12.6.3.1 Liability management exercise (LME)

A liability management exercise (LME) means that a bank offers to buy back certain debt instruments, or to convert certain debt instruments into equity.1 The debt instruments are normally bought back at a discount. Hence, a LME serves as burden-sharing by subordinated debt holders. The fact that the beneficiary bank performed a liability management exercise is thus relevant in the context of burden-sharing.

In every LME, three values are of importance: i) the market value of the debt instruments, ii) the nominal value of the debt instruments, and iii) the price at which the debt instruments are bought back. The buyback price will usually be set between the market value and the nominal value. The fact that the buyback price is lower than the nominal value means that there is a discount (or ‘haircut’). This results in a capital gain for the bank. A buyback price which is higher than the market value means that there is a premium on top of the market value; this encourages investors to participate in the LME.2

Regarding terminology, it should be pointed out that the term “LME” is not always used; a LME can go by many names. A LME usually concerns subordinated debt. Consequently, a LME is usually referred to as “subordinated liability exercise (SLE)”. Sometimes, the terms “debt buyback” or “debt repurchase” are used; and in the case of a conversion, the specific terms “Debt for Equity Offer” or “exchange offer” may be used. In this section, the term “LME” will be used.

How is the fact that the bank has conducted a LME taken into account by the Commission? Consider the following recital:

This recital is from the decision on Eurobank.4 The above-cited recital forms part of the assessment on burden-sharing. The assessment seems quite succinct, since the cited recital consists of only three sentences. However, it refers to recitals 122 and 123, which provide a description of the LME’s conducted by Eurobank. These recitals read as follows:

As is indicated by these recitals, Eurobank has conducted several LME’s. Each LME-transaction has its own modalities. Information on these modalities can be found in the above-cited recitals. The first modality is the form in which the LME takes place: the 2012 LME were Tender Offers (i.e. debt buyback), while the 2013 LME was an Exchange Offer (i.e. a conversion). Secondly, the types of securities that are subject to the LME are mentioned. For instance, the LME conducted in 2013 concerned lower tier one and lower tier two securities. More detailed information is not given in the Decision. This information can sometimes be found on the website of the bank.5Thirdly, some information is provided on the price at which the securities are bought back. In the above-cited recitals, it is indicated that the price is based on the market value and that it included a premium (of not more than 10%). Furthermore, the securities are bought back at a discount to the nominal value. This discount (or haircut) creates a capital gain. Fourthly, the acceptance rate is mentioned. Finally, the capital gain resulting from the LME is indicated.

Participation in a LME can be mandatory or voluntary. The LME’s performed by the Irish Banks were voluntary. However, there was a strong incentive for investors to participate. In that regard, it has been remarked that the Credit Institutions (Stabilisation) Act 20106 served as a threat to subordinated debt holders to accept the LME offer.7 This is also visible in the statement of the Minister for Finance of 31 March 2011: “If these LMEs fail to deliver the expected Core Tier 1 capital gains to each of the banks, the Government will take whatever steps are necessary under the Credit Institutions (Stabilisation) Act 2010 or otherwise to ensure that burden sharing is achieved. Any further action, after investors have had an opportunity to take part in these LMEs, will result in severe measures being taken in respect of the subordinated liabilities”.

And even before this statement of the Minister, there was a strong inducement for investors to participate in the LME. This is illustrated by the case of Anglo-Irish Bank.8 Anglo conducted LME’s in August 2009 and December 2010.9 The October 2010 SME took place through an exchange offer: the creditors were invited to exchange their securities into senior notes. The exchange ratio was 0,2. In other words: for each euro note exchanged, they would receive 20 eurocents of the new senior notes. With respect to the LME, the technique of the “exit consent” was used. This means that the LME included a condition: investors participating in the LME had to vote in favour of an extraordinary resolution. This extraordinary resolution gave Anglo the right to redeem the still outstanding securities concerned at a price of 1 eurocent for every thousand euro. This effectively amounted in an expropriation of the investors that did not participate in the LME. Unsurprisingly, the acceptance rate of the LME was high (92%).10 To conclude, although the LME was voluntary, the technique of the exit consent served as an incentive for creditors to participate in the LME.

Does the Commission require a minimum level of burden-sharing? The decisions on the LME’s conducted by the Spanish banks are important in this regard. In the decisions on Banco de Valencia, BFA, Banco CEISS, NCG, Catalunya Banc, Banco Gallego, the Commission noted positively that the commitments regarding burden-sharing of hybrid instruments went beyond the prerequisites of the Restructuring Communication.11 In these decisions, the Commission explained that it would consider a cash buyback of hybrid securities at market price plus a 10%-premium to fulfil the requirements of the Restructuring Communication.12 The LME’s performed by the Spanish banks were structured as follows.13 First, the hybrid and subordinated debt securities14 were bought back at their net present value. This resulted in an immediate capital gain for the bank, since the debt instruments were bought back at a significant discount (‘haircut’) from the nominal value of the instruments. Second, the proceeds of the buyback of the debt instruments would automatically take the form of ordinary shares (or other equity-equivalent instruments) of the bank.15 Consequently, there would be no cash outflow. The conversion into core capital would further reduce the capital needs of the bank.

It should be pointed out that the Commission almost never dismissed a LME as insufficient. Only in the case of Bank of Ireland, the Commission explicitly mentioned that the discount was too low. Bank of Ireland conducted several liability management exercises.16 With respect to most capital instruments, Bank of Ireland complied with the Commission’s policy. However, in one instance, the discount at which a certain capital instrument was bought back by Bank of Ireland was actually too low.17 The Commission concluded that this particular transaction resulted in insufficient burden-sharing – which should be reflected in the depth of restructuring. The Commission added that “in doing so, account should nevertheless be taken of the isolated nature and limited size of the transaction in question as compared to the significantly more numerous times for significantly larger amounts in which Bank of Ireland fully complied with the Commission’s policy”.18 This is the only decision in which the Commission explicitly declared that a LME resulted in insufficient burden-sharing. It illustrates that the Commission does require a minimum discount – and thus a minimum level of burden-sharing.