The buy-back by taxpayer-owned banks, Northern Rock (Asset Management) and Bradford & Bingley, of £2.4 billion of their subordinated debt over the course of 2010 saved the taxpayer an estimated £1.5 billion at present value, according to the National Audit Office. Subordinated debt is debt that ranks after other loans in terms of pay-out in the event of liquidation.
These buy-backs have taken place against the background of the Treasury’s approach, designed to maximize value for money for the taxpayer, of ensuring the banks are able to wind down in an orderly way, perhaps over 15 years. To achieve this, the Treasury has had to provide subsidized loans to the banks and various guarantees and assurances. So long as Treasury follows its current approach, it protects all the creditors of the banks including the holders of subordinated debt who in the event of insolvency might lose everything.
It was originally assumed subordinated debt holders would absorb losses in times of difficulty, and they were paid a correspondingly high interest rate. In the event, taxpayers are actually paying to support the banks and are taking on the risk that should have fallen to investors.
The NAO, therefore, concludes that the subordinated debt holders were being paid an excessive interest rate for risk that was being, in practice, adopted by taxpayers, and that buying back that debt was value for money.
The buy-backs of debt were opportunistic, although many other banks had undertaken similar transactions. UK Financial Investments, the arm’s-length body of the Treasury, helped to ensure the buy-backs were well-executed and the pricing, between 25 and 57 pence to the pound, maximized value for the taxpayer while encouraging the holders to sell.
However, the holders of £619 million of subordinated debt did not accept the offer to buy back the debt and a further £825 million was not included in the offer. This debt remains expensive and is of limited value to taxpayers. The Treasury should continue to explore ways of eliminating this debt at minimal cost.