It is 6 years this month since Bradford & Bingley was nationalised and nearly 5 years since I started my extensive analysis of the likely outcome for its subordinated bonds and those of fellow casualty Northern Rock. Yesterday UKAR, which manages the nationalised banks, finally announced that the European Commission has removed restrictions on the redemption and payment of interest on the debt of Northern Rock (Asset Management) Plc and Bradford & Bingley Plc.

I believe that UKAR have been pushing for the removal of these restrictions for some time. For example, back in March 2012 the Corporate Treasurer at UKAR asked me for my views as to what level might result in a successful tender for the outstanding subordinated bonds of B&B and NRAM. As a result I conducted extensive research across both fund and individual holders of the bonds and prepared a detailed report for UKAR. From subsequent exchanges with UKAR it became clear that, while they were keen to resolve the issue of the expensive rumps of subordinated debt and the dividend blockers sooner rather than later, they were restricted by the EC or HMT on pricing that would be sufficient to achieve the required tender thresholds. Since then I have maintained contact with large holders of the remaining bonds and also sent regular reminders UKAR of the commercial sense in addressing the issues sooner rather than later. I was rather fearing that UKAR had given up in trying to persuade the politicians at HMT and the EC to drop their bleatings over ‘moral hazard’ so yesterday’s announcement came as something of a surprise.
The rationale for the EC finally removing the restraints is explained as ‘the rules are now expected to increase, rather than reduce, the cost of the UK Government winding down the banks after their financial performance improved.’ This has been blindingly obvious for some years as evidenced by a February 2012 UKFI Report on the Sale of Northern Rock which states:
All creditors, including the Government, are expected to be repaid in full by Bradford & Bingley plc and the intervention in the company is forecast to yield a positive annual rate of return of 5% to 6% to HM Treasury. This reflects a total investment from the Government of £27 billion and a total return to the Government of c. £49 billion.
 
I am sure it is just a coincidence that the politicians have only taken notice when there is a general election coming up (and soundbites over the massive profits and potential dividends to the taxpayer the current Government has generated from the nationalised banking mess created by the last lot) is a complete coincidence.
Anyway turning back to yesterday’s announcements, the juicy part of the Bradford & Bingley installment reads:
The European Commission has today agreed to amend the Commitment to allow the payment of principal and coupons on subordinated debt instruments provided that:
 
(i)         the amount paid to each bondholder is not more than the net present value of the amount that the bondholder would receive on the repayment of the statutory debt; and
 
(ii)         payment is made in the context of a repurchase or redemption of a bond or bonds such that all liabilities of B&B owing to the relevant bondholder are extinguished; or
 
(iii)        the payment is in respect of bonds with nominal of no more than £130m in total.
If I am reading it correctly (i) is a must with (ii) and (iii) being either ors. (ii) requires the bonds to be extinguished so would mean a tender offer. However (iii) will always be satisfied because Bradford & Bingley has less than £130 million of subordinated bonds outstanding which would make condition (ii) irrelevant. The announcement goes on to say:
B&B is considering all options in light of the announcement and the terms and conditions of the debt instruments.
From my dealings with UKAR I am pretty sure that their preferred route would be tender offers with consent solicitations to amend the terms of the bonds such that any untendered bonds are repurchased on the same terms as tendered bonds providing there is a sufficient acceptance level to pass the necessary resolution. So the question is very much the same one UKAR asked me back in March 2012 – what level would a tender need to be pitched to gain sufficient acceptance? The main variables is answering this question are:
1.    How long will it take before the Statutory Debt is repaid and coupons could be resumed; and
2.    What discount rate will the majority of holders apply.
Earlier this year I had a stab at modelling the rundown of Bradford & Bingley based on available information from the annual report etc. and forecast that it will be 2024 before the Statutory Debt is repaid in full:
https://docs.google.com/spreadsheet/ccc?key=0AshzbUJuMAkqdDZjTnM3MmxUWGFxVVRxQjFoWWJtVUE&usp=drive_web#gid=0
Of course at that point there will still be a material value of mortgages outstanding so the full rundown could take some years longer with interest on the sub-debt being paid from 2024 until the rundown is complete.
Looking at the discount factor UK 10 year Gilts (best proxy for the cost to the Government of refinancing) currently yield about 2.5%. The yield on perpetual sub bonds of Lloyds Banking Group is about 6.5%. So the answer should lie between these two numbers. As an extremely large holder said to me today ‘We are willing sellers if we can reinvest the proceeds in other situations of equal quality at yields that are (at least) equal to what we have now.’
There is no mention in condition (i) of the latest EC dictat of how a discount rate would be set in determining NPV so presumably UKAR have enough discretion here to be able to structure an attractive offer. It is worth noting that there have been big buyers at prices well above quoted market prices in recent months and those buyers will be looking for tender prices which represent a reasonable return on their investment.
As always I would be interested to here the views of holders so please contact me by email – mark@fixedincomeinvestments.org.uk