I too joined the call on Thursday and have been mulling it over. I imagine others may still be chewing on it as well.

On the positive side, there did seem to be a core business buried in there that could be viable. Given all that has happened, they do still have 4m apparently loyal customers, the mortgage book is prime with average LTV of 51%, and they managed to grow their mortgages and current accounts a small amount. When asked about deposit outflows in the Q&A, they just said that liquidity remained strong (arguably they would benefit from some deposit loss, given their loan-to-deposit ratio at around 87%). Branch network of 95 (post closures) doesn’t look excessive.

Depending on your view, a cost-to-income ratio over 100% suggests there is plenty of scope for efficiency gain and rationalisation, progress in cutting costs seems to be fairly slow however.

But, it’s clearly a sub-scale bank in a market where increased (and increasing) capital requirements make being a challenger bank even without legacy issues a tough proposition before being saddled with £2bn of Non-Core RWAs (around 30%) on non-core assets of £4bn as well as the fair value unwind and other legacy issues. Looks like they will lose at least another £250m next year (£60 final fair value unwind, £160 fair value unwind, £30m operating loss / conduct). So they don’t have enough capital, either in total or CET1, and they lack credibility or market confidence to be able to raise any at a reasonable price.

There is, however, potentially still value in the business, but I find it difficult to see how they are going to realise (particularly the £400m of DTA) that value on a standalone basis in any reasonable time frame (assuming they now have to just let their non-core assets run off, and that despite having a loan-to-deposit ratio of 87%, growing the mortgage book is going to be tough in the current market). In essence, they’d need shareholders with access to a decent amount of capital and a long term (10-20 years) view. That doesn’t seem to fit either the current shareholders, or bondholders.

The optimistic view would that there are other challengers banks who are going to need to scale to really compete, and this could be an opportunity to do that – the core franchise seems strong, there are obviously efficiencies and synergies available, and as Mark pointed out, with £406m of unrecognised DTAs, you could offer to £400m for the equity, and essentially get the bank for free (assuming you were making a profit elsewhere). On the flip side, the pension is a big issue, and that seems to be the top priority to sort out. Whether they can pull of a sale who knows, but I think it is beyond any doubt that is best outcome for all stakeholders (shareholders, senior and sub bondholders).

As to their Plan B, I’m in agreement with Mark that I’m totally unconvinced it’s workable, although coming at it from a slightly different angle – I just don’t think it makes any sense for any bondholders (before even worrying about the retail element). My guess would that there are virtually no bondholders for whom unlisted equity (even if you are effectively getting it at a big discount to book) is attractive – they own the bonds (senior or sub) to get an income stream and capital back at maturity (or sooner). On that basis, if what is being proposed is £300m equity plus £450m bail-in which is then caveated with having to raise a further £250m in 2018, plus MREL after that to get a bank returning single digits in 2020, I’m struggling to see why that is better or bondholders than going to resolution (which will presumably be the threat). Perhaps I am misunderstanding what would happen in resolution, but if the shareholders are wiped out, and you then bail in all the debt (£850m), the bank is now owned by the bondholders, has equity of around £1.55bn before 2017 losses plus DTA of >£400m. Under the premise that what bondholders would want is to get their capital back ASAP (i.e. no waiting until the mid 2020s), can you then sell some (most of?) the bank for £850m? The £160m of project costs might be reduced if going that route, and perhaps further opportunities for minimising costs and targeting a run-off. To me, the recovery rate, and more importantly timescale is potentially better in that scenario than agreeing to a debt-for-equity swap leaving you with 60% of a bank trying to operate on a standalone basis and potentially burning capital. I’m envisaging here that most bondholders are more interested in the downside than they are in the (remotely) potential upside.

So, if the threat is agree to convert alongside £300m of new equity (which as Mark outlined, is probably going to want to own the whole bank, as their interest would likely be outsized returns over the longer term), or resolution, there is a case for opting for resolution. And as was hinted at on the call, even then it’s not clear: they were asked something along the lines of what happens if Plan B fails, and all they said was that they were above their regulatory minimum (which seems reasonable – at £250m loss on RWAs reducing to £6bn, that leaves around £450m equity and a 7.5% CET1).

It doesn’t seem a particularly well thought through plan to me: not least because £300m of new equity is roughly 5% CET1 at end 2017 (assuming £6bn RWAs), which would take them back above 12%. So why do you need to bail in the debt as well? Bailing in the sub debt gives a CET1 advantage, but doesn’t increase total capital (which they are also short of), which then forces them to try to raise another £250m of T2 in 2018 (looks highly optimistic to me if you’ve forced an equity conversion on your last £250m of T2). To generate more total capital, they would need to do something with the senior.

Aside from that, I’m not sure they appreciate how much of 42RQ at least is held by retail investors (many of whom already took a haircut in 2013 on the conversion from the PIBS). It was only due to Mark’s herculean effort both to negotiate a deal that made sense to accept (haircut but still providing an income stream) and then coordinating it and there was then a genuine threat of total wipeout. Do retail holders have more than 25%? I’d guess so but who knows. Then there is the issue of forcing retail into unlisted equity. And that’s before you worry about what is no doubt a significant portion held in SIPPs and ISAs which as far as I remember can’t hold unlisted equity.

I’ve never before heard retail investors ask questions like they were on the call on Thursday. I suspect they were surprised! I also suspect it will present a serious obstacle to their Plan (before even considering the banks “ethical principles”).

But in 2013, their initial suggestion ended up being vastly different from what was achieved with Mark’s help and that could be the case this time.

One scenario I am struggling to see come to fruition is whereby Plan B results in sub holders bailed into equity whilst senior gets redeemed at par in Sept. They need more total capital, and the only stakeholders involved in this who can provide additional total capital (as opposed to just converting T2 -> CET1) are the senior bondholders.

One thing I did catch but didn’t quite understand was that they seemed to imply they couldn’t issue AT1. I didn’t understand whether they meant there is some technical reason why they can’t have AT1 in their capital stack, or that the market wasn’t open for them to do so (I assumed the latter).

The conclusion I’ve come to so far is, like Mark, that their Plan B is unlikely to work as-is, for a whole host of reasons. But like 2013, some creative thinking could pull together something workable, or if not, resolution might not be disastrous for bondholders. Off the top of my head, for example:

– £300m new equity (I’m assuming in any world this has to come from existing investors who are otherwise wiped out if they don’t participate), pulls them back to around £1bn CET1, 15+% CET1 pre-2017 losses, around 12.5% CET1 post-2017 losses
– Amend existing T2 to become AT1. Add a couple of percent to the coupon (so 11% -> 13%, 8.5% -> 10.5%). Adds around £10m interest cost per year. Potential maturity extension (5, 10 years?). Or even perpetual (not sure if that’s allowed for AT1)
– Convert senior to T2. Add a couple percent to the coupon (5.125% -> 7.125%?), maturity extension. If they only need £250m, redeem part in cash, part in T2. Adds another £10m in interest cost.

I’m sure there are plenty of other similar variations, but something like that could (1) increase total capital, and increase both CET1 and AT1 (2) respect the capital hierarchy (3) provide bondholders with ongoing income stream and (4) provide those providing equity all the upside should be bank be turned around (5) provide immediate capital in the event of stress (through AT1).

The one thing that was made clear from the call was that they seem to be in no hurry, and given the complexity of the pension negotiations which would appear to be a precursor to any offers (Sabadell certainly seem to be saying so), I won’t be holding my breath for the next step.