Saturday, August 22, 2009

Priority of ING Hybrids vs. Shares Issued to Dutch Government

ADDED 8/29: A payment was made to the Dutch government in May 2009, and that would be a mandatory payment event, a matter discussed in subsequent posts:

Added 1/4/2010: My discussions from 10/26 on ING's settlement with the EC and my view on how it impacts the hybrid owners: ING to Partly Pay Back Dutch State with Share Issuance
More on ING The last linked post provides more details than the first one. See also: ING Preferred Stocks (Hybrids): Links in one Post ING did complete a successful rights offering and repurchased 1/2 of the Junior Securities issued to the Dutch government and made a payment on those Junior Securities (ING completes rights issue and State repayment - ING), both of those events are Mandatory Payment events.

**********Original Post:

What I am about to discuss is a complicated topic, but nonetheless important for owners of ING's hybrid securities right now. The issue is whether ING would have to cease paying the Dutch government as a prerequisite to deferring interest on its hybrid securities. Even in Europe, the bond prospectuses that I have seen have what is called "stopper" provisions. A junior bond has priority over common stock. Equity preferred stock stands in between common and all bonds. If ING paid a dividend to holders of a security junior to the hybrid securities (list-Hybrid Securities - ING), it is stopped from deferring payment to the junior bond holders. If ING defers all dividends and interest payments on securities of a lower priority than a senior bond, it may then defer payment to the owners of the hybrid securities. All of the holders of securities at the same level of priority have to be treated the same.

This is the stopper provision in IGK:

"Unless we have paid in full the accrued and unpaid interest on the Securities

• in respect of each of the immediately preceding four consecutive Interest Periods, or

• if four Interest Periods have not occurred since the Securities were issued, since the issue date,

we will not recommend to our shareholders, and to the fullest extent permitted by applicable law will otherwise act to prevent, any action that would constitute a Mandatory Payment Event or a Mandatory Partial Payment Event.

If a Mandatory Payment Event occurs then, except as described in the next paragraph, the accrued and unpaid

interest payable on the Securities on each of the immediately succeeding four consecutive interest payment dates will be mandatorily due and payable in full on those interest payment dates, notwithstanding that any Deferral Notice has been given by us in relation to such accrued and unpaid interest or the occurrence or continuance of any Required Deferral Condition (other than a Required Deferral Condition that occurs after the occurrence of the relevant Mandatory Payment Event, in which case such accrued and unpaid interest shall not be due and payable). We are not required to pay any deferred interest upon a Mandatory Payment Event."

( See page S-18 424B5)

This is not the best stopper provision that I have seen, since it allows for a cure going back only for 4 quarterly payments.

The same question came up in relation to the preferred stock issued by U.S. banks to our government for the TARP funds. I never tried to resolve the issue based on 100% certainty, but I believe that the government bought equity preferred. This meant that the bank would have to stiff the U.S. government before it could defer payments to their junior bond holder. One U.S. bank, which has not yet been seized, has just done that. But I thought that such action would be a momentous and gutsy step for a U.S. bank to take. Interesting Question: Priority of Government Bank Preferred Stock or Equal Ranking with Existing Preferred Previously Sold to Investors?

During the height of the financial crisis, as previously discussed, ING received a bailout from the Dutch government. These transactions are described at ING's web site: Transactions with Dutch State - ING

As I read the term sheet, the shares issued to the Dutch Government appear to be equity, not debt, and it is clearly stated that the shares rank "pari passu with ordinary shares". While there is always doubt when an American tries to figure out what foreigners mean, this appears to be a security junior to the ING hybrids. Interest is payable annually at the the higher of Euro .85 or some percentage above a common dividend. Since there is no common dividend now, the Dutch government is no doubt expecting to be paid. The dividend is non-cumulative. The shares were purchased for 10 billion Euros. So that is a lot of dividends coming to the Dutch government for its shares.

I have no idea what discussions are taking place in Europe now. But, I am having difficult seeing why the Dutch government and central bank would permit the elimination of their dividend payment to satisfy a policy of the EC unless they had no choice. Again, I am not stating an opinion so much as expressing a reservation on why Moody's and Fitch view it as almost a done deal that a deferral is going to take place. It would seem to me, being just an individual from America's heartland, that ING would be sued if it tried to pay its government while deferring interest on its junior debt.

