Thursday
There is something about this story about bank debt buybacks that I don't quite understand, although I have only had two cups of coffee as of the time of writing:
"European banks are turning to buying back their own debt in order to raise some of the billions in extra capital required by regulators. At least six major banks have launched debt buybacks in the last two weeks and investment bankers say more are likely."
Okay, so if a bank has debt - ie, others are lending it money - and the bank buys back, or in other words, pays off some of that debt, like paying off a credit card, say, how is this raising capital? The bank is presumably paying the debt off with, er, what? Fairy dust?
"In Lloyds’ case, it will exchange bonds previously issued for new instruments that are compatible with new regulations. The move allows lenders to book profits and reduce the stock of non Basel III capital on their books without issuing new equity or offloading assets."
This is not very clear. What is the defining characteristic of "Basel III capital" in this case?
Finally we get a glimmer of how this actually works:
"The capital raised in this way is likely to be in the hundreds of millions. It boosts earnings by realising “own credit” gains that are otherwise purely theoretical. The market price of banks’ debt has fallen dramatically in recent weeks, which enables banks to buy back their debt for an amount above the market price but below the cash they raised by selling the instruments, booking a profit."
Now I understand - I think.
As usual, the CityAM publication has a blisteringly good item on the Eurozone's latest absurdities today. It is become my daily morning read. The fact that several of its writers are friends and acquaintances is, of course, purely coincidental.
But this has been happening for some time already: it's a peculiar quirk of mark-to-market.
If you risk rises causing bond prices to fall, you can book a profit as you mark to market the value of debt you've issued.
Posted by The Pedant-General at December 8, 2011 11:08 AM
If you construct a complex enough system to bounce ideas around long enough you can tire most people sufficiently to convince them that creating food, clothes and other assets out of thin air is quite possible.
Posted by John B at December 8, 2011 11:27 AM
Didn't Dickie Branson buy NR partly with money borrowed from NR?
Posted by NickM at December 8, 2011 12:49 PM
To venture a guess...
They're probably trying to count their available line(s) of credit as an asset. Less current debt means that they can borrow more.
If you accept that they can borrow today, buy assets likely to hold or increase in value tomorrow, and pay it off in a year with badly-devalued money, then it's plausible.
That is, once you've accepted that gambling on future inflation is an acceptable use of a central bank's resources and that, for a bank to torpedo it's own currency to profit off such a bet is not a conflict of interest at all
Posted by Sunfish at December 8, 2011 01:06 PM
It also matters whether these regulatory requirements specify ratios or absolute numbers.
It may make sense to reduce liabilities and reduce assets (i.e. in this case the cash you use to buy back the debt) in order to change the ratio.
Hard to think of an example given the complexity of banking regulations, but I can certainly see in principle why it may make sense to jiggle the numbers around.
Posted by PeterT at December 8, 2011 01:13 PM
Frack me, smited before I could even proofread.
There ain't a lot that you can do in this town.
You drive down to the lake and then you turn back around.
You go to school, learn to read and write,
so you can walk into the county bank, sign away your life.
I work at the filling station on the interstate
pumping gasoline and counting out-of-state plates.
They ask me 'how far is it to Memphis?' and where's the
nearest beer.
They don't even know that there's a town around here.
Posted by Sunfish at December 8, 2011 01:14 PM
So I think I get it. The bank issued a bond with a par value of, say, $1000. But currently the bond is trading at $900. So the bank buys it at that price, and since the bank doesn't have to pay itself back, they clear $1000 of liability off their books. Their net reserve position improves by $100.
In effect, what the bank did was discharge their debit at 90 cents on the dollar. The way the article was worded was a bit confusing; this isn't about raising cash per se, but about improving their net reserve position by clearing debts at less than face value. Pretty clever actually.
Posted by Cousin Dave at December 8, 2011 03:30 PM
Much kudos Sunfish. I wonder how many other Samizdata commenters can quote Steve Earle.
Posted by CIngram at December 8, 2011 04:45 PM
After Cousin Dave's point; companies have been accused of deliberately frightening the markets about the quality of their debt, in order to pull this one off.
Posted by PeterT at December 8, 2011 05:30 PM
Cousin Dave is correct as far as he goes, but I suspect there is more at work here. Simply buying your debt back at a discount does indeed create an accounting gain (legitimately), which would increase capital. The question is, where did they get the cash to do so? If they simply had it lying around, fine. But if they had to issue new debt ordinarily it would be a wash. My bet is they're issuing new debt instruments designed to comply with the new Basel III rules and qualify as capital, whereas the old ones purchased did not. (Debt can sometimes qualify as capital if it has some "equity-like" features, such as mandatory convertibility, some risk with regard to interest payments, etc.) That's just a guess, though.
Posted by Laird at December 8, 2011 06:41 PM
Much as I'm generally wary of this sort of accounting trick being used illegitimately, this makes perfect sense in a very nonpartisan way. Cousin Dave's summary is quite right. The conditions allowing it to happen aren't common, but when it does it's a real accounting profit, not some trick of sketchy regulation.
Posted by Alsadius at December 8, 2011 08:09 PM
CIngram-
That was my anthem in high school.
PeterT-
Why not undersell your own debt? Publically-traded companies have been doing the same thing with their earnings forecasts to bump their stock prices since more or less forever?
Posted by Sunfish at December 9, 2011 01:31 PM
And people complain that I do not go into the details of banking practices.
If one does - one runs the risk of going raving mad, and without any benefit (as attempts to explain these antics are pointless).
All one needs to know is that modern banking is a scam - a vast (although very complicated) fraud.
And that it will not (can not) last.
Posted by Paul Marks at December 12, 2011 12:25 PM
