By Gregory Turnbull-Schwartz
The Co-operative Group will ask people to whom it owes money to accept a minority ownership right in its troubled banking business, in lieu of repayment. Two aspects of the Co-op announcement are troubling. First is the failure to adhere to fundamental concepts like contract, obligation and debt, which are important to our economic framework. Second is the apparent willingness to treat debt holders (lenders) differently depending on whether they have loaned the Co-op money via a mutual fund, or whether they loaned the money by purchasing individual bonds.
As to the first part, when I heard the Co-op Group chief executive speaking about offering bondholders an opportunity to “share in the upside of the transformation of the bank,” I thought I should check the definition of ‘bond’. Being at work and not having a vast library of hardcopy reference books lying around, I consulted Webster’s New World College Dictionary and sure enough I found: “Bond – anything that binds, fastens or restrains.” That seems pretty clear. No ‘maybe’ or ‘potential’ about it – a bond binds and restrains.
Default by another name
In days gone by, the type of action being considered by the Co-op was considered to be a default. Bondholders: here are the keys to the door, have your equity upside and good luck. Why is it now acceptable that bondholders should take a minority stake in an asset where the owner remains in the driver’s seat? The owner has blundered, failed to invest wisely, and the owner should either give up the business to the debt holders (those to whom money is owed) or should continue to pay its obligations, including debt.
The second part of the announcement, regarding different types of investors in the same bonds, is interesting. To clarify, if I have a lot of money and invest in individual bonds, I will be treated more favourably than if I invest via some pooled vehicle like a pension fund. What part of law, precedent, investment theory or simple sense of fairness informed that decision? The end beneficiary of the bond’s cash flow (interest receipts as well as eventual return of principal) may well be the same. For many people, there is a question of whether the Co-op bank (or banks in general) ought to be bailed-out by taxpayers or by investors. But ‘investors’ is a broad term. Some investors lend money to banks, and there is a contractual obligation for the bank to repay it – these are bond investors.
Other investors buy equity or shares in a bank, or an entire bank as in the case of Co-op, without any contract. They are allowed to vote for a management team, or appoint one. They can influence strategy and share in the upside if there should be any. These equity investors, who have no contract, get a higher potential return for their investment. Bond investors only ask to be repaid the money they loaned, with interest. If a business goes into bankruptcy, equity investors, who had influence over management and corporate direction and the risks being taken, should be wiped out. Bondholders should then take over the asset, from which they should try to recoup their money. Should bondholders take the pain before taxpayers? Yes. Should bondholders be asked to bail-out the owners of the asset, allowing those owners to remain in control and steer the future direction of the bailed-out business? Absolutely not.
Gregory Turnbull-Schwartz is a fixed income investment manager at Kames Capital
Comments