Introduction
During the global financial crisis of 2007-08 many large global banks required assistance from governments in order to prevent greater instability and collapse of the financial system. The UK provides a good case study with Northern Rock and Bradford & Bingley being fully nationalised and Royal Bank of Scotland being part nationalised with the UK government holding over 80% of the shares. The following is a discussion of the events surrounding the nationalisation and the effects on the institution’s securities. The past provides some insight but given the implementation of Basel III and other measures to limit the costs to governments and taxpayers; future bank failures may mean very different outcomes for security holders.
Part nationalisation - RBS case study
The government has owned 82% of RBS since late 2008 when it stepped in to stop the bank failing. In 2007 RBS was one of the world’s largest banks and the largest retail and corporate bank in the UK with assets of £1.9trn. On 2 August 2012, there were reports that the government was considering taking on the remaining 18% as ministers were concerned about the bank’s continued reluctance to lend to small businesses, in spite of several measures brought in by the government to encourage more finance to be made available to this sector.
Equity
- Shareholders were heavily diluted by government support
Senior debt
- The capital injections by the government (equity rights issues/government ownership) did not mean the imposition of loss on senior debtholders
- The capital injections actually provided an extra buffer of equity to absorb losses and, as such, provided protection for RBS’s senior debtholders
- Senior debt interest and principal obligations continue to be met
- As the UK Treasury are majority owners of RBS, senior debt is considered low risk
Subordinated debt and Tier 1 hybrids
- The capital injections by the government (equity rights issues/government ownership) did not mean the imposition of loss on subordinated debt or Tier 1 hybrid securities
- The capital injections actually provided an extra buffer of equity to absorb losses and, as such provided protection for RBS’s subordinated debt and Tier 1 hybrid securities
- In November 2009 Treasury required that RBS not pay coupons on existing Tier 1 hybrid and subordinated debt nor exercise call options unless there was a legal obligation to do so (as part of EC conditions for state aid)
- While Treasury decided not to impose loss on subordinated debt and Tier 1 hybrid securities when other banks were nationalised in 2008 (given the financial instability that would result), if the government proceeds to fully nationalise RBS it is more likely that some securities would suffer loss. Subordinated debt and Tier 1 hybrid securities could incur losses or be completely wiped out. Such securities have traded at distressed levels
The buy back of debt
- RBS has also conducted various “liability management” exercises through exchange or buy back of securities at discounts of up to 30% of face value (meaning subordinated debt and Tier 1 hybrid holders that accepted the buy backs also accepted up to 30% loss of capital). Some of these buy backs have been coercive in that the bank offers slightly better terms leaving investors little choice other to accept the offer or remain in a deeply discounted security with no certainty of future call
- RBS increased its capital base through buy back or exchange at a discount and used the buy back to manage expectations regarding upcoming calls
- RBS has warned investors who decide not to participate in the offers to buy back or exchange that "all decisions to exercise calls on any notes targeted that remain outstanding will be made with reference to the prevailing regulatory, economic and market conditions at the time". Clearly stating they will not call these securities if it is not in the bank’s interest to do so
The effect on RBS securities
Figure 1 illustrates the impact of major events on RBS’s share price (left axis) and senior and subordinated credit default swap (CDS) spreads (right axis). CDSs are instruments which insure against bond default, therefore reflect the perceived market risk of related senior and subordinated debt securities. Risk rises with the increase in spread (right axis) and reflects a fall in the price of the securities.
Figure 1
- From October 2007 to April 2008 the RBS share price declined close to 40% to 275 pence and CDS spreads increased with deterioration of RBS’s position. Over that period subordinated CDSs peaked in March 2008 at about 200bps prior to the announcement of a write down of £5.9bn and a record £12bn rights issue to raise capital and offset the loss
- From April 2008 to June 2008 spreads contracted (improved) in the lead up to the completion of the rights issue and the associated infusion of the £12bn in new capital
- The bank continued to struggle through to August 2008 when it posted a pre-tax loss of £691m for the first half of 2008. The loss was at the time, the second biggest in UK banking history. The share price fell below 200 pence
- September 2008 the US nationalises Fannie Mae and Freddie Mac. Lehman Brothers files for Chapter 11 protection and Merrill Lynch is acquired by Bank of America in a rescue takeover. AIG is nationalised, and Lloyds TSB announces it will acquire HBOS in a government assisted takeover
- October 2008 RBS’s share price falls to around 85 pence
- November 2008 The Government takes a 58% share in RBS for £15bn, with a further £5bn of preference shares. Sir Fred Goodwin steps down as RBS’s chief executive, and is replaced by Stephen Hester
- December 2008 RBS shares fall to 50 pence
- January 2009 RBS announces that losses for 2008 could be up to £28bn, with the majority consisting of write downs on the ABN Amro acquisition. CDS spreads blow out rapidly. RBS shares fall over 67% in a single day to 10.3 pence. RBS, worth over £75bn just two years previously is now valued at £4.5bn. 19 January 2009 is described as the “Blue Monday Crash” with all UK bank suffering heavy share price losses. The government launches a second bank rescue plan, converting its £5bn in preference shares in RBS to common stock, taking its overall holding to 68%. The government acquired B shares in December 2009 taking total economic ownership to 81.15%
- February 26, 2009 RBS reports a loss of £24.1bn for 2008, the biggest in British corporate history. Subordinated CDS spreads blow out close to 600bps
- Subordinated CDS spreads peak for RBS in October 2011 at 897bps driven by the reporting of new losses related to European exposure. At this time investment bank UBS described RBS as the “most vulnerable” bank in Europe
- With continued issues at the bank and heightened global risk, CDS spreads have never recovered and continue to trade at elevated levels. The share price has also never recovered and as of November 2012, trades sub 50 pence