While I do not what is happening behind closed doors, I do have an opinion that the EC has permanently hurt its financial institutions with its "burden sharing" concept as applied to debt, as opposed to just equity. You would expect under these circumstances for the firms to eliminate their common dividends, and equity preferred non-cumulative dividends in some cases. Bonds would be off limits unless you want to cause more harm, particularly over the long term.

If anyone else has any thoughts on this subject, please leave a comment. You have to have a google account to leave a comment.


  1. I don't think Moody's and Fitch view it as "almost a done deal." I think they are just being ultra-conservative, perhaps to make up for their devil-may-care attitudes during the halcyon pre-meltdown days, when AAA credit ratings were being handed out like beads at Mardi Gras.

  2. Cathie: Sure, the ratings agencies are probably in a cover their ass mode, since this issue impacts investors around the world and involves a great deal of money.

    I would emphasize "almost" a done deal from the official actions taken by the rating agencies. Though, I understand what you are saying. There is already some stink involved in what has happened in Europe.

    Fitch talked about the ability of the firms to resist the "influence" of the EC and Moody's said it was highly probable that the EC would advise ING to defer. And Fitch cut the ratings, taking AEG all the way to BB from investment grade (with a negative watch) without a deferral being announced. So, while I see no reason to characterize it as an "almost done deal" myself, those 2 rating agencies are acting now as if it was "almost" a done deal. The issue that I raised in my two posts tonight dealing with priority is one of the reasons why I do not regard it as almost done. Possibly, Fitch and Moody's honestly believe it is warranted, or possibly they are acting out of less noble motives. But I do believe that their official statements and actions are consistent only with an "almost done deal"

    I have not seen anything yet from S & P which is interesting.

    I have several posts discussing Moody's in particular. I am not a fan. I view the agencies as enablers of the improvident and reckless expansion of credit in the U.S. mortgage market prior to 2008. (item # 8: and

    I have their activities listed as #3 in importance of the causes for the world's near Depression:

  3. This is an interesting subject and I also invest in hybrids. The rating agency argument appears to be that no further government help would be provided without ceasing payment on preferred shares. Thus, I think you are right about the existing ING government support. The problem is whether ING will need more government capital in the future due to deterioriating conditions, and in this case there is a risk that a requirement would be to cease preferred payments. You might also want to contact the IR department of ING to ask them to clarify the capital structure priority. IR departments should answer these kind of questions.

    However, I also agree with the comments that these downgrades were done on multiple companies based on a broad theory about EC policy, which to me doesn't reflect much about the health or policy situation of individual issuers.

  4. Brett: While the EC burden sharing policy applies without question to any future aid, I read it to also apply retroactively to aid already given. Both the Fitch and Moody's press releases indicate to me that they also believe the EC policy is retroactive, and would apply even if no further aid was received by the financial institution. ING and Aegon are unlikely to need any further aid, unless the the world or the U.S. enters into a double dip recession. The last statement from the Dutch Central banks, as I recall, was that both firms were adequately capitalized and in no need of further assistance.

    The applicable part of the EC burden sharing policy, as it applies to subordinated junior debt which may be deferred is as follows:
    "The banks should be able to remunerate capital, also in the form of dividends and coupons on outstanding subordinated debt, out of profits generated by their activities. However, banks should not use State aid to remunerate own funds
    (equity and subordinated debt) when those activities do not generate sufficient profits. Therefore, in a restructuring context, the discretionary offset of losses (for example by releasing reserves or reducing equity) by beneficiary banks in order to guarantee the payment of dividends and coupons on outstanding subordinated debt, is in principle not compatible with the objective of burden sharing33. This may need to be balanced with ensuring the refinancing capability of the bank and the exit incentives34. In the interests of promoting refinancing by the beneficiary bank, the Commission may favourably regard the payment of coupons on newly issued hybrid capital instruments with greater seniority over existing subordinated debt. In any case, banks' should not normally be allowed to purchase their own shares during the restructuring phase"

    While it is difficult for an individual investor to figure out what is happening in the U.S., let alone in Europe, it looks to me like this EC policy is tied to an approval process for the current restructuring plans.

    My involvement in the European hybrids is not material to me. I am receiving a great deal of interest, however, in my posts from around the world, which is primarily why I continue to write about it. The other reason is that it will impact my decisions in the future to buy European debt. I will now be far more reluctant to buy European debt based on what I am seeing now.

    Citigroup is a much bigger basket case, and received a great deal more aid. And it is still paying interest on its junior debt. That is an important point to make about the future, in the way the U.S. and the EC deal with these matters. It was never the U.S. policy to require owners of debt to burden share as a condition to receiving state aid. And, it does not make much sense since the interest is still owed and interest may be accumulating on the deferred payments.

