Sometimes Companies Buy Low And Sell High

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I liked that the two top articles in Money & Investing in the Journal today were (1) that European banks are buying bonds, and that's bad, and (2) that American corporates are selling bonds, and that's bad. And: probably!

The European banks are behaving sensibly:

With the European crisis knocking down the value of banks' longer-term debt, some are taking advantage by buying back their debt from investors at a discount from the original value. Banks can book the difference in price as an accounting gain, adding to their bottom line — and their ability to withstand losses.

There's enough opacity in European banking that you could be forgiven for assuming that "accounting gain" means "fake gain." And indeed one can have an accounting gain merely by having the price of one's debt drop, and that looks fake-ish. That's not what's happening here though: these banks are taking the critical extra step of actually saving money by taking advantage of that price drop. If I sell you a bond for €100 and then buy it back for €90, I have no debt and €10 more than I used to have, so that looks like gain, and also is gain.

Does it look like capital, or as the Journal puts it "ability to withstand losses"? Sure, I mean, money's money and more of it is better than less. But the Journal and friends are probably not totally wrong to worry. My perhaps idiosyncratic view of bank capital is: you should want your banks to have a relatively long average duration of funding, and be sad if they're almost exclusively funded via skittish overnight markets, and so (perpetual, fully loss-absorbing) common equity capital is a super way to bring up the average duration but you shouldn't sneeze at 30-year bonds either, because when the world gets all Bear Stearns on you you don't have to pay back the thirty-year bonds either.*

If you think that way you might worry that the regulatory desire to maximize narrowly-defined "good" capital sometimes conflicts with the also laudable desire to maximize funding duration and minimize the risk of quick implosion. Maybe U.S. banks' trust preferreds aren't quite as good at being "capital" as common stock is, because one day they have to be repaid, but that doesn't mean that we should be entirely happy when a big bank gets rid of billions of dollars of subordinated thirty-year liabilities using basically short-term funding. Similarly, when SocGen boosts capital by six basis points by buying in €1.7 billion in long-term debt using, basically, short-term ECB funding, one might worry that adding six basis points of perpetual funding does not make up for an overall shifting of SocGen's profile from capital-and-long-bonds-and-deposits-and-ECB to just-common-capital-and-a-pile-of-overnight-funding. Because that capital is only as good as SocGen's ability not to lose money, and that overnight funding is only as good as SocGen's ability to maintain market confidence (or the ECB spigot), and the fact that it can buy those bonds cheap is not a great sign for either.**

Anyway! The American corporates are happier news because their borrow-money-and-then-pay-back-less-money plan is baked directly into the terms of the bonds:

With some new corporate bonds, investors are setting themselves up for inflation-adjusted losses even if interest rates don't rise. Highly rated Texas Instruments sold three-year bonds in July at a yield of 0.60%, while three-year bonds from Anheuser-Busch InBev sold with a yield of 0.80%. Those returns will be wiped out by inflation, which stood at an annual rate of 1.7% in June.

That's ... honestly, that's kind of amazing to me, and I will not pretend to understand it. More buyers than sellers! TI, who has no regulator to be concerned with its leverage ratios and capital adequacy, has a sensible plan for the unnecessary money that it raised: it's going to buy back stock.***

New Tactics Boost Bank Profits [WSJ]
As Corporate-Bond Yields Sink, Risks for Investors Rise [WSJ]

* Unless you're bankrupt. Or it's 30 years from now.

** That said:

In some of the more-complicated transactions, banks have been able to book multiple gains. In March, Commerzbank bought back €965 million of debt securities and other capital instruments at a discount for new Commerzbank shares. The bank booked gains from the discounted price of the debt, the elimination of interest payments and the new equity issued to the buyers. Altogether, the move will provide the bank an extra €1.2 billion by 2017, said a spokesman.

I'm cool with that, no? You take out debt and hybrids at a discount for common stock, you are unambiguously improving capital in every useful sense of the word.

*** Whatever, "We intend to use these funds for general corporate purposes, which, among other things, could include stock repurchases."

Also: as a general rule companies buy high and sell low on the share repurchase side so there's a decent chance TI will squander its inflationary profits from this bond.

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