Bradford & Bingley Shareholder Action Group

Subordinated Bonds (PIBS)
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The Perpetual Subordinated Bonds (formerly called PIBS) - Revised 12/12/2014

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This was our initial comment on the position of the bondholders:

Our view is that the Government is not treating the bondholders of the subordinated debt of Bradford and Bingley bank equally to the bondholders of the subordinated debt of other banks caught up in the British banking crisis.  

Whereas the capital of all other bondholders in these banks is being protected, the capital of the bondholders invested in the subordinated debt of Bradford and Bingley bank may be wiped out under the present system of ranking within the Treasury order relating to the nationalisation of Bradford and Bingley bank. The Government has arbitrarily ranked itself (the Treasury and the FSCS) ahead of subordinated bondholders in settlement.

What is the “subordinated debt” of a bank?

The subordinated debt of the bank is formed, in this case, by the bonds sold by the bank to finance its operations. These bonds pay interest twice per year in return for the use of the investors’ capital. The capital remains the investors’ property and is only loaned to the bank in return for an income in the form of the interest payments. 

The word “subordinated” means that in the event of the winding up of the bank these bondholders will be ranked behind the existing senior debt of the bank (for example “covered bonds”) and behind depositors, but before shareholders (stockholders). 

Significant changes to the operation of the bank (e.g. winding up) would, under the terms of issue of these bonds, force an immediate repayment of the bondholders’ capital at par (the face value of the bonds). As these bonds normally trade at a premium to the issue price this would normally result in a loss of some part of the investment capital. 

Who bought these bonds and why? 

The subordinated bonds of British banks and building societies have traditionally been seen as a safe investment and are bought by investors requiring a stable long term income. The bonds have been available for over 25 years and have formed a significant part of the pension planning of most investors. Since the issue of these bonds no bank (or building society) has defaulted on payment. No bank (or building society) has ever forced repayment at par - for example, in the event of takeover, demutualisation or winding up. 

The bonds have been readily tradable on the British bond market and market maker Collins Stewart is a significant dealer in these bonds. 

Although bond issues from the smaller building societies have traditionally been at the higher end of the yield range, the credit crunch has led investors to move towards the larger issuers such as Bradford and Bingley, and Halifax, even though some of the smaller mutual societies have robust finances.

What has happened to the banks issuing these bonds? 

Since the financial crisis, when three of the largest banks who have issued these bonds required refinancing, the bondholders’ circumstances have changed significantly.

Halifax Bank of Scotland is to be merged into Lloyds bank and the bondholders’ investments will become part of Lloyds financing, where it will continue to pay interest. These bondholders’ investments are safe. 

Northern Rock has been nationalised and refinanced by the Government and continues its operations. Northern Rock was reducing its mortgage book prior to eventual sale (the most probable outcome) when the financial crisis is over. The Government has recently (March 2009) invested several billion in the bank to provide liquidity to the mortgage market. Bondholders’ investments continue to pay interest as usual and will go with the bank to a buyer in the future.

However, should the Government fail to find a buyer, the bank would be wound up and creditors would be repaid their capital in order of ranking. The subordinated bondholders would be repaid their capital at par, face value, of their bonds.

Bradford and Bingley has been nationalised by the Government, which has broken the bank up in the following manner: 

1. Deposits: The deposits of retail savers who bought products sold through the branch offices have been sold to the Spanish owned bank, Santander, together with the branch network.

2. Lending: The Government has funded the outstanding loans in the form of mortgages and personal loans, with a loan.  

Terms of the Government loan 

Under the terms of the loan the Government has provided a total £18bn of which £14bn is to be provided by the Financial Services Compensation Scheme (FSCS), which is industry funded. The £14bn equates to the amount of B&B savings guaranteed by the £35,000 deposit protection scheme. A further 4 billion loan has been provided by the Treasury.  

The Financial Services Authority triggered the FSCS immediately following the Government (FSA) decision that B&B did not meet its requirements for a deposit taker. NOTE The Government, both Treasury and  FSA, have not yet defined precisely which requirement of the FSA B&B did not meet despite being questioned upon this matter many times. 

The Government (BOE) will provide the FSCS with a loan for the £14bn and interest on the £14bn loan will be charged to the retail banking sector. Thus the Government itself is only providing a loan of £4bn. 

Interestingly, the first Treasury order issued on the Monday morning following Nationalisation ranked the Government (FSCS and Treasury) ahead of all bondholders for repayment. This would be the normal position for depositors not shareholders.  

However, after some swift legal objections from the lawyers representing the covered bondholders (major financial institutions) the Treasury order was immediately amended and reissued moving the covered bondholders up the ranking, thereby securing their investment before the Government in settlement but still placing the Government before the subordinated bondholders and 100% shareholder, the Treasury.

In this highly unusual and unique settlement ranking the Treasury is therefore both above and below the subordinated bondholders while the FSCS is above the subordinated bondholders.

NOTE The legality of this settlement structure is questionable.

The Implications for Bondholders of B&B Subordinated Debt arising from the current situation. 

