The EU and AIB’s Government Preference Shares

I have been sceptical all along about the government’s decision to use €7 billion of public money to purchase preference shares in AIB and BOI earlier this year at a time when the combined market value of these banks had reached a low point of about €1 billion.

When I appeared before the Oireachtas Committee on Finance and the Public Sector in May, I argued that the Irish banks would not have the resources to pay back these preference shares and that they would end up being converted into ordinary shares.

My recent presentation to the Labour Party also argued that the government’s preference shares were most likely going to be converted to ordinary shares, thus foregoing the automatic eight percent annual divided associated with these preference shares.

AIB’s statement in relation to its negotiations with the EU Commission brings us close to this event.

Some highlights from the AIB statement:

The EC has indicated that, in line with its policy and pending its assessment of the AIB restructuring plan, AIB should not make coupon payments on its Tier 1 and Tier 2 capital instruments unless under a binding legal obligation to do so.

AIB has agreed to this request by the EC and announces that under the terms of the Stg £350,000,000 Fixed Rate/Floating Rate Guaranteed Non-voting Non-cumulative Perpetual Preferred Securities of AIB UK 3 LP which has the benefit of a subordinated guarantee of AIB (“the LP3 Preferred Securities”) that the non-cumulative distribution on these securities, which would otherwise have been payable on 14 December 2009 will not now be paid.

The effect of this decision by AIB will be to trigger the “Dividend Stopper” provisions of the LP 3 Preferred Securities, so that AIB will be precluded, for a period of one calendar year from and including 14 December 2009, from declaring and paying any distribution or dividend on its “Junior Share Capital”, an expression which, at the moment, comprises AIB’s ordinary shares (“the Ordinary Shares”) and the Irish Government €3.5bn preference shares (“the Preference Shares”) issued on 13th May 2009 to the National Pensions Reserve Fund Commission of Ireland (“NPRFC”).

Were the Dividend Stopper to remain in force, AIB would be precluded from paying the dividend due on the Preference Shares on 13 May 2010. Under these circumstances, in accordance with the terms of the Preference Shares, the NPRFC would become entitled to be issued, at a date in the future, a number of Ordinary Shares related to the cash amount of the dividend that would otherwise have been payable.

However, consistent with the stated objective of the Minister for Finance of not taking majority stakes in the banks (including in AIB) the preference of each of the Minister for Finance, and AIB is for AIB to pay the dividends normally on the Preference Shares. In furtherance of this objective, the Department of Finance and AIB are in continuing discussions with the EC in respect of AIB’s restructuring plan (which is required in compliance with state aid rules), one element of which would allow AIB to resume declaration and payment of dividends and distributions as normal.

Reuters reports a European Commission spokesmen as responding to this statement as follows:

“In the Commission’s approach to restructuring aid for banks, it is possible for the period of coupon restrictions to be adjusted if this would favour private capital raising that would in turn reduce the amount of state aid,” it said.

“The Commission will support efforts of AIB to raise private capital, including measures aimed at providing adequate remuneration to the government’s preference shares without necessarily diluting existing shareholders,” it added.

Some questions about this:

1. What is “adequate” remuneration of the government’s preference shares?

2. Will any private investor want to inject equity into AIB with anything approximating the current €3.5 billion/8 percent divided preference share deal remaining in place?

3. What chances are there that private equity will become involved to an extent that the EU Commission will allow the government to receive dividends on its preference shares?

4. The EU Commission’s policy of not wanting taxpayer funds to get shovelled in one end of banks only to get shovelled out the other end to pay bondholders is clearly aimed to protect European taxpayers. How does the less well articulated policy expressed in the Reuters article protect Irish taxpayers?

And a final observation. Remember that many people in government assured us that the €7 billion investment in preference shares was a sound one that would pay off for the Irish taxpayer. Many of the same people have assured us that NAMA will at least break even.

23 thoughts on “The EU and AIB’s Government Preference Shares”

  1. All the banks will still be insolvent even after NAMA. Still more public money will be wasted. The banks function as if nationalized. All losses guaranteed. No profits for the foreseeable future. Hence no dividends. Shares = 0

    They are now a form of workfare for bank employees. Add them to the unemployed! True rate of unemployment? Add navy, army and air force too!

  2. The first major fault lines are now beginning to appear in the NAMA edifice and in government financial policy as a whole.

    We can be thankful that these warning signs have finally appeared, even at this late stage.
    Legal responsibility for the bankers gambling debts have not yet been transferred to the Irish taxpayers and even Brian Cowen and Brian Lenihan must now see that they have been misled by the bankers.

