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Debt buy-backs under attack

Following the financial markets' comeback, Swedish banks are starting to regain that which was lost in the near-perfect storm that struck following the Lehman Brothers collapse. Swedish banks SEB and Swedbank have both recently announced their respective debt buy-back programmes, aiming to strengthen the banks' important core capital bases (Tier 1 and Tier 2).

SEB's tender included a buy-back of $1.1 billion of subordinated debt, which eventually added to its Tier 1 capital base. The transaction was priced at 75 cents on the dollar, entailing a substantial discount on the bank's own debt. Swedbank, another of the big four Swedish banks, will buy back up to $438 million of its own Tier 2 debt. Nordea, finally, just issued a hybrid bond of $1 billion to strengthen its Tier 1 capital ratio. All these transactions could be interpreted as signs of strength – ambitious buy-back schemes and debt instrument issues are of course only possible if the financial position allows it, one could argue. There have, however, been critical voices raised.

While Swedbank and SEB may likely be facing credit losses in the Baltic area and the Ukraine, some have claimed that the banks are inflating the market with false hope. One reason is, for instance, that SEB posted a net profit of $162 million from its buy-back transaction in its Q2 report, which normally would be considered something positive. But some say the recorded profit is misleading in that it is a result from the debt buy-back, which in turn was possible only because the banks' risk premium had increased. So the market was assigning a discount to the debt, making it cheaper than normal. In doing this, the bank will, in the long run, find it harder to fund itself at the low rates it was able to do before the buy-back.

The final outcome of this exercise may be that the banks' owners lose value as the value of their shares plummets. Others might argue that the banks' efforts to strengthen their capital bases at this point constitute preparations for the stricter capital requirements that are likely to follow from the financial crisis by regulators in the EU. Those banks that have begun such strengthening at this early stage will, then, be several steps ahead of their peers when such requirements are implemented.

Whatever the reason for buying back the debt, and even taking into account the various political difficulties with such transactions, it should be stressed that, as with any debt buy-back, the borrower can de-leverage itself at a substantial discount. The SEB transaction was made at a 25% rebate and some US debt buy-backs during the worst financial distress about a year ago were made at as low rates as 30 cents on the dollar. Any business, whether a bank or non-bank, would want to reduce its debt at those rates.

Adam Söderqvist

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