OVERVIEW OF JSC PAREX BANKA TAKEOVER
On 8 November 2008, the Cabinet of Ministers decided on the take-over of JSC Parex banka by the Latvian State through the state-owned JSC Latvijas Hipotēku un zemes banka ( Mortgage and Land Bank of Latvia ) . It was an unprecedented event in the Latvian financial sector therefore raising numerous questions and yet more manifold opinions. Variety of interpretations was also boosted by initially limited information as a number of documents were classified as secret or restricted use information in accordance with the Law on the State Secret and Information Disclosure Law for the purposes to protect legal rights and justified interests of the recipient of financial services (incl. depositors), state and business participants.
The objective of this overview is to inform the public about the reasons and necessity for the takeover of JSC Parex banka, its course of developments and results.
Abbreviations used: EC – European Commission EBRD – European Bank for Reconstruction and Development FCMC – Financial and Capital Market Commission MoF – Ministry of Finance of the Republic of Latvia BoL – Bank of Latvia Mortgage Bank – state-owned Latvijas Hipotēku un zemes banka (Mortgage and Land Bank of Latvia) Cabinet – Cabinet of Ministers of the Republic of Latvia PA – state JSC Privatisation Agency Parex – JSC Parex banka |
1. REASONS AND PREHISTORY OF TAKEOVER
1.1. Changes in the global financial system
Changes in the global financial system occurred firstly in the high-risk mortgage lending market of the United States already in 2007 and then spreading across also other global financial markets. The instability of the global financial system had an impact on the European Union (EU) member states as well. In early 2008, Britain’s Northern Rock was nationalized by the state to bail the bank out. In the second half of 2008, several large and highly approved banks and financial institutions went bankruptcy, for instance, Lehman Brothers in the United States and Carnegie in Sweden.
These developments of international scale raised anxiety about the overall stability of banking and financial systems. Financial institutions were attempting to attract additional capital considering extraordinary options, including mergers and asking for the Government bailout, as well as increasing liquid asset volumes (improving liquidity). As Latvia is part of integrated global financial system, recent developments, insolvency and financial problems of leading banks made more cautious also the Latvian public and responsible authorities.
1.2. FCMC inspections
In view of instability of banking system in other EU member states, FCMC, the responsible supervisory authority for the Latvian financial and capital markets, has been carrying out increased oversight of bank sector already since the summer 2008 in order to monitor daily liquidity positions and the risks of banks in Latvia, including Parex.
The financial situation became yet more unpredictable under the impact of global recession therefore negative changes could occur in a comparatively short period of time. Supervision conducted by FCMC allowed to identify and react to the actual situation in Parex; however, practical and urgent financial assistance was needed for improving the situation, which could be offered only by the Cabinet.
Following supervision measures regarding Parex have been taken by FCMC since the summer 2008, illustrating fast developments:
FCMC invited representatives of Parex to the meeting of the Board of FCMC to discuss the results of bank exposure assessment pursuant to inspection findings. And consider lending policy (supervision and assessment of loans issued by the Bank and loan portfolio concentrations), investment policy (compliance with financial instruments concentration and limits), monitoring of the Bank’s client and customer service.
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At the very beginning of November 2008 it was evident that Parex faced rather serious problems and involvement of the Cabinet was required for their tackling. Takeover of Parex was considered as one of the most efficient scenarios for ensuring stabilization of the Latvian financial system. It was ascertained that Parex had sufficient amount of assets and financial instruments to stabilize activities of Parex, by taking full control over the Bank by the State and applying the necessary support to it.
1.3. Reasons behind problems occurring particularly with Parex
Key reasons for Parex crisis:
· global financial market turmoil;
· increased deposit withdrawal from Parex as a result of rumours and deficiency in Parex client financial resources, in particular regarding Latvian neighbouring countries’ residents;
· Parex had entered into two agreements with syndicated lenders, – a 500 million euro loan on 29 June 2007 2 and a 275 million euro loan on 21 February 2008. Repayment of loans was scheduled in early 2009, however, Parex would be incapable of repayment because of the plunge in the Bank’s securities portfolio value;
· As a result of global financial crisis the quality of Parex foreign securities portfolio had worsened; Parex had no parent bank, which could assume issuing additional guarantee or any collateral to Parex creditors.
2. Necessity of takeover
2.1. Presumptive consequences if no bailout of Parex carried out
If the Cabinet had not decided on the takeover of Parex, the Bank actually would have been exposed to inevitable insolvency in the nearest future. Eventually, there would be enormous negative consequences in the national financial system afterwards as a result of potential insolvency, including:
· The Government should have to pay guaranteed compensations to Parex depositors in accordance with Deposit Guarantee Law. In three months, a total of about 660 million lats would have to be paid to depositors. However, at that time the Deposit Guarantee Fund contained only 82.9 million lats, thus the rest should be paid from the Latvian State budget, but the latter lacked the required funds as the Latvian State had not yet entered into an agreement with international lenders, European Commission and International Monetary Fund regarding the opening of credit line.