    Even if the government tries to fly in the face of this new evidence, at least they will now not be able to say “we didn’t know” and for that we can be grateful.

    In introducing the NAMA proposal, Finance Minister Brian Lenihan said and I quote; “‘Our sole objective is to ensure that householders can access credit for home loans and consumer credit, that small and medium-sized business can fund their enterprises, that deposit-holders have confidence that their money is secure and protected, and that international investors are satisfied about the stability of our banking system.”

    Even he cannot now avoid admitting that he has failed totally on all counts, with the exception of depositors funds and a blanket guarantee of bankers debts and the creation of NAMA was not necessary to achieve that aim.

    The Dubai situation shows how scarce international investment funding has become for real estate assets and if the Irish government is not careful it will find itself knocking at the IMF’s door.

    There now needs to be a radical rethink on the part of government as to how the banking situation is going to be resolved.

    One of the very first actions to be taken by Dubai is to get its bondholders to reduce the face value of its debts, something which was never even considered by our minister for finance.
    http://www.nytimes.com/2009/12/02/business/economy/02leonhardt.html?_r=1&partner=rss&emc=rss

    We also need to know, as was done in Sweden, who these bondholders are. In addition we need absolute transparency in relation to the true level and identity of the banks debtors.

    Mr. Cowen and Mr. Lenihan are now on very thin ice and they would be well advised to to try to carry the Irish people with them in the dark days ahead. This will only happen if there is absolute transparency in relation to the true state of affairs relating to our bankers.

    It’s understandable that the bankers only care about themselves, but you Mr. Cowen and Mr. Lenihan have a duty of care for ALL THE IRISH PEOPLE.

  3. Karl.

    Thought the post was closed to comments but obviously it was just that Greg just wasn’t doing the night shift last night.

    To address the issue, I thought the Prefs had warrants attached that converted into 25% of the ordinary capital. Am I wrong in that? If that is the case it would be a whole lot better to spend another 1-2 billion and nationalise it entirely. Of course if the Government just said it was allowing the guarantee to fall away in September 10 it would/could nationalise for nothing.

    Ignoring how we got here, adequate remuneration for the prefs in any normal investor’s hands without Government support is way above 8% given the likelihood of default. However, as the Government own the prefs and is ensuring there is no default you could argue the premium should be very low (akin to senior government bond spreads). Due to the circular nature of the risk/ownership the answer thrown up is bizarre.

    Private equity? Not until the timebomb of mortgage defaults and the sub 5 million non-Nama dross washes through the system.

  4. Will any private investor want to inject equity into AIB with anything approximating the current €3.5 billion/8 percent divided preference share deal remaining in place?

    Karl,

    I don’t pretend to understand the nuances of finance, but to my lay mind it seems that the answer to (2) was ‘no’ back when the govt pumped money into AIB in the first place.

    It seems to me the 7bn preference share deal was a big hook to get the Irish taxpayer to sign up to Nama. The “bait” of dividends at (insert-ridiculous-number-here)% was always just going to get cut out of the stomach of the Irish taxpayer, once we’d been reeled in.

    For, any payment to the Irish taxpayer on the preference shares will just erode the capital position of the banks further, requiring even higher “long run economic value” in order to avoid nationalisation.

    But I’m sure Eoin will point out the numerous gaps in my admittedly elementary understanding of the financials involved here….

  5. @ Eoin

    “the pref shares are issued at 1 cent each to actually protect the government’s investment, i believe, as i think preference shares can only be redeemed from profits, from the share premium account, or from the issue of new ordinary shares”

    This is Section 62 of the Companies Act.

    It seems that application of share premium is very restrictive.

    I don’t see that the Preference Shares can be redeemed from the Share Premium Account. It can be used to provide “for the premium payable on redemption of any redeemable preference shares or of any debentures of the company”

    If that is the case how is the government’s investment protected?

    62.—(1) Where a company issues shares at a premium, whether for cash or otherwise, a sum equal to the aggregate amount or value of the premiums on those shares shall be transferred to an account, to be called “the share premium account”, and the provisions of this Act relating to the reduction of the share capital of a company shall, except as provided in this section, apply as if the share premium account were paid up share capital of the company.

    [GA] (2) The share premium account may, notwithstanding anything in subsection (1) be applied by the company in paying up unissued shares of the company (other than redeemable preference shares) to be issued to members of the company as fully paid bonus shares, in writing off

    [GA] ( a ) the preliminary expenses of the company, or

    [GA] ( b ) the expenses of, or the commission paid or discount allowed on, any issue of shares or debentures of the company;

    [GA] or in providing for the premium payable on redemption of any redeemable preference shares or of any debentures of the company.

