked, the contingent liability for the state is increased by the €1.3 billion that gets added to the list of guaranteed debt. And if you believe that the losses are such that they should wipe out the equity of the banks, then the extra €1.1 billion will still get wiped out and the state will have lost any opportunity to clean out non-guaranteed subdebt holders. So this could cost the state more in the long run, provided we extend the guarantee in its present form, as it appears the government wants to do.
The holders of the old bonds received 50 to 67 percent of face value of those bonds. But the bonds were trading at 10 cents in February (click here for chart) so presumably the whole exercise would have saved a lot more money then. The NAMA announcements then increased confidence that overpayment would mean that the core equity capital wouldn’t get wiped out (with these undated subdebt bonds being next in line.) The announcements of debt buyback programs by the two banks also increased the price – as with when you mount a takeover bid for a publicly listed firm where you need to offer a premium relative to current prices, the banks needed to make the deal attractive to get large amounts of bondholders to be willing to crystallize the losses taken here. The debt was trading in the 40-50 range prior to the purchase program.
It’s been reported that the coupon rate on the new debt was 12.5% which will eat into future profits (or more likely make future losses even bigger.)
So, all told, this looks like a really good deal for the unguaranteed subdebt bondholders. A few months ago they were facing total wipeout. Today, they’ve taken losses of between 33 and 50 percent but they’ve obtained a bond with a far higher coupon payment and, perhaps more importantly, they’ve now most likely got themselves insured by the Irish taxpayer.
From the point of view of AIB management, however, this debt buyback is the main step that they could take to boost their core equity capital by €1.5 billion as ordered by the Minister for Finance. So it might not really be that great a deal for AIB shareholders or for the taxpayer, but it lets AIB management live to fight another day. (The rest of the money might be made up by the great American\Polish bank Goodwill boondoggle.)
So what’s the future for the bank subdebt holders? Here’s one potential plan for dealing with these guys: Make it clear that NAMA is going to pay fair price, so shareholders are wiped out (or given some small compensation). Also announce that, despite this week’s legislation to make it possible to extend the existing guarantee, that any future extension won’t include subordinated debt. Then offer subordinated debt holders a debt-for-equity swap. This wouldn’t cost the state anything and it would provide some amount of private equity ownership that could keep the banks listed even if they’re 80-90 percent state-owned.
One interesting wrinkle to all this relates to everybody’s favourite financial instrument, Credit Default Swaps. It is possible that some of the bondholders who didn’t take the offer up may have hedged with CDS and are waiting for something like a delayed coupon payment which might be judged a credit event, which would then allow them to recover par value. This stuff is decided on by a body called the International Swaps and Derivatives Association (see here for examples of the decisions they have to make – they have, for instance, “deferred” a decision on Bradford and Bingley’s bonds, which I wrote about here.)
If it were the case that most of outstanding subordinated debt holders were holding CDS insurance, and a debt-for-equity swap offer was viewed as a credit event, then the government could end up negotiating the swap with the mysterious CDS issuers (to whom the bonds would then pass.) Ok, that’s enough speculation for now.