Financial Regulatory Forum

Northern Rock defers payments to bondholders, ahead of likely EU order

By Reuters Staff
August 18, 2009

By Tom Freke and Clara Ferreira-Marques
LONDON, Aug 18 (Reuters) – State-owned British bank Northern Rock said on Tuesday it would defer paying interest on a range of subordinated bonds, propping up its capital position and preempting an anticipated European Commission requirement.

The loss-making lender, nationalised in early 2008 after it became the first major British victim of the credit crisis, said it had decided to defer payment of coupons until further notice on almost all of its subordinated debt.

“The company will continue to make payments on its debt where it is contractually obliged to do so,” Northern Rock said in a statement.

The bonds affected total almost $2.8 billion, but analysts said the move was not critical for the bank as it did not include Lower Tier 2 bonds, on which deferring payment could have put Northern Rock in technical default.

“It should not be a surprise,” credit analyst Olivia Frieser at BNP Paribas said. “This is Tier 1 and Upper Tier 2 debt, and Northern Rock is only deferring where they legally can.”

Bradford & Bingley, itself nationalised last year, deferred its Lower Tier 2 payments earlier this year, but under a previous law. It would be harder for Northern Rock to do the same under current legislation, Frieser said.

Northern Rock, which slid to a statutory loss of 724 million pounds ($1.19 billion) in the first half of the year, said last month that its capital base had fallen below its minimum regulatory capital requirement.

The British government has pledged to help the bank meet its capital requirements once restructuring has taken place at Northern Rock and subject to appropriate state aid approval from the European Commission, which is expected in the coming months.

“Right now, pending their restructuring, Northern Rock are below regulatory capital requirements and still making a loss, so that’s their reason to do this,” BNP Paribas’ Frieser said. “Had Northern Rock not taken this decision themselves, the (European Commission) could have required a similar decision of them as it still needs to approve the bank’s restructuring plan.”
EUROPEAN PRESSURE
The Commission last year ruled that German bank BayernLB could not pay out any interest on a Tier 1 bond as a condition for its approval of billions of euros in state aid.

Belgium’s KBC <KBC.BR> said earlier this month it was advised not to pay interest on a Tier 1 bond pending regulatory approval of its restructuring plan, as regulators force bondholders to share the pain of bailed-out banks.

Nationalised Irish lender Anglo Irish Bank also said it would not pay interest on its lowest-ranked Tier 1 debt due to a regulatory decision, but subsequently offered to buy back the bonds, albeit at a substantial discount to their nominal value.

“It will be interesting to see what banks with less state ownership, like Royal Bank of Scotland and Lloyds, do, as they might come under pressure from Europe to not pay subordinated debt coupons,” Elisabeth Afseth at Evolution Securities said. “This is not likely to help new Tier 1 issuance.”

Prices for Tier 1 bonds, the riskiest subordinated bank bonds, fell off a cliff this year on fears banks would not pay coupons or repay the bonds. The market has started to recover, but issuance has slumped.

“The market has completely changed over the last couple of years, and few investors who bought this debt in 2006 and 2007 would have expected the coupons to be deferred,” Afseth said.

“Investors from here on in will see the debt as very different from the past.”

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