After reported steep paper losses on the value of its bonds, a UK bank that serves 14,000 charities announced a fresh £15mn debt funding from its owners.
CAF Bank announced on Monday that it had reached a deal to pay the shortfall if the lender were to be forced to sell bonds and crystallize the losses.
The value of bond portfolios fell sharply as interest rates rose. This is bad for lenders who are heavily exposed to bonds, and it contributed to the failure of Silicon Valley Bank (US) in March.
Bonds that pay a fixed interest rate of 3%, for instance, will be worth less when the market interest rates are above 5%. The banks do not lose money as long as they hold the bonds to maturity. However, they may be forced to sell if they receive too many requests from depositors.
CAF Bank (a subsidiary wholly owned by the foundation) reported last week the value of its bonds was £33.4mn less than the book value on April 30. The paper losses are equivalent to nearly three quarters of the £45.1mn regulatory cap.
Bank policy is to keep bonds until they mature. The bank would only have to realize the loss if they had to sell their bonds prematurely. This would lower the ratio of capital to assets that are risk-weighted below the minimum regulatory requirement of 14 percent.
CAF Bank announced on Monday that the new funding would be combined with the bank’s surplus capital of over £20mn to cover “theoretical losses” on the bonds.
The bank said that the additional funding was agreed by the board of trustees and the Charities Aid Foundation.
The bank stated that the funding should be paid back “much earlier” due to its profitability. The bank said that the documentation was being finalised in order to be able to drawdown funds immediately upon completion.
Neil Heslop is the chief executive officer of the Charities Aid Foundation. He said on Monday that the bank would get all the money it invested if the bonds were held until maturity. This approach was endorsed by the independent auditors.
He added that the Charities Aid Foundation had agreed to additional funding which exceeded this theoretical loss, when combined with the bank’s already significant regulatory surplus capital.
The bank reported a pre-tax profit of PS10.6mn during the year to April. It holds £1.5bn as deposits and is focused on small and medium-sized charitable organizations.
The Prudential Regulation Authority (PRA), the main regulator in charge of overseeing the financial strength of the bank, has declined to comment.
CAF Bank said Friday it is “entirely confident that the theoretical mark to market position is a technology issue and not a reflect of the capital strength” of the bank.
Sir John Vickers said that losses on fixed-rate mortgages or bonds when interest rates rise are not just “paper losses”.
Even if assets are held until maturity, the cost of funding this position has increased with interest rates – unless they have been hedged, or if there are depositors who are insensitive to rates, said Vickers.