Note from Ben: The following post is from John in Ottawa
Denmark Makes History with Bondholder Haircut
A lot of the controversy surrounding the financial crisis is that bank senior bondholders have not suffered any losses throughout this financial crisis. You have probably heard the expression, “Privatize the profits and socialize the losses.”
Today, two extraordinary things happened. First, Bloomberg reports that a Danish bank that has already been bailed out once, to the tune of $2 billion will be allowed to fail and bondholders and uninsured depositors will take a haircut.
Amagerbanken A/S, the insolvent Danish lender seized by the government, is the first European bank to be rescued under new regulations designed to ensure senior bondholders suffer losses in a bailout.
Investors in about 2 billion kroner ($360 million) of notes face losing almost half face value after the transfer of 15 billion kroner of the Copenhagen-based bank’s assets to a state- owned company, Bloomberg data show.
Liabilities staying at the failed bank total about 13 billion kroner and include subordinated and hybrid debt, about 5.6 billion kroner of bonds backed by the government, as well as senior unsecured bonds. Denmark is dealing with Amagerbanken under regulations introduced in October designed to ensure taxpayers don’t have to meet the bill when lenders fail.
The bank estimates its assets amount to about 59 percent of liabilities, meaning that creditors, including holders of senior unsecured bonds on which a government guarantee expired Sept. 30 and depositors with more than the insured maximum in their accounts, will face write-offs of about 41 percent.
“The bank hasn’t collapsed and gone into bankruptcy like the Icelandic banks, but has been selectively bailed out with a transfer of assets and a partial transfer of liabilities,” said Simon Adamson, an analyst at CreditSights Inc. in London. “Normally when this happens, senior debt and deposits are protected, such is the sensitivity around them, but this is bank resolution with debt and deposit haircuts, rather than a simple liquidation.”
Iceland’s three biggest banks collapsed and were wound up with debt amounting to more than $61 billion, or 12 times Iceland’s economy.
The second extraordinary thing in my view is that Amergerbanken’s assets are reported as being less than their liabilities. That is, the value of the loans outstanding is less than the deposits.
I’ll get to why this is extraordinary in a bit, but by way of background for those of you not familiar with bank balance sheets, here is what is going on. It may, at first blush, sound just fine that the bank appears to have loaned out less money than they have on hand in deposits. It appears that the deposits can easily cover the outstanding loans. But this isn’t how bank balance sheets work.
Deposits are liabilities because customers can come into the bank and ask for their deposit back. Loans are assets because the bank expects loans to be repaid. Here is the rub. The deposits (liabilities) on the bank balance sheet don’t equate to cash in the teller’s drawer.
When a customer makes a deposit, two entries go onto the bank balance sheet; the deposits (liabilities) are increased and cash (assets) are increased. When the cash is loaned out, cash (asset) is decreased and loan (asset) is increased. Deposit (liability) stays the same. When a banks assets (the sum of their cash and loans due) becomes worth less than their liabilities (deposits) and equity (bank capital), they are technically bankrupt. This is the reported case with this bank.
Their equity was wiped out last year and even the $2 billion bailout has been wiped out, and their reported assets are worth less than their remaining liabilities. The last part of the last sentence is the extraordinary part. Here is why. You may already be familiar with “Bank Failure Fridays.” Every Friday, virtually without fail, the FDIC in the US shuts down three or four or more banks. These are smaller regional and community banks with loan portfolios that are mainly commercial real estate. Strip malls and the like. They have shut down several hundred since the crisis began and there are nearly 1000 banks on their “troubled bank list.”
In every case, and I follow this closely, when the FDIC shuts down a bank they list the assets (loans outstanding) as being greater than the liabilities (deposits). Then they go on to say that the cost to the FDIC, and ultimately the taxpayer because the FDIC has long since gone broke, will be about 50% of the reported value of the assets.
For instance, they may report that the bank had $100 million in assets, $70 million in deposits, and the cost to the FDIC is estimated to be $50 million! Now, just forgetting for a second about equity or bank capital, our example bank should be in the green to the tune of $30 million, but the FDIC is saying that it going to cost them (the bank is in the red) $50 million.
Those loans on the bank’s books and reported on their balance sheets and annual reports aren’t worth $100 million, they must only be worth $20 million ($20 million assets plus $50 million bail out equals $70 million to pay back the depositors).
So, thanks to the Federal Accounting Standards Board suspending “mark to market” rules at the beginning of the crisis (which require banks to fairly report what their loans are actually worth each month) these regional and community banks can pretend they are solvent until the teller’s tray really does simply run out of cash. Then the FDIC obfuscates the situation by representing to the public that the bank has more assets than liabilities when the truth of the matter is, the FDIC has had to write off as much as 80% of the loans.
The second extraordinary item in this Bloomberg report is that the Danish authority marked the assets to market and reported the “marked to market” value of the assets. They didn’t hide the truth! This failure to mark to market is not restricted to regional and community banks. It is the reason that the financial crisis lingers and will continue to linger for years as “to big to fail” banks report that they are solvent, but keep running out of cash because their loans are non-performing and not worth half of what is recorded on their balance sheets.
Oh, and by the way, as long as banks are allowed to report that their balance sheets are healthy, and as long as they keep being bailed out by the Fed, the bankers can keep paying themselves huge bonuses.
John in Ottawa