PIMCO message to clients on Roskilde

By Edward Harrison On Aug 26, 2008

PIMCO, the brainchild of Bill Gross and now owned by the German insurance giant Allianz, is concerned enough about the bankruptcy of Roskilde Bank in Denmark to have sent the following e-mail out to its clients. I have put important parts in red not already highlighted in the text.

Note that the bailout plan involves a collective bailout consortium by 100 other financial institutions, in effect spreading the loss thinly across the entire banking system rather than leaving the Danish taxpayer on the hook for the whole enchilada. In return for their taking on the Roskilde as shareholders,the other institutions will likely get a central bank backstop against some further losses — a moral hazard in my estimation. Moreover, some preferred and other debt from the legacy Roskilde will be subordinated to the equity interests of the consortium and made worthless with limited recovery. Old equity has been wiped out.

Is this a possible solution other markets might try? There seem to be positives and negatives to this solution.

he Danish Central Bank announced yesterday that it will lead a rescue plan to bail out Roskilde Bank (Denmark’s 8^th largest lender). Back in July 2008, the Central Bank had already granted an emergency liquidity guarantee to Roskilde following larger than anticipated losses on the bank’s real estate exposure. This solution was temporary and was contingent on the sale of Roskilde. See our July 11^th note below for more background.

Since the provision of this emergency liquidity line in July, Roskilde has been unable to attract any offer and losses in its real estate portfolio rapidly escalated due to high single name concentrations to property developers. Based on the regulator’s and the auditor’s assessment, the bank has been declared insolvent and given until the end of August to rebuild its capital in line with regulatory requirements. In the absence of any access to new equity from public markets or an outside buyer, Roskilde had no other alternative but to accept the central bank’s bail out.

Under this plan, the Danish Central Bank alongside 100 Danish financial institutions has taken control of Roskilde. The consortium will buy all of Roskilde’s assets and transfer them in a newly created ‘new bank’ and will assume all debts and other liabilities at the exception of hybrid and UT2 debt. After all this, Roskilde will hand in its banking license and will no longer carry on any operations. The consortium will inject DKK4.5bn (€607m) of equity in the ‘new bank’ and assume DKK37.3bn of senior debt. In addition, we understand that the government is likely to pass a new law allowing a DKK12bn risk shield to protect the new bank’s shareholders, and absorb future losses at Roskilde.

Senior creditors have the choice between transferring their debt to the new bank or being redeemed at par immediately. The treatment of bondholders at the UT2 and preferred level will be dramatically different as these securities will remain in the ‘old bank’, which has already reported negative equity of DKK2.5bn and will no longer have assets. The old bank will have no funds to redeem the UT2 and preferred debt issues and coupons will be deferred. Whilst UT2 and pref holders will be entitled to some compensation upon a possible privatization and/or sale of the bank, these securities will effectively rank lower in priority than the equity holders of the new bank, leading to very limited hopes of recovery. This affects €335m of UT2 and pref securities. Needless to say that the old bank’s shareholders have been wiped out.

It is important to stress that, unlike other European and U.S. banks, Danish banks do not issue LT2 (sub debt) instruments, but dated UT2s. The key difference between LT2 and UT2 is that the UT2s can absorb losses and defer coupons. The unusual features of Danish sub debt at least partially explain the harsher regulatory treatment than what has been experienced by holders of Northern Rock and IKB at the sub debt level. If Roskilde had standard LT2 outstanding, our guess is that these securities would probably be transferred in the new bank, and therefore face meaningfully lower losses than the dated UT2s and preferreds.

Moody’s is the only agency rating Roskilde and has affirmed senior at A3 with outlook developing, and logically downgraded its sub and pref ratings to C. Note that there is no notching between UT2 and pref given expectations of a very limited recovery.

Whilst Roskilde is a small and atypical bank and the size of outstanding UT2 and prefs is limited at €335m, the regulatory response and decision to leave UT2 and pref holders take the hit alongside shareholders provides a new and negative precedent for pref and UT2 securities, and another positive precedent for senior bondholders.

Related articles in English
Is Denmark’s Roskilde Bailout a Harbinger of Deals to Come?, Deal Book
Danish Central Bank to Take Control of Roskilde Bank, Bloomberg

Related articles in Danish
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