Bailout checkout

Bad banks give low returns but high rewards

Bailing out UBS and ING looks at first blush to have been a poor use of taxpayers' money. The Swiss and Dutch states made internal rates of return (IRR) from the bailouts of nine per cent and three per cent, respectively, according to Breakingviews' calculations. That's well below what private-sector investors would expect for making investments in struggling financial firms in the depths of a crisis. But the governments' profit also included something more valuable - the prevention of worse economic outcomes.

In 2008, Swiss authorities put 6 billion Swiss francs ($5.3 billion) of capital into UBS via mandatory convertible bonds. Then the Swiss National Bank stumped up a $24-billion loan to help fund a bad bank set up to take UBS' bad assets off its balance sheet.

The convertibles became shares in August 2009 and were sold for a quick 1.2 billion Swiss franc profit. The loan was paid back in regular instalments over five years as the bad bank was unwound, accruing interest of $1.6 billion along the way. Finally, the government received $3.8 billion this month when UBS exercised an option to buy back the remaining assets of the bad bank. Crunch all that and the Swiss state made an IRR of roughly nine per cent.

ING's contemporaneous rescue issue started with a euro 10- billion recapitalisation via hybrid debt. The state then borrowed euro 21.6 billion (from ING itself) to fund a euro 24-billion bad bank.

The bad bank has to date netted the Dutch state euro 800 million of profit, after using the proceeds of asset sales to pay off the loan. The capital injection has also delivered euro 11.3 billion in interest and capital repayments. Throw in other fees and the taxpayer has so far made an estimated 2.6 per cent internal rate of return.

These aren't the sort of numbers that would satisfy a rational investor seeking high risk-adjusted returns in a dangerous situation. But the bailouts averted economic Armageddon. What's more, both rescues were well designed, inflicting bearable pain on the rescued institutions. The deals ended up costing UBS and ING about 4 billion Swiss francs and euro 4 billion, respectively, say people familiar with each transaction. Good value, though, for dodging outright nationalisation.