Warrants and the subsidy to private investors–a summary

The recapitalization of Greek banks has recently been completed. Three out of the four large banks (Alpha Bank, National Bank of Greece, Piraeus Bank) managed to raise private capital exceeding 10% of their assessed capital needs. According to the rules set for the recapitalization process, this enabled the three banks to remain under private control. The fourth bank (Eurobank) went under the control of the Hellenic Financial Stability Fund (HFSF), which represents the state.

Because of the losses that banks realized on their holdings of Greek bonds (PSI), and the expected losses on their private-sector loans, bank capital was negative prior to the recapitalization process. That is, banks had more debts (in the form of deposits, bonds, etc) than assets to back up these debts. Therefore, if new private capital had to come in the banks at the same terms as new HFSF capital, it would have been impossible for the banks to raise any private capital: the new capital would have been used to pay the banks’ old debts.

One reason why banks were able to raise new private capital was an implicit subsidy: private buyers of shares received warrants (options to buy additional shares in the future), while the HFSF shares, bought at the same price, carried no warrants. A recent article in the New York Times argues that the warrant subsidy was unnecessarily large. This issue is not obvious, especially given that without any subsidy the banks would have gone under state control, with the perils that this entails (political interference, etc). In a recent post to our blog, Spyros Pagratis finds that the warrant subsidy was about 1.7 billion Euros for the three banks that raised private capital. Given that the private capital raised by these banks was about 3 billion Euros, the subsidy could explain fully why the banks managed to raise private capital. Pagratis’ post is available here, and a recent related post by the same author is available here.

About D_Vayanos

London School of Economics

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One Response to Warrants and the subsidy to private investors–a summary

  1. I take a different view. A bank bail-out and/or recap process MUST give the tax payers preferred status and not private investors! The idea cannot be that tax payers lose as little as possible. Instead, the idea should be that tax payers have a fair chance on making a profit on their investment (see TARP). If that means that private investors cannot be interested, it means just that. Just tell the former owners to leave the door keys on the desk. When investors invest in distressed companies, they don’t do that with the goal of losing as little as possible of their investment. Instead, they do it with the intent of making money out of it!

    It’s not the ownership (state or private) which matters the most. What matters the most is management. A bail-out and/or recap process where the state assumes temporary ownership must stipulte in irrevocable terms that competent and professional management will be put into place and that there is no possibility for political intervention.

    Why would one have confidence in owners/management who had run a bank into the ground in the first place?

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