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National Audit Office report: Stewardship of the wholly-owned banks: buy-back of subordinated debt

Stewardship of the wholly-owned banks: buy-back of subordinated debt

Investors in taxpayer-owned banks were paid an excessive interest rate for risk actually being shouldered by taxpayers. The buy-back was therefore value for money.

"Opportunistically buying back the subordinated debt of the taxpayer-owned banks was value for money in the circumstances. The holders of this debt had been paid to bear the risk of taking loss if the banks ran into trouble, but were rescued as part of the nationalisation. It is good for the taxpayer that the debt-holders have now shared part of the costs of restructuring the banks. It remains to be seen if the cost of subsidizing the banks will eventually be recouped by the taxpayer."

Amyas Morse, head of the National Audit Office


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.


Publication details:

ISBN: 9780102969573 [Buy a hard copy of this report from TSO]

HC: 706, 2010-2011

Published date: March 18, 2011