    [GA] (3) Where a company has before the operative date issued any shares at a premium, this section shall apply as if the shares had been issued after the operative date, so however that any part of the premiums which has been so applied that it does not at the operative date form an identifiable part of the company’s reserves within the meaning of the Sixth Schedule shall be disregarded in determining the sum to be included in the share premium account.

    http://www.irishstatutebook.ie/1963/en/act/pub/0033/index.html

    Also posted on the Preference Share thread.

  6. @ Eoin

    “the pref shares are issued at 1 cent each to actually protect the government’s investment, i believe, as i think preference shares can only be redeemed from profits, from the share premium account, or from the issue of new ordinary shares”

    This is Section 64 (1) of the Companies Act.

    64.—(1) Subject to the provisions of this section, a company limited by shares may, if so authorised by its articles, issue preference shares which are, or at the option of the company are to be liable, to be redeemed, so, however, that—

    [GA] ( a ) no such shares shall be redeemed except out of profits of the company which would otherwise be available for dividend or out of the proceeds of a fresh issue of shares made for the purposes of the redemption;

    [GA] ( b ) no such shares shall be redeemed unless they are fully paid;

    [GA] ( c ) the premium, if any, payable on redemption, must have been provided for out of the profits of the company or out of the company’s share premium account before the shares are redeemed;

    [GA] ( d ) where any such shares are redeemed otherwise than out of the proceeds of a fresh issue, there shall out of profits which would otherwise have been available for dividend be transferred to a reserve fund to be called “the capital redemption reserve fund”, a sum equal to the nominal amount of the shares redeemed and the provisions of this Act relating to the reduction of the share capital of a company shall, except as provided in this section, apply as if the capital redemption reserve fund were paid up share capital of the company.

  7. @ Eoin,

    So it seems that Section 62 prohibits the use of the Share Premium Account to pay dividends or repay capital and that this is confirmed by Section 64.

    Do you agree?

  8. @ Eoin,

    This from BofI Annual Report 31 March 2009. Page 174

    “Principal rights

    The 2009 preference stock is perpetual.

    The 2009 preference stock entitles the NPRFC to receive a non-cumulative cash dividend at a fixed rate of 8 per cent of the issue price per annum, payable annually in arrears on 20 February at the discretion of the Bank. If a cash dividend is not paid by the Bank, the Bank shall issue units of ordinary stock to the NPRFC.

    The number of units of ordinary stock that the Bank would be required to issue in the event of non-payment of a cash dividend will be calculated by dividing the amount of the unpaid dividend by the Thirty Day Average Price1. These units will be settled on a day determined by the Bank, in its sole discretion, provided that this must occur no later than the day on which the Bank subsequently redeems or repurchases or pays a dividend on the 2009 preference stock or any class of capital stock.”

    So, if the cash dividend is missed ordinary shares must be issued at a time determined SOLEY AT THE BANKS DISCRETION with a long stop of the date of redemption of the preference shares.

    Do you agree?

  9. @ Eoin,

    This from BofI Annual Report 31 March 2009. Page 71

    “Pursuant to the recapitalisation transaction referred to above, the Bank issued, on 31 March 2009, 3,500,000,000 units of new preference stock of €0.01 nominal value at an issue price of €1.00 per unit and granted warrants to subscribe for up to 334,737,148 units of Ordinary Stock of €0.64 nominal value to the NPRFC.”

    This from BofI Annual Report 31 March 2009. Page 78

    “The exercise price per unit of ordinary stock issued pursuant to the warrants will be €0.52 for 177,213,784 units of ordinary stock and €0.20 for 157,523,364 units of ordinary stock. Any difference between the exercise price and the nominal value of the ordinary stock (being €0.64) shall be paid up from the Bank’s undistributable reserves (including the stock premium account) or (subject to there being no contravention of the rights of other stockholders) from the Bank’s distributable reserves.”

    So, the Preference shares were issued @ 0.01c nominal value. The premium paid was 99 times the nominal value. The premium went to the Stock Premium Account.

    Do you agree?

    The stated purpose of the Stock Premium Account, with respect to the exercise of Warrants, is to pay the difference between the nominal value of shares issued 0.64c and the exercise price 0.52 & 0.20. That’s €83.4m.

    Do you agree?

  10. @ All (That is anyone who is still following this thread).