1. Subordinated Bondholder’s capital:

In practice, the current Treasury order positions the bondholders of subordinated debt lower in the settlement rankings than the Government (Treasury and FSCS) meaning that the Government would seize the subordinated bondholders’ capital to pay itself for funding the operations of B&B in the event of any shortfall.

There is a possibility of there being no capital left in the bank following the Government’s charges for any shortfall in capital repayments and any interest which would arise over many years of funding B&B.  This would mean that subordinated bondholders would be wiped out as are the shareholders of B&B. 

However, in the unlikely event that there should be any capital available to repay bondholders, then the subordinated bondholders would be repaid their capital at par (the face value of £1 per bond) which for most investors would mean a loss as they bought their bonds at a premium to face value.

2. Subordinated Bondholder’s interest payments:

Under the terms of the current Treasury order there may be little hope of the money being made available to make interest payments in the long term and this is reflected in the current price of the bonds. In January, the Government issued a notice to subordinated bondholders advising them that interest payments were not guaranteed and each payment would be subject to the availability of money.

In March the Government arbitrarily cancelled the repayment of dated bondholders’ bonds and reiterated its earlier warning with regard to interest payments.

NOTE  This means that no contract with a British bank is safe in the event of Nationalisation as the terms may be changed arbitrarily and applied retrospectively by the Government.  The net effect of the Government’s action was to raise the cost of lending to British banks immediately by 100 basis points and reduce the availability of lending as potential lenders are now being offered bondholder levels of interest for taking on equity levels of risk. Who would buy the subordinated bonds of a British bank now?

N.B. See the postscript at the end of this document for subsequent news on the interest payments after the above was written.

The Issue for Bradford and Bingley bondholders 

Following an examination of the current situation of each of the three banks described above it is clear that the bondholders of subordinated debt of Bradford and Bingley are not being treated equally to the bondholders of subordinated debt in Northern Rock or HBOS.  

The bondholders of subordinated debt within Bradford and Bingley are being treated extremely harshly when compared to the bondholders of subordinated debt of the other two banks. The bondholders of subordinated debt within Bradford and Bingley are the only group among all of the bondholders caught up in the whole of the British banking crisis who are being treated in this manner.  

In 200 years of British banking history no previous Government has seized the capital of the bondholders of the subordinated debt of a British bank! In part, this cautious and protective behaviour of previous British Governments is how Britain gained its international reputation for reliability and probity in banking, alas all this has now gone. 

The current situation of bondholders of Bradford and Bingley subordinated debt raises several questions: 

1. Why is the Government placing itself above the Bradford and Bingley bondholders in the rankings for settlement?

2. Why is the Government not treating all bondholders involved in these banks equally?

3. Why is the Government not acting consistently in the application of the rules dealing with the winding up of these banks?

4. Why is the Government proposing to seize the capital of the bondholders invested in the subordinated debt of Bradford and Bingley? This does not form part of the banks capital, but was loaned to the bank by the bondholders in return for interest.

5. Is the Government aware that in seizing the bondholders’ funds contained in this subordinated debt, it is taking the life savings of pensioners and small savers who rely upon this money for income and will in many cases never be able to replace it?

The Way Forward

The Primary Objective must be to convince the Government to amend its Treasury order for Bradford and Bingley to move the subordinated bondholders up in the ranking for settlement and place them before the Government claim (Treasury and FSCS claim).

This single change will at least guarantee the subordinated bondholders a repayment of £1 per bond.

However transferring these bondholders to another Government controlled bank, HBOS or Northern Rock, would bring the treatment of bondholders of the permanent subordinated debt of Bradford and Bingley into line with all other bondholders caught up in the British banking crisis.


N. Williamson 15/11/2008 (Revised 19/4/2009)

Postscript. In May 2009 the company announced that it would not be paying interest on some of its subordinated debt when the next payments were due in June and July, and there is no apparent prospect of payments being resumed. This is of course exceedingly bad news for all the subordinated bond holders and it is not at all clear why the company has chosen to cease payment. Is it a case of can’t pay or won’t pay? Press comment seems to suggest that the Government is trying to ensure it gets its money back as a priority over all other debtors and hence is prejudicing the bondholders. Anyway the end result was that the announcement caused a collapse in the market price of the subordinated bonds, which are still trading of course.

As we have previously pointed out, the terms of the former PIBS, now called perpetual subordinated bonds, did permit the company discretion to suspend payment of the interest on them if ordinary dividends were ceased. So legally there is possibly no technical “default”. But in essence as the company is now owned entirely by the Government, it is in essence an arm of the Government defaulting on its debt.

A summary of the then current position was issued in May 2010 in this note: Update_1

A further note on the position of bondholders after the announcement by the Independent Valuer of the valuation of the ordinary shares (which disclosed much additional information) was issued in this note: Update_3

This note was issued about the tender offer in November 2010 for the Subordinated Bonds: Update_9.

This note on the latest tender offer from the Government to redeem the bonds was issued in December 2014: Update_22

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