RBS: Royal Bank of Scotland has finally unveiled plans to buy back some of its hybrid debt. Repurchasing or swapping 6.2 billion pounds of its pile of debt-like equity kills three birds with one stone. But taking its time may have been costly.
A debt swap should still help investors. The European Commission decreed last November that, starting in April, RBS would not be allowed to pay coupons on its hybrid debt for two years. Allowing investors to swap this paper for lower-yielding senior debt, or just receiving cash at knock-down prices, should be popular.
It also tidies up RBS's balance sheet. An after-tax gain of 1.25 billion pounds will not only increase the bank's core Tier 1 ratio by 0.35 per cent, but reduce the proportion of the capital structure made up of hybrids, which financial regulators want to phase out. Moreover, the exercise helps cancel out the dilutive effect of issuing more equity. RBS has also announced plans to convert preference shares into ordinary shares. This, combined with the effect of paying deferred 2009 bonuses in stock, will mean issuing shares worth another 1.5 billion pounds. But because RBS is simultaneously reducing its long-term cost of debt, the overall impact is to increase earnings per share by 1.2 per cent in 2013.
However, RBS's capital gain could have been bigger if it had acted sooner. The idea of a swap was first mooted in January but the price of some of the bank's hybrids has rallied by over 10 percentage points in the last month, according to Evolution Securities. RBS is offering an average premium of just 170 basis points to where the hybrids are currently trading. This reduces the incentive for investors to participate in the swap.
There are two reasons why RBS delayed. Having entered the UK asset insurance scheme, its capital needs were less pressing than those of Lloyds Banking Group . It was also in a closed period before annual results. Investors who bought the hybrids in anticipation of an exchange are likely to take up RBS's offer. But others may decide the cost of two fallow years is better than selling out. If RBS does not get a decent response, it may wish it had moved sooner.
