Debt-for-equity-swap Of The Week

A lot of people don't like the idea of banks being expected to sort themselves out via debt-for-equity swaps because they think that somehow debtholders are being 'forced' to lose money. Nonsense. The only serious alternative is government bail-outs, whereby the taxpayer is forced to give the banks money.

The good news is, if you just leave it to market forces, then debt-for-equity swaps are what will happen anyway, even though these swaps come in an infinite number of guises. From BusinessWeek:

RBS and its National Westminster Bank Plc unit offered to buy back some dollar-denominated preference shares with a face value of $14.3 billion, paying as little as 52 cents on the dollar, the Edinburgh-based lender said in a statement...

D'you see that? Those preference shares (halfway between shares and bonds - so the same principles apply) are trading at 52p in the £1. The pref holders have already lost 48% of their initial investment - provided they are offered a choice of 52p in cash; or ordinary shares or new bonds with a market value of 52p, then they shouldn't be too bothered.

The gimmick is that the old pref's had a nominal value of £1 but the cash paid out, or new shares or debts issued have a nominal value of 52p, so the bank can book the difference of 48p as a gain. It's not really a gain, it's just losses which have been crystallised in the hands of the bondholders, which have to be removed from the bank's accounts to prevent double-counting.

RBS, which is 84 percent owned by the government after it arranged a 45.5 billion-pound bailout of the lender, also said it converted $935 million of its 9.118 percent preference shares into ordinary stock. Investors in $548 million of the shares opted to receive a cash payout rather than common stock...

Again, d'you see the key word there - 'opted'?

RBS said it decided not to follow Lloyds TSB Group Plc in issuing contingent capital notes because it saw “limited benefits from doing so at this time...”

Which is a pity - those CoCo's are like rolling debt-for-equity swaps, something that Denis Cooper and I once dreamed up during an email exchange (not having realised that they already existed).