WIREDGOV

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.

Amyas Morse, head of the National Audit Office, said today:

"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."

Notes for Editors

1. Subordinated debt issued by banks as part of their capital was intended to absorb losses in the event of the banks' running into difficulty. Subordinated debt attracts a higher interest rate because it is regarded as higher risk. This is because, should banks be wound up, subordinated debt holders only receive the money owed to them if there are assets left following the payment of more senior creditors.
2. Under new banking capital regulations arising from Basel III, subordinated debt in its current form will no longer be recognized as a form of bank capital. Regulators and banks are developing a replacement known as 'contingent capital', which would act like subordinated debt but, importantly, would convert to equity at a predetermined level of financial stress. The intention is that, were contingent capital used in situations like that of Northern Rock and Bradford & Bingley, it would convert to equity before taxpayer intervention. If such intervention became necessary, this equity could be subject to losses or even wiped out along with the rest of the equity.
3. UK Financial Investments is an arm's-length body of the Treasury set up to set up to protect and create value for the taxpayer as shareholder and creditor of UK banks. Treasury has set UK Financial Investments the objective of developing and executing a strategy for disposing of taxpayers' investments in the banks through sale, redemption, buy-back or other mans. UK Financial Investments manages taxpayers' shares and loans in the wholly owned banks on a commercial basis.
4. Press notices and reports are available from the date of publication on the NAO website, which is at www.nao.org.uk. Hard copies can be obtained from The Stationery Office on 0845 702 3474.
5. The Comptroller and Auditor General, Amyas Morse, is the head of the National Audit Office which employs some 900 staff. He and the NAO are totally independent of Government. He certifies the accounts of all Government departments and a wide range of other public sector bodies; and he has statutory authority to report to Parliament on the economy, efficiency and effectiveness with which departments and other bodies have used their resources.

All enquiries to Barry Lester, NAO Press Office: Tel: 020 7798 7937

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