12.5.3.2 Dilution

Dilution means that the ownership percentage of the current shareholders is reduced as a result of an issue of additional shares to which the current shareholders have not subscribed. Dilution can result in a loss of control by the current shareholders. Dilution is thus a form of burden-sharing by the shareholders of a beneficiary bank.

Dilution can be illustrated by one of the bank State aid cases. For instance, the Restructuring Decision on the Irish bank PTSB indicates that the shareholders of PTSB had been heavily diluted, since the Irish State holds 99,2% of PTSB as a result of the capital injection of EUR 2,3 billion.1

More detailed information can be found in the 2011 Annual Report. In this Annual Report, it is indicated that the issue price was EUR 0,06345 per share; in total, 36.249.014.972 ordinary shares were placed.2 The number of issued shares multiplied by the issue price corresponds to the amount of the capital injection (36.249.014.972*0,06345 = 2,3 billion). Since the issue price (of EUR 0,06345 per share) was higher than the nominal value of each share (EUR 0,031), the capital injection included a share premium of 0,03245 per share. Thus, of the 2,3 billion recapitalisation, EUR 1,123 billion (= 36.249.014.972 * 0,031) was recorded in share capital and EUR 1,131 billion was recorded in share premium after costs (which amounted to EUR 46 million).

Originally, there were 276.782.351 ordinary shares. Following the capital injection, there were 36.525.797.323 ordinary shares, of which the Irish State held 36.249.014.972 ordinary shares. This corresponds to 99,2% of the share capital.3

The Commission noted positively that the chosen purchase price per share resulted in a high level of dilution.4 NB: the level of dilution is related to the height of the issue price. The higher the issue price, the lower the number of shares obtained by the State, and thus the lower the level of dilution.

It has to be pointed out that dilution of shareholders can only occur if the State aid is granted through a recapitalisation in the form of shares. Obviously, if the State aid only consists of a guarantee or an impaired asset measure, then there is obviously no question of dilution. But also if the State aid consists of hybrid securities, then there is no dilution. Issuing hybrid securities does not affect the share capital. Only if common shares are issued, dilution can occur. For instance, in 2009, OVAG benefited from a EUR 1 billion recapitalisation: the Austrian State subscribed to participation certificates (Partizipationsscheine).5 These participation certificates are treated as Tier-1 capital6, but they do not constitute shares. Consequently, the existing shareholders of OVAG were not diluted by the 2009 recapitalisation.7

In some cases, dilution was related to a future capital increase. This can be illustrated by the case of ING. This bank was recapitalised in the form of Core Tier 1 securities. Since these securities were not ordinary shares, the existing shareholders of ING were not diluted by the recapitalisation. However, the restructuring plan contained a capital raising exercise: ING would have to raise EUR 5 billion via a share offering. This capital increase would result in a dilution of the existing shareholders.8

The same reasoning can be found in the decision on the viability plan of SNS REAAL. In 2008, SNS REAAL was recapitalised in the form of Core Tier 1 securities. In September 2009, SNS REAAL raised EUR 135 million in new capital. This capital increase was used to partially repay the State aid. In the 2010 Restructuring Decision on SNS REAAL, the Commission considered that the shareholders were sufficiently diluted by the EUR 135 million capital increase (equivalent to 10% of shares).9

Banca Monte dei Paschi di Siena (“MPS”) was recapitalised in the form of ‘Monti-bonds’ (in the decision referred to as ‘new instruments’). These ‘new instruments’ are hybrid capital instruments. The restructuring plan of MPS included an accelerated repayment schedule with respect to the ‘new instruments’. To that end, MPS intended to increase its capital by at least EUR 2,5 billion.10 This capital increase would significantly dilute the existing shareholders. If the capital increase would not be successful, then the ‘new instruments’ would be converted into normal shares. This conversion would also result in the dilution of existing shareholders.11

The case of the Portuguese bank Banif provides another example of such a conversion mechanism. The recapitalisation of Banif took place in the form of ‘special shares’ (of which some had full voting rights and some only limited voting rights) and CoCo’s. The special shares with limited voting rights and the CoCo’s were subject to a mandatory conversion mechanism.12 If EUR 450 million of private capital would not be raised by 30 June 2013 or if the CoCo’s were not repaid within the stipulated timeframe, all the outstanding CoCo’s would be converted into shares with full voting rights. This would lead to dilution of the existing shareholders.13

Does the level of dilution matter? Before the introduction of the 2013 Banking Communication, the Commission did not set an ex ante threshold for burden- sharing. Nevertheless, in a few cases in the pre-2013 Banking Communication era, the Commission expressed it doubts whether burden-sharing by shareholders was sufficient.

In that regard, the case of HSH Nordbank is a very important case.14 In this case, the Commission considered that there was insufficient dilution by the minority shareholders. There was a recapitalisation of EUR 3 billion.

In 2008, the minority shareholders had a stake of 25,67%. The share capital in 2008 was EUR 881 million. In other words: there stake was (0,2567*881=) EUR 226.152.700. In 2009, their stake of EUR 226.152.700 as compared to the EUR 2460 million share capital was only 9,19% (i.e. 226.152.700 / 2460 million).

It should be recalled that the level of dilution is related to the height of the issue price. The higher the issue price, the lower the number of shares obtained by the State, and thus the lower the level of dilution. For instance, if the issue price would have been EUR 10 (instead of EUR 19), then the share capital would have increased by EUR 3000 million (instead of EUR 1579) and would have been EUR 3881 million (instead of EUR 2460 million). In that case, the shareholdings of the minority shareholders would have been diluted to (226.152.700/3881 million =) 5,83% (instead of 9,19%).

In its Opening Decision on HSH Nordbank, the Commission considered that the issue price was too high and that consequently, the minority shareholders benefited disproportionately by not being completely diluted.17 However, in the final decision, the Commission took into account several additional burden- sharing measures. The EUR 500 million lump sum payment in shares would dilute the stakes held by the minority shareholders.18

Also in the case of Royal Bank of Scotland (RBS), the Commission was of the opinion that there was insufficient dilution, because the issue price of the B shares was above the share price of RBS. Consequently, the B shares had a less dilutive effect than a standard ordinary share issuance or rights issue. This would go against the concept of burden sharing. However, since the B shares included some hybrid-like features, the Commission concluded that these features compensated for the less dilutive effects.19

Of crucial importance is the 2013 Banking Communication which requires full burden-sharing by shareholders: point 41 stipulates that losses are first absorbed by equity. This would point at a dilution level of 100%. However, as is illustrated by the decision on the Cooperative Central Bank (CCB), an almost complete dilution – thus not a complete dilution – can under circumstances also be accepted by the Commission. The State aid to CCB was assessed under the 2013 Banking Communication. Cyprus acquired 99% of the shares and voting rights of the CCB. Its existing shareholders, the CCIs, were almost completely diluted and left with 1%.20 The Commission first considered that the State would normally be entitled to 100% of CCB’s shares. However, the July 2013 strategy – agreed between Cyprus and the programme partners within the Framework of the Economic Adjustment Programme for Cyprus – envisaged that the old owners (i.e. the CCIs) would have a minimum level of participation in order to preserve some of the cooperative characteristics.21 Therefore, the Commission accepted the 1% shareholding of the historical owners.22