    If the Dutch government is willing to forego payment, and "burden share", then I would not need to hazard a guess as to what happens next.

    As least for now, the EC policy looks like it might expire on 12/31/2010:"This Communication is justified by the current exceptional financial sector crisis and will be applied until 31 December 2010." at p. 13

    I am sufficiently confident in my opinion about the priority situation that I would not bother contacting the PR department at ING. If anyone else wants to do it, please leave a comment.

    One way to avoid the priority problem for the Dutch government would be to exchange their dividend paying common shares for regular common shares which do not currently pay a dividend. This would remove the Stopper issue. I do not see why the Dutch would want to do that.

    ING and Aegon do not appear to this Tennessean to be European equivalents of Citigroup, where the government just converted its preference shares into common.

  5. Thanks for all of the great blogging on this subject! I am very surprised that the risk of deferment on the ING subordinated debt has not had any negative impact on the common stock (ING). Any thoughts as to why this is so? One would think that a deferral of dividend payments on the subordinated debt would have a MAJOR impact on ING common stock. Am I missing something here?

  6. redwing: Andy Hall's first solo album was called Redwing (song #4)

    Most likely, I would expect the common to rise since the company has relieved itself of the burden, at least temporarily, of paying interest on its junior debt. This would give ING more leeway to recover from its improvident investment decisions. The common shareholders would want the junior debt holders to share their pain.

    I believe the EC policy will adversely impact all of the financial institutions long term in my opinion by raising the cost of financing. The EC has already done this as the rating agencies have slashed ratings based on the possibility of deferral and the enunciation of the policy as applied to debt now.

    I mentioned in my last post that I would downgrade all European junior debt by one notch just based on the enunciation of the EC "burden sharing" policy. While this is a permanent downgrade for me, others may disagree, forgive or forget. I have a long memory.

  7. bottomline, I would say that the preferred shares of Aegon are a better investment than ING. It looks to me that Aegon is in the process of fulfilling its obligations to the dutch state. In this context, stopping payments on some $6Billion dollars of perpetuals would have highly negative market reprecussions. Perpetuals are a key part of funding strategies for life insurance firms with long-term liabilities. It makes no sense to introduce this market uncertainty just as the firms are beginning to recover confidence and also raising common stock.

    AEGON's financials are recovering. It is not a disaster case and should stand out from many of its peers. The amount of government aid was limited and management wants to reduce this ASAP.

    The preferred should trade about 200 basis points above senior debt, so whenever fitch downgrades due to there so-called theories on EC actions, it's a buy opportunity because large institutions usually are forced sellers based on rating rules. This is a case when individual investors can benefit from the constraints placed on larger investors. Buy AEGON preferred. I have $10mm in this and I've just reviewed the issue with my analysts...I'm pretty impressed that you guys picked up on the key legal issues. Good job!

  8. Brett: I am just an individual investor trying my best, I would agree that Aegon is not in as deep as ING to the Dutch government, and AEG is further along in paying the money back. This would make Aegon a worse case for the EC's "burden sharing" than ING.

    I did have to amend my comments about the priority issue involving ING.
    For some reason, it did not connect earlier that the Dutch government is not entitled to a dividend from ING in a year where no common dividend is paid to the ordinary common shareholders. This is the case for 2009. So the Stopper provision, as far as ING is concerned, will only come into play now if and when ING reinstates the common dividend.

    You may want to check again with your advisors about AEG. In the summary of the agreement that I found in the annual report, I did not see a suggestion that payment was contingent on a common dividend being paid during the prior fiscal year. This is a fairly important point, and I do not have the answer. I am just raising the issue.

    My involvement is someone less than yours with 350 AEB bought in increments at between 4 and 8. And AEH is smaller than that but bought all at once at less than $5. So I am in a wait and see mode with no interest now in buying in European hybrid issues:

    I do recall reading that Aegon was talking about making a payment to the Dutch government which is why they raised that 1 billion euros selling stock, to save them some money: So Aegon may have a different agreement as it relates to when money has to be paid to the government. Sorry I can not be of more assistance in resolving that issue. If you find out something about Aegon please leave a comment for others to read. I am just sitting tight.

  9. Brett: I added a Post on another part of the Stopper provision in Aegon's prospectuses that may come into play if and when Aegon buys back a junior security: It did say it wanted to buy back some of those securities issued in connection with its bailout last year.