8.6.3 Pricing of recapitalisations

The Recapitalisation Communication stresses that closeness of pricing to market prices is the best guarantee to limit competition distortions.1 Nevertheless, the Commission recognises that the remuneration for recapitalisations cannot be as high as the then-current market levels.2 At the same time, the Commission stresses that the total expected return on recapitalisation to the State should not be too distant from current market prices.3

With respect to the issue of remuneration, the Recapitalisation Communication refers to the ECB recommendations: on 20 November 2008, the Governing Council of the European Central Bank provided recommendations on the pricing of recapitalisations. Pursuant to the ECB recommendations, the required rate of return for fundamentally sound banks4 could be based on a “price corridor”. The price corridor consists of a lower bound and an upper bound. The lower bound is the required rate of return on subordinated debt.5 The upper bound is the required rate of return on ordinary shares.6 Pursuant to this methodology, the minimum remuneration will amount to between 7,0% and 9,3% on average7 for fundamentally sound banks, according to the bank’s risk profile and the structure of the capital instrument. As such, the average price corridor represents an indicative range.8

Pursuant to point 28 of the Recapitalisation Communication, the Commission accepts a minimum remuneration based on this methodology. This remuneration is differentiated at the level of an individual bank on the basis of i) the type of capital chosen, ii) appropriate benchmark risk-free interest rate, iii) the individual risk profile. On top of this entry level of remuneration, Member States may include a step-up clause. This follows from point 29 of the Recapitalisation Communication; and will be discussed in section 8.7.

Many recapitalisation schemes included a remuneration methodology in line with the Recapitalisation Communication and the ECB recommendations. There were some exceptions. For instance, the Lithuanian recapitalisation scheme contained a remuneration formula that differed from the ECB formula.9 Instead of using the bank’s CDS spread, the sovereign CDS was used.10 The Commission accepted this, because the remuneration exceeded the remuneration calculated on the basis of the ECB formula.11 In footnote 6, it was remarked that some Lithuanian banks had a higher credit rating than the Lithuanian State.

Another interesting case is the case of the Finnish recapitalisation scheme. Under this scheme, the Finnish State subscribed to subordinated debt issued by the beneficiary banks. The interest that those banks had to pay was based on the Finnish government 5-year bond yield with an add-on of 600 basis points.12 Two things are of importance here. Firstly, this remuneration level significantly exceeded the remuneration level set by the ECB recommendations of 2008. Secondly, the remuneration under the Finnish scheme is not based on the risk profile of the individual banks. The Commission observed that this “one size fits all” solution might – in theory – create a biased outcome in favour of the banks with a high risk profile. However, with reference to the “particular situation of Finland” the Commission found this “one size fits all” solution to be justified. The Finnish banking sector is characterised by a relative homogeneity of the prudential situation of the banks. There is no bank with a regulatory capital ratio below 8,5%, so the overall level of capitalisation of the Finnish banks is relatively high.

The cases of the Lithuanian recapitalisation scheme and Finnish recapitalisation scheme illustrate that the Commission accepts alternative pricing methodologies, provided that they lead to a higher remuneration than the methodology based on the ECB recommendations.13

In the Second Prolongation Communication, the Commission gave some further guidance, in particular with respect to capital instruments bearing a variable remuneration. Thus far, the Commission guidance mainly applied to capital instruments bearing a fixed remuneration.14 Point 8 of the Prolongation Communication requires that the new shares should be subscribed at a discount to the market price.15 With respect to hybrid instruments, the Second Prolongation Communication introduced an “alternative coupon satisfaction mechanism”.16 This mechanism requires that coupons which cannot be paid out in cash would be paid to the State in the form of newly issued shares.17

Pursuant to the guidance provided in the Second Prolongation Communication, the new Spanish recapitalisation scheme provided that the entry price for the recapitalisation via ordinary shares would be based upon a discount, of at least 25%, on the market or economic value of the beneficiary bank. The dilution effects, due to the recapitalisation of the FROB, would be taken into consideration before that discount is computed.18 As the Commission noted in its decision on NordLB, “an acceptable discount in its recent decisional practice has been identified to be 25%”.19 A sufficient discount is a form of an ex-ante remuneration of the capital injection.20

The Recapitalisation Communication stresses that closeness of pricing tomarket prices is the best guarantee to limit competition distortions.21 This general principle is translated into the following criterion: if there is a significant participation of private investors (30% or more) on equal terms as the State, then the Commission considers the remuneration to be appropriate.22 This criterion– which is laid down in point 21 of the Recapitalisation Communication – is applied in the cases of the Swedish recapitalisation scheme, the Portuguese recapitalisation scheme, the German scheme and the new Spanish recapitalisation scheme.23

To take the Swedish scheme as an example: under this scheme, the Swedish State would only take part in recapitalisations if there was a participation of at least 30% of private investors. Another condition was that the State and the private investors would participate on equal terms.24 Point 21 of the Recapitalisation Communication further stresses that in case of a significant participation of private investors, there does not appear to be any need for ex ante competition safeguards or exit incentives. There is however one precondition: the terms of the deal are not such as to significantly alter the incentives of private investors. The decision on the Swedish recapitalisation scheme provides some further clarification about this precondition.25 Firstly, the private contribution should not stem mainly from the current shareholders or other investors with a vested interest in the bank. Secondly, the remuneration should not be below the remuneration indicated as appropriate in point 26 to 30 of the Recapitalisation Communication.

The recapitalisation of Nova Ljubljanska banka (NLB) took place through a public offering of the shares. First, the existing shareholders were given the opportunity to take up the new shares (pro-rata to their shareholdings). Second, shares not taken up by the existing shareholders were offered to the open market. The Slovenian State was one of the existing shareholders (49%) and subsequently acquired 49% of the newly issued shares. In addition, the Slovenian State had committed to purchase any shares not taken up by the general public.26 This commitment amounted to an underwriting of the capital increase of NLB. Because of the (implicit) underwriting by the Slovenian State, the Commission considered that the NLB-case was not comparable to the situation contemplated in point 21 of the Recapitalisation Communication. The Commission concluded that regardless of the outcome of the IPO, the Slovenian State cannot be said to have acted on equal terms with private investors.27

An important (pricing) principle can be found in points 15 and 44 of the Recapitalisation Communication. Pursuant to these points, a low remuneration can be accepted on the condition that the lower remuneration will be reflected in the restructuring plan. This principle has been applied in several bank State aid cases. For instance, in the Rescue Decision on Catalunya Banc, the Commission considered that it was justified that no remuneration was paid for the recapitalisation measure provided that the absence of remuneration would be compensated by in-depth restructuring in the restructuring plan.28

A low remuneration thus has to be compensated for by far-reaching restructuring. This principle can be linked to a greater concept: the need for far- reaching restructuring. As will be discussed in-depth in chapter 10, the “need for far-reaching restructuring” is a central concept in the Commission’s State aid control policy. While there are also other factors that trigger the need for far-reaching restructuring, section 10.4 will focus specifically on the principle that a low remuneration has to be compensated for by far-reaching restructuring.29 In the context of the current chapter, it can be concluded that the Commission has shown some flexibility by accepting a lower remuneration in several bank State aid cases.