UK charity bank raises fresh debt after steep paper losses on bonds

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A UK bank serving 14,000 charities has announced £15mn in fresh debt funding from its owner after reporting steep paper losses on the value of its bond holdings.

CAF Bank said on Monday it had struck a deal with the Charities Aid Foundation, the UK’s largest charity by income, to cover the shortfall that the lender would face if it were forced to sell the bonds and crystallise the losses.

As interest rates have risen sharply, the value of bond portfolios has plunged. This hurts lenders that are particularly exposed to bonds and contributed to the collapse in March of Silicon Valley Bank in the US.

Bonds paying a fixed rate of 3 per cent, for example, are worth much less when market interest rates rise above 5 per cent. Banks do not suffer losses as long as they can hold on to the bonds until maturity — however, they are at risk of becoming forced sellers if too many depositors want their own funds back.

CAF Bank, a wholly owned subsidiary of the foundation, reported last week that the value of its bond holdings was £33.4mn lower than their book value as of April 30. The paper losses were equivalent to almost three-quarters of its £45.1mn regulatory capital.

The bank’s policy is to hold its bonds until maturity. It would only be forced to realise the loss if it had to sell the bonds prematurely, which would reduce the bank’s ratio of capital to risk-weighted assets below a 14 per cent regulatory minimum.

The fresh funding, together with the bank’s existing surplus capital of more than £20mn, would cover “the theoretical loss” on the bonds, CAF Bank said on Monday.

It said the extra funding had been agreed between the bank’s board and trustees of the Charities Aid Foundation.

The funding would be structured as subordinated debt with a six-year term but the bank said the amount should be repaid “much sooner” because of its profitability. Documentation “is being finalised with a view to drawdown immediately after completion”, it added.

“The important fact is that these bonds will always be held until they mature, so the bank will get back everything it invested — an approach endorsed by its independent auditors,” said Neil Heslop, chief executive of the Charities Aid Foundation on Monday.

“As an additional reassurance, the Charities Aid Foundation has agreed additional funding that exceeds this theoretical loss when combined with the bank’s already significant surplus regulatory capital,” he added.

The bank, which holds £1.5bn in deposits and is focused on serving small and medium-sized charities, reported pre-tax profits of £10.6mn for the 12 months to April.

The Prudential Regulation Authority, the lead regulator responsible for overseeing the bank’s financial strength, declined to comment.

CAF Bank had said on Friday that it was “entirely comfortable that the theoretical mark-to-market position is a technical issue and not a reflection of the capital strength of the bank”.

But Sir John Vickers, who chaired a commission on the UK banking sector after the 2008 financial crisis, said: “Losses on bonds or fixed-rate mortgages when interest rates go up are not just ‘paper losses’.”

“Even if the assets are held to maturity, the expected cost of funding that position has risen with interest rates — unless it has been hedged or there are sticky depositors insensitive to interest rates,” said Vickers, a former chief economist at the Bank of England.