· Numerous central and local government institutions, which had their current accounts and salary accounts with Parex, would have to encounter problems with fulfilment of the Bank’s obligations. Total central and local government deposits with Parex accounted for 143 million lats on 30 September 2008.
· Material loss would be caused to the business environment because of delays in mutual payments thus resulting in further national economy downturn and GDP decrease, and problems with liquidity on an overall scale of national economy and potential decrease in deposit volumes, including non-resident deposits.
· Interbank payment system would be essentially impeded.
2.2. Strategic importance of takeover
By taking control over Parex, the Latvian State rendered assistance to the overall financial sector, not only to Parex, because the deepening of problems with Parex could have resulted into a domino effect. An increased financial sector confidence crisis, which could result into a dramatic outflow of funds to foreign banks and deep crisis of financial resource availability having a negative impact on the whole Latvian national economy.
Moreover, in the opinion of BoL, Parex insolvency would have left material negative impact both on the Latvian financial sector and payment system, undermining the foreign depositors’ trust to the State for the following reasons:
· At the end of September 2008 Parex was a second - largest bank in Latvia in terms of assets and the Bank’s assets constituted 13.8% of total assets of the Latvian banking sector. Parex had a significant role in servicing the Latvian retail and corporate transactions.
- Regarding the overall payment system of the Latvian State in first half of 2008 Parex ranked the third in terms of the opened client accounts (646 thousand) and issued payment cards (448 thousand); Parex ranked the third also as regards the number of client credit transfer performed in Latvia (4.5 million transactions) and payments by card (6.5 million transactions); Parex was the fourth largest bank in terms of the number of credit transfer transactions (16.5 billion lats); Parex was the second-largest bank in terms of volumes of payments made by cards (167.7 million lats).
· In the BoL's interbank automated payment system (SAMS) Parex ranked the fourth in terms of the number of performed transactions and the fifth in terms of transaction volumes.
· In the BoL’s electronic clearing system (EKS) Parex was second in terms of the number of payments in lats and third in terms of volume.
· In the BoL’s interbank euro payment system TARGET2-Latvija Parex was second in terms of the number of transactions and third in terms of transaction volumes. Within EKS Parex was second both in terms of the number and volumes of payments in euro.
· In the period from 16 October 2008 and 23 October 2008, Parex transactions in the Latvian money market constituted 2% of total turnover of local interbank money market; Parex share in the turnover of local currency market was 23% in September 2008.
· At the end of September 2008 Parex had attracted 13.6% of total Latvian resident deposits, including 14.5% of total private individual deposits and 11.8% of corporate deposits.
· Parex market share in the corporate lending constituted 7.4%, and retail lending, 8.8%. Parex was a leading bank in terms of non-resident deposits, accounting for 26.2% of total non-resident deposits placed in Latvia.
By taking over Parex, the Latvian State prevented insolvency of the leading credit institution stabilizing the Latvian financial system and attesting that the Government stood ready to render assistance to depositors. Collapse of such a bank as Parex could create even bigger losses to the whole financial system than the total amount of Parex rescue funds, as the Bank’s customers, residents, non-residents, natural and legal persons, would have lost trust in all banks, seriously striking at the heart of the whole sector. It should be noted that the deposit outflow in September, October and November of 2008 was not limited to Parex, it was observed also in several banks in Latvia. Meanwhile, the volume of deposits grew in several other banks, which depositors regarded as safer banks. Total deposit volume in the banking sector fell in October 2008 month-on-month, but already in November deposits started growing, proving high enough depositor confidence in the banking sector overall.
3. TAKEOVER PROCESS
3.1. Taking over majority stake in Parex by the State
In early November 2008 it was clearly evident that Parex would instantaneously go bankrupt if no State assistance rendered. Whereas allotting the state support provided that Parex remained under shareholders control would cause concern about adequate use and recovery of state funding. As a result of debate and considering experience of other countries (for instance, takeovers of Northern Rock and Bradford&Bingley in the UK ), it was decided that the best solution would be taking control over the majority stake in Parex by the State. Theoretically the Bank’s shares could have been taken over without the shareholders’ consent pursuant to the provisions of Article 105 of Constitution (Satversme), but in that case complicated legal procedures should be applied, which would considerably delay the procedure and as a result it would be impossible to bailout Parex. Consequently, it was decided to hold negotiations on the Bank’s takeover with Parex majority shareholders Valērijs Kargins and Viktors Krasovickis, who both owned 84.83% of Parex share capital. Takeover process further development as follow:
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The purchase of shares was postponed under several conditions, namely, in the event if: EC has granted its approval to State aid . As the takeover of Parex is deemed as the State aid in terms of EU (Community) acquis communautaire , the EC consent was prerequisite for the takeover. The Competition Board of the Republic of Latvia and FCMC have issued consent to the transaction pursuant to national laws . V. Kargins and V. Krasovickis receive unconditional, irrevocable written consent of two third of the total syndicated lenders for the takeover . Other conditions of the Agreement (pledging of the rest capital shares and movable or immovable property owned by V. Kargins and V. Krasovickis, keeping all the current deposits in the amount of 14 million lats of V.Kargins and V.Krasovickis in Parex accounts etc.). Several restrictions were imposed on Parex regarding decision-making and activities from the signing date of Investment Agreement until the closing date . According to the Investment Agreement, in the event all the conditions precedent have not been fulfilled within 2 weeks , the Mortgage Bank and the Republic of Latvia have the right to terminate the Agreement. On the same date MoF instructed the State Treasury to place a term deposit totalling 199 999 924.63 lats with Parex. Funding from the issue of Latvian treasury bills was used for placing the deposit . Parex used the acquired securities as collateral in order to borrow the funding from BoL to maintain liquidity. | |
