Tuesday 25 August 2009

Debt for equity swap of the week

From The FT:

Debt markets were given a significant confidence boost on Monday when Santander, Spain’s largest bank, launched a programme to buy back securitised bonds with a face value of ($23.6bn).

The deal, believed to be the biggest of its kind, is expected to help stabilise some debt markets by setting a floor for prices for securities that are often hard to value. The bank said in a regulatory filing that the offer covered 27 different issues of bonds backed by mortgages, consumer credits and business loans. The deal comes as Santander, in a separate deal, moves to replace more than 30 different debt securities with two new issues. In both cases, the aim is to profit from depressed pricing in the secondary markets...

Although offering as little as 61 per cent of par value on some bonds in the latest proposal, Santander is likely to have pitched a few points above current trading values, making the offer attractive to institutional investors under pressure to mark their assets to market. In June, Rabobank of the Netherlands bought back €986.5m worth of residential mortgage backed bonds at a discount.


The key to all this is that the bank are only paying 61% of 'par value' or 'face value' or 'nominal value'. In other words, as at today's date, the bank's balance sheet shows a 'debt' of €16.5 bn, but the bank only has to pay €10 bn to get rid of it once and for all. That gives a handsome book profit of €6.5bn, which, being profit, is added to their 'equity' (i.e. shareholders' funds) and so improves their capital adequacy ratio.

I doubt sorely whether the bank can afford to redeem these in cash, so of course it has to raise another €10 bn from somewhere. But as it is buying back/redeeming 'securitised' bonds (i.e. the holders thereof now realise that they are of dubious value) and replacing them with 'normal' bonds (which will be worth something approaching par value) it can still crystallise a profit.

Either way, they have converted €16.5 bn of debt into €10 bn of debt and €6.5bn of equity, which is all good stuff from the bank's point of view.

H/t Flintster1994

5 comments:

James Higham said...

Debt for equity may be a business mechanism but it's a stop gap thing.

Hauling ourselves out of the whole debt culture is not hard to do - four steps will see it happen.

Mark Wadsworth said...

Which four steps?

Lola said...

I have always reckoned Santander's self professed assumption that were a strong bank was highly questionable. Not only because they have had their fingers as deep in all this clever securitised debt malarkey as every other bank, but also because their exposure to Spanish property would come home to roost, sooner or later.

I reckon this move goes part of the way to making me feel smug - again.

Aren't they also massively exposed through Ferroval to various infrastructure plays,like BAA for example? (Which IMHO should be broken up forthwith.)

This is just the start of it, you mark my words.

Alex said...

They can afford to buy back their own debt, as can RBS and Barclays who did similar things. Banks are awash with cash from quantitative easing - that includes Santander through Abbey & A&L - and in addition Braclays have been issuing a lot of long term debt.

All of the banks are playing a sort of scam buying back discounted debt and issuing fresh debt at higher coupons. The scam is that they book gains of the repurchase of the old debt but issue debt at todays higher coupons, so they pay more in future than they would have paid if they had left the original debt outstanding.

The irony is that they buy back subordinate debt (quasi equity) but issue new senior debt, which implies a more unstable liability side of the balance sheet (higher ratio of senior debt to equity/sub debt), and yet the accounting profit implies stronger capital ratios.

Mark Wadsworth said...

Alex, yes that's a good point as well. All they are doing is realising a pre-existing gain on subordinated debt with a relatively low coupon (the investor's loss is the bank's gain).

In commercial terms, they haven't made a gain at all as the NPV of payments due on the new bonds is probably much the same as that on the old bonds.