    If the Preference Shares were issued at a nominal value of €0.01 (and notwithstanding that the coupon is paid on the issue “price”) what is the redemption value of these shares?

    Is it €35m or €3.5bn?

    My problem is, I can’t see how Preference Shares can be redeemed at a premium.

  11. @ All

    If one of the statutory uses of a Stock Premium Account is to allow the issue of authorised (but as yet un-issued) ordinary share capital the €3.15 billion could be used to issue bonus ordinary shares @ a nominal value of €0.64.

    “[GA] (2) The share premium account may, notwithstanding anything in subsection (1) be applied by the company in paying up unissued shares of the company (other than redeemable preference shares) to be issued to members of the company as fully paid bonus shares, …….

    I presume that bonus shares can only be issued to existing shareholder. The NPRFC is not (as yet) an ordinary shareholder (except perhaps in the ordinary course of business). Is my interpretation correct?

    Why were the Preference Shares issued with a premium of 99 times the nominal value?

    The Stock Premium Account is treated as part of the “Capital Stock” of the company. It cannot be used for distribution purposes. Is that correct?

  12. Or, the nominal value of the Preference Shares can be extinguished with relative ease and the “premium” if any can be used to convert to Ordinary Shares on redemption.

    Was this premium established because there was a high probability that the Preference Shares would be redeemed and there would be no necessity for the government (NPRFC) to purchase Ordinary Shares in order to redeem the Preference Shares (with premium)?

  13. This is Section 64 (1) (c) of the Companies Act.

    “[GA] ( c ) the premium, if any, payable on redemption, must have been provided for out of the profits of the company or out of the company’s share premium account before the shares are redeemed;”

    Is there a “guaranteed” premium on redemption or would such a premium be at the discretion of the Board?

    If it is at Board discretion are the Board constrained by solvency regulations?

  14. “If the bank redeems up to €1.5bn of the State investment in New Preference Shares from privately sourced Core Tier 1 capital prior to 31 December 2009, then the Warrants will be reduced pro rata to that redemption to an amount representing not less than 15% of the ordinary shares of the bank.”

    http://www.finance.gov.ie/viewdoc.asp?DocID=5669

    The share premium account cannot be used to redeem the Preference Share before 31 December 2009.

    The finance to do that would have to come from “privately sourced Core Tier 1”.

    Or maybe it could be. But what happens the Warrants if it is used to redeem prior to 31 Dec?

  15. “In return for the overall investment the Minister will get preference shares with a fixed dividend of 8% payable in cash or ordinary shares in lieu. These preference shares can be repurchased at par up to the fifth anniversary of the issue and at 125% of face value thereafter.”

    But the “face value” (not the amount paid) is only €0.01. No?

  16. “On purchase of the New Preference Shares, the State will receive an option (the “Warrants”) to purchase 25% of the existing ordinary shares in each bank (calculated on a post-dilution basis). The State may exercise this option from the fifth to the tenth anniversary of the purchase of the New Preference Shares.”

    If the Preference Shares are redeemed (or converted?) before the fifth anniversary the Warrants cannot be exercised?

  17. To summarise.

    1 Is a premium payable on the redemption of the preference shares and how much is it?

    2 Is the premium guaranteed or at the discretion of the Board?

    3 Would the payment of a premium be subject to solvency regulations?

    4 Do the Warrants have any real value before the fifth anniversary?

    5 Would the share premium account be used as a seamless method of converting the Preference to Ordinaries?

    6 What is the “face value” of the Prefs?

  18. @KW
    We were told by the NAMA lobby that we were making money from the blanket guarantee. As analysis on this site showed the return we were getting for the risk was vastly less than it should have been.

    We were told that our banks were getting healthier because the value of ordinary shares in the banks was rising. This in turn showed, Brian Lenihan said, that the markets believed our banks had a net value irrespective of NAMA. Then it emerged that our banks share price was entirely a function of the expected NAMA discount. So every increase in the price of the shares was a loss to the taxpayer on the loans we took over.

    We were told that we would get a really great dividend on these preference shares. Now it looks like we are getting ordinary shares. See above.

    “Many of the same people have assured us that NAMA will at least break even.” This is their worst fib of all. I don’t believe this toughness of the NAMA valuers spin. They were claiming all Irish property had fallen on average by 50%. But now the Ringsend Site is down 85%, new apartments in Dublin admitted to be down 50%, apartments in Newbridge down 66%. And prices have still not stopped falling. Losses of €40Bn are now probable.

    How many fibs do we have to get from the government before a public outcry stops them?
    Fib , Brian, fib!

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