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3.3. When the decision on the taking controlling interest in Parex by the Latvian State was publicly disclosed, the reaction of public and Parex depositors to it was rather different. Some backed the move of the Government, while other were concerned about the takeover of Parex taking it as a signal on an inevitable Parex bankruptcy and hastily withdrew their deposits from the Bank. To ensure stabilization of Parex and overall Latvian financial system as soon as possible, an efficient action was required for normalization of the situation in Parex and deciding on the Bank’s further status. Further developments leading to increasing of influence of the State in Parex equity capital were as follow:
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Thereby debates started on amending the Investment Agreement stipulating a takeover of all shares owned by V.Kargins and V.Krasovickis, excluding the necessity to receive consent of syndicated lenders. | |
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Imposing restrictions on fulfilment liabilities was most acceptable decision to prevent the outflow of assets from Parex, and it could be praised from today’s point of view. | |
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The Cabinet also required the Mortgage Bank to alienate investments in Parex not later than in 12 months of closing date of Investment Agreement. Thereby until 15.01.2009 the Mortgage Bank shareholders meeting had to approve the mandated lead adviser for the alienation process and start seeking an investor without delay . The Mortgage Bank was also designated to carry out in-depth legal analysis of Parex financial standing. | |
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The purchase agreement was concluded on 22.01.2009. After conclusion of this transaction, the Mortgage Bank holding in Parex was increased up to 85.15%. The Cabinet expressed interest in possibilities to also acquire the shares of other Parex minority shareholders. | |
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In January 2009, the outflow of funding from Parex had considerably decreased, and as a result no additional deposits made by the State Treasury were required. Notwithstanding, Parex ended the year 2008 with loss mainly due to expenses on loan loss provisions. | |
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The Cabinet also supported increasing of Parex equity capital, which was a prerequisite for carrying out the EBRD transaction. | |
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Such a decision was made to preclude possible inclusion of Parex in Mortgage Bank consolidated group in accordance with international accounting standards. Consolidation would mean mutual risks and their taking over among associated companies. However, it had always been of strategic importance for Mortgage Bank to participate in specialized State aid programs aimed at business promotion and therefore there was a necessity for reducing the scope of Mortgage Bank and risks not related with performing above functions. Arrival of EBRD representatives in Riga to launch negotiation on possible involvement of EBRD in Parex equity capital. | |
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March 2009 – 30% (232.5 million euro), February 2010 – 40% (310 million euro), May 2011 – 30% (232.5 million euro). The above terms were supported also by BoL and FCMC. The State Treasury was designated to ensure placing the deposit with Parex for carrying out the first payment (March 2009). The minister of finance had to issue the State guarantee to the syndicated lenders for the remaining payments (February 2010 and May 2011). | |
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The Law on Bank Takeover was also drawn up and passed by the Parliament (Saeima) on 18 December 2008. The Law specifies the cases where the bank takeover is permissible and the procedure according to which the State may take over a bank. The Law sets a legal framework for tackling problems in the banking sector, to provide a mechanism for taking over the bank and setting the amount of compensation to shareholders. The Cabinet Regulations No 112 of 10 February 2009 on the procedure for setting, offering and payment of the amount of fair compensation to the bank shareholders or a bank issued on the basis of the Law on the Bank Takeover took effect on 13 February 2009.
4. FURTHER DEVELOPMENTS
Since the Latvian Privatisation Agency has become the majority shareholder of Parex looking for strategic investors is one of the key tasks of PA, as a State representative. The State is not interested in retaining the shares of Parex in its possession for unlimited period of time, but to attract investors who would acquire the State shares and continue stabilizing of Parex and further development.
This objective was partially attained on 16 April 2009, when the agreement was signed with EBRD on the acquisition of Parex shares. By the acquisition of 25% + 1 of ordinary shares of Parex, EBRD will invest 57.5 million lats in Parex share capital and 15.5 million lats (22 million euro) in the Parex subordinated capital, which later would be transformed into shares or recovered as a loan. EBRD has a great experience in restructuring banks and involvement of EBRD into Parex equity capital could be taken as a positive signal regarding Parex potential viability and development.
Currently, several restrictions on Parex activities regarding the offering of financial services imposed by the Cabinet and FCMC, including granting loans, are still effective. Therefore an urgent short-term goal is to fully resume Parex financial services promoting the rightful returning of the Bank in the financial services market.
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24.03.2009 |
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11.05.2009 |
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23.07.2009 | EBRD entered into a 22 million euro subordinated loan agreement with Parex, as well as agreed on modifications to the share purchase agreement and shareholders agreements. | |