Lola has sent me a link to this. You don't actually need to follow that link to get the gist of this post. In fact, you can save yourself even more time by just reading Lola's summary.
There is an underlying pattern, and a sort of twisted logic, emerging here. As I have said before:
Modigliani & Miller won a Nobel Prize for pointing out that the total 'enterprise value' of a company is usually equal to the value of all its shares and its bonds. Corporate finance wizards claim that companies can boost their own value in the good times by replacing shares with bonds (in other words, using borrowings to fund a share buy back), if this is true, then in the bad times, the reverse must also apply (in other words, doing a debt-for-equity-swap).
It was Ed (in the comments here) who pointed out why New Star had such high bank borrowings in the first place:
New Star's debt burden was taken on last April in order to facilitate a return of cash to shareholders. At the same time, New Star moved to the London Stock Exchange's main market and Mr Duffield and his family interests sold their stake down from 20 per cent to 12.5 per cent.
Let's call that an 'equity-for-debt-swap', which happens in The Good Times. And now that New Star have hit The Bad Times (and rightly so, according to Lola), the earlier deal is unpicked and the company does a debt-for-equity swap, i.e. the banks waive their loans and are issued with shares instead.
As ever, I should point out that New Star are of no particular interest to me (or probably anybody else reading this) , but all this illustrates that debt-for-equity-swaps are the market solution to over-leveraged companies. And why are our commercial banks in trouble? Because they have insufficient Tier One/Two capital, i.e. they rely on borrowings, i.e. they are over-leveraged. If our benighted gummint hadn't waded in with £37 billion of taxpayers' finest (plus all the other guarantees), then this is how banks would have been recapitalised.
Thursday, 4 December 2008
What goes around, comes around
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4 comments:
So would you have spent the government/taxpayer money on banks in a debt-for-equity move?
PT, in the absence of gummint sloshing taxpayers' money around, the banks would have had no choice except to do debt-for-equity swaps.
Bondholders etc in banks would have waived some of their bonds in exchange for an equal value of shares. Problem solved without need for a penny of taxpayers' finest or any government involvement (short of overseeing the proceedings, perhaps).
Okay, that was always my confusion and why I accused it of being "interventionist".
Would you have had the government step in a debt-for-equity move as a last resort should private capital not be forthcoming?
Careful, your future Chancellor role is dependent on the correct answer.
PT, it's not a question of whether 'private capital is forthcoming' or not , the banks have already got the money that bondholders subscribed, it's just a question of rejigging the repayment terms (instead of a lump sum on date X, the bondholders get a share of profits in perpetuity).
And no, this would not apply to ordinary depositors - the banks and building societies which are mainly funded by deposits are the most cautious and not in need of new share capital (HSBC, Nationwide etc).
So the dilemma you envisage is unlikely to happen in real life - if it came to the point where the government had to honour its deposit guarantee (because bank losses were so big as to wipe out shareholders and bondholders), of course I, were I chancellor, should honour it, that's a different topic.
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