Going Dutch – SNS nationalisation

We have been talking about the emergence of, and the effects of, the financial crisis in our blogs for a number of years now. However, more than 5 years into the crisis even we can be surprised. On Friday the Dutch government nationalised SNS, as capital injections from the private sector failed to appear. This action was undertaken to maintain the stability of the Dutch financial system.

This legal manoeuvre involved a confiscation of all SNS equity and group and bank level subordinated debt by the authorities, and an injection of cash into the bank. The holders of the aforementioned equities and bonds quite simply no longer have these securities. To paraphrase Monty Python, they are ex securities. Investors have lost all legal rights. Instead, they have been offered potential compensation based on the value that the Dutch government ascribes to the securities. However, their judgement of what that amount may be is highly likely to be zero.

We have examined many times the potential weakness embedded currently in financial issuers and how the tiering of debt is becoming more significant for investors. Before the financial crisis, senior and subordinated debt from the same bank were seen as equal under all circumstances except an event of default, in which case the senior bonds would see better recovery values. The fact that for systemic reasons the authorities wouldn’t want the bank to stop operating meant that subordinated debt benefitted from the halo effect of the perceived need to sustain the bank for the benefit of the financial system. However, since 2008, countries all over Europe have been putting in place legislation, in the form of so called “resolution regimes”, to allow them to deal with failing banks, without necessarily having to keep the whole bank going. This use of these recently introduced new laws in the Netherlands allowed the authorities to separate the claims of subordinated bond holders from those of other, more senior, bond holders. This is something we have not encountered before in this form (for example, while the UK government did nationalise the preference shares as well as the equity of Northern Rock, it didn’t actually nationalise the subordinated debt, whereas in Denmark a different approach was followed, leaving bondholders on the wrong side of a good bank/bad bank split). This Dutch approach allows for the quick and efficient bailing in (writing off) of subordinated debt and allows the bank to continue operating, thereby protecting the financial system.

‘Going Dutch’ is an expression used when you agree to share a restaurant bill. However, going Dutch SNS style means subordinated bond holders pick up the tab, as they have been eliminated, losing all the capital value of their investment. They have explicitly provided 1 billion euros of capital to help the ongoing health of the Dutch financial system.

Early intervention of this sort to protect the financial system is obviously bad news for subordinated bond holders, with their status becoming more equity and less bond like. It will be interesting to see what the market and the rating agencies think of this new approach in the ongoing battle to support the financial system. Is it a one off, or something we are going to come to see as common practice?

2 thoughts on “Going Dutch – SNS nationalisation

  1. Surely this is the price of failure: equity holders through to bond holders take a hair cut or even get wiped out – it’s morally correct. It’s what Baghot would have advocated. Yes, it’s painful, but it’s one way of using market forces to impose discipline on financial institutions along with supervision by regulators.

    Once investors, especially senior bond holders, know this can happen to them they’ll be more cautious about lending to these institutions and demand higher interest rates. To counter that rise in the cost of capital, management must therefore earn investors trust by demonstrating prudence, improve transparency and maintain a well run loan book. Eventually investors will reward good management.

    The ring fencing of the utility parts of banks from the more racy bits such as investment banking, as proposed in the UK, makes sense. It makes them simpler to evaluate and control, potentially less risky and already Fitch said this morning it could have a positive impact on their credit ratings.

    The government then either rehabilitates these failed banks back to properly functioning entities with new management or sells off the assets and they cease to exist. What ever is left should then be redistributed according to creditors’ seniority. That’s how a healthy capitalist system works. Failure is permitted rather than subsidised and I think the Dutch are on the right track.

  2. Has any work been done to see how widespread the potential is for this to be replicated elsewhere in the banking sector?

    This would seem to be a disasterous consequence for bond holders as well as equity holders but apart from a relatively short lived correction yesterday, the investment markets appear to have shrugged this off.

    Any ideas who may be next or on what scale?

    many thanks

    Martin Bonynge
    Director

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