Thursday, August 20, 2009

European Commission Pressuring Financial Firms to Defer Debt Payments? If so, That is Extremely Irresponsible

I noted in an earlier post today that both Fitch and Moody's downgraded the hybrid securities of ING, and Fitch downgraded Aegon, two firms which received financial assistance from the Dutch government during this latest financial crisis. I currently own AEB, AEH, IND, INZ, ISF and IGK, and took a hit today. Mostly, except for the recent purchase of IGK, I lost some of my gains purchasing these securities during prior meltdowns. All of these securities have cumulative features, and require the payment of interest at the coupon rate in the event of an optional deferral. This is the provision from the IGK prospectus on a voluntary deferral:

"Subject to the payment restrictions described below, we may defer all or part of any accrued interest otherwise due on an interest payment date by giving a notice to the trustee (who shall in turn notify the holders of the Securities) not less than 16 business days prior to the interest payment date on which that accrued interest or part thereof would otherwise have been due and payable. Any interest or part thereof that we have deferred as described above shall bear interest at the rate of 8.50% per annum from and including the interest payment date on which that interest or part thereof would otherwise have been due and payable to but excluding the date on which that interest or part thereof and accrued and unpaid interest thereon have been paid in full, except that interest shall not accrue on any such deferred interest payment or part thereof for any period during which a condition exists that requires us to defer interest as described below."


This is what is meant by a cumulative interest payment. It is a very common type of provision for junior debt securities. Another ING hybrid security will have similar language except the deferral would earn interest at the coupon rate for that security. I believe the 8.5% coupon for IGK is the highest among the publicly U.S. traded ING hybrids. An optional deferral does not save
ING money. Interest is still owed and interest might have to be paid on the deferred balance. Each prospectus needs to be inspected separately on these issues.

In my opinion, the European Commission does interfere with the recovery of these financial institutions by pressuring them to defer paying their bond obligations when the firms are solvent. This would actually do more harm than good. Whenever a financial firm defers payments on its junior bonds, it will be viewed by many as a sign of distress, no matter what anybody says, which is more likely to make matters worse for the firm. Nothing positive of a non-political nature is accomplished by any such action by the European Commission. The interest is still owed as I understand the provisions contained in the prospectuses for the junior bonds which I own. A deferral does have tax implications for a U.S. holder, which is one reason that I placed some of my purchases in a retirement account.

A more detailed explanation of deferral rights and the consequences thereof can be found at pages S 17-18.

Since nothing is gained of a positive nature by pressuring the solvent financial institutions to defer paying their obligations, the only explanation left is that the European Commission is acting primarily- if not
exclusively- out of political considerations. Moody's seem confident that the Commission would pressure ING to defer honoring its debt obligations, even though ING is taking steps to pay the Dutch government back. Fortunately, the U.S. government, under both Republican and Democratic Administrations, has recognized so far the stupidity of what the Europeans are apparently now trying to do, at least according to the rating agencies.

I am going to wait and see what happens. Hopefully, the Commission will reconsider, put politics aside, and act in the best interest of the European financial institutions. Or, while Moody's appears to believe it would be difficult for ING to ignore pressure from the Commission, possibly the Dutch government would stand behind them if ING gives the Commission the finger which is exactly what ING should do. Now, to be candid, I have no idea whether ING even has that option. I just hope that it does.


  1. I agree with your assessment. It is bureaucratic political posturing. Fitch and the other rating agencies are in CYA Mode. The market is in Skittish Mode and has over-reacted, creating a buying opportunity (although hopefully not as spectacular as the one in March, when Fitch issued a previous downgrade).

    I found this provision in the AED prospectus encouraging:

    "[Aegon] will satisfy any Mandatorily Deferred Payments and Optionally Deferred Payments (with any interest accrued on such deferred payment, as applicable) using proceeds raised by the Alternative Interest Satisfaction Mechanism. In addition, we may elect at any time to satisfy any Payment using the Alternative Interest Satisfaction Mechanism. Applying this mechanism means that we will issue Common Shares for cash in an amount as required to provide enough cash for us to make full payments on the Capital Securities in respect of the relevant Payment. We will calculate the number of Common Shares that we must issue to raise the full amount of money due on the Capital Securities on the relevant Payment date. You will always receive Payments made in respect of the Capital Securities in cash."

  2. Cathie: There is no doubt in my mind that Aegon can pay its obligations, at least for now, and both Aegon and ING intended to pay those dividends for the current quarter in September, ex dividend in late August for the ones that I own, before the politicians mucked things up . The firm just raised 1 billion in Euros by selling stock and claimed to have a 3.5 billion surplus. If AEG is going to be strong armed by the European commission to defer paying interest on its junior debt, then I do not seeing it issuing any capital securities to generate funds under this Alternative Interest Satisfaction Mechanism, though I could be wrong about that of course. But, in the last analysis, I do not believe the problem is lack of money to make the payments.

    During the height of the financial crisis each country in the EU fashioned their own bailout package for financial institutions under their respective jurisdictions. The Dutch government and central bank were responsible for Aegon and ING. Apparently the paper pushers at the European Commission did not approve of those aid packages. A statement by Fitch indicates that the firms receiving an aid package actually approved by the Commission are not likely to be subject to the Commission's burden sharing: "Banks that have benefited from broad industry-wide support measures, which themselves have been approved by the Commission, and which have not been
    subject to a name-specific process, are likely to be unaffected by the EC's recent statements."

    There was a similar movement in the U.S. that I discussed in my blog, where liberal Democrats primarily, argued that Paulson should have conditioned receipt of TARP money on a deferral by the bank of cumulative interest payments on their junior debt issues. No sensible person thought that was a good idea then or now. When a large financial institutions ceases making timely payments on its debt, it is sending the wrong signal to the market. Both Aegon and ING were making progress toward recovery and the EU is apparently putting an unnecessary and idiotic obstacle in their path to recovery.