Latvia: Parex Bank Capital Injection, 2008

At the time of the GFC, Parex was Latvia’s second-largest bank in terms of assets, comprising 13.8% of total assets in the Latvian banking sector (EC 2008a; FCMC 2009b). Parex was the third-largest bank in the overall payment system with 646,000 customer accounts (EC 2008a; FCMC 2009b). Parex had attracted 13.6% of total Latvian resident deposits as of September 2008, of which 14.5% were retail deposits and 11.8% were commercial deposits. As of September 2008, Parex was the leading bank in foreign deposits with 26.2% of total nonresident deposits placed in Latvia (FCMC 2009b).

In autumn 2008, Parex faced a capital shortfall owing to massive credit losses and market losses in addition to increasing liquidity problems and deposit runs of LVL 240 million (EC 2008a; FCMC 2009a; FCMC 2009b; OECD 2016). Parex’s liquidity indicator fell from 44.2% on August 31, 2008, to 31.4% on November 5, 2008; the regulatory minimum was 30%. Throughout autumn 2008, Parex’s CAR fluctuated around the regulatory minimum of 8%; the CAR fell to 7.9% on October 28 (EC 2008a; FCMC 2009b).

Parex had two senior syndicated loans maturing in February and June 2009, totaling EUR 775 million, or nearly one-sixth of the bank’s total liabilities. According to the EC, Latvian authorities doubted that Parex would be able to pay back, extend, or replace these loans; these senior creditors were preparing to announce a default event in which the EUR 775 million would have been due immediately rather than in 2009. Considering these senior syndicated loans, deposit runs, insufficient bank capital, and a request from Parex’s management for help, Latvian authorities decided to intervene (Baudino et al. 2022; Epstein and Rhodes 2019; EC 2008a). The initial intervention included a guarantee of the senior syndicated loans (see Key Design Decision No. 2, Part of a Package) (EC 2008a).

Initial Investment Agreement

The November 10 takeover of a bank by LHZB, a state-owned commercial bank with a mandate to promote the mortgage market, was unprecedented in the Latvian financial sector since privatization in the 1990s (FCMC 2009a; FCMC 2009b). In its annual report for 2008, the FCMC said:

By taking over [Parex] the Latvian state prevented insolvency of a leading Latvian credit institution, stabilized the whole Latvian financial system and certified to depositors that the state [was] ready to support them. The loss to the financial system as a result of the collapse of a bank like [Parex] would have exceeded the funds invested to stabilize the operations of [Parex] because customers—residents, non-residents, natural persons and legal entities—would have no longer believed in Latvian banks and consequently undermined their activity. (FCMC 2009b, 10)

The FCMC also said that a negotiated government takeover of Parex was the most efficient way to stabilize the bank.^FAccording to a parliamentary report, taxpayers would have paid EUR 939.1 million to fulfill deposit guarantee commitments had the government not taken over Parex (Parliament of Latvia 2015). Although it was possible to take the bank’s shares without shareholders’ consent under Article 105 of the Latvian Constitution, complex legal proceedings would have slowed the process and State Aid would have been too late. Thus, Latvian authorities decided to negotiate the takeover with the two majority shareholders (FCMC 2009a; FCMC 2009b).

These negotiations were held among the FCMC, Ministry of Finance, BOL, and Parex. The Cabinet of Ministers made the decision to take a 51% stake in Parex on November 8, 2008 (FCMC 2009b). The two majority shareholders said that it was the correct decision to seek help from Latvian authorities, and authorities subsequently decided the structure of assistance. They also told the press that they had the right of first purchase when the government decided to sell its 51% stake (BBC 2008). If the two majority shareholders did not meet all the conditions set forth in the initial investment agreement within two weeks, LHZB and the Latvian government could terminate the agreement (FCMC 2009a).

According to the FCMC’s 2008 annual report, authorities did not want to give State Aid to Parex with the majority shareholders in control. Latvian authorities observed the experience of other countries and concluded that in order for Parex to properly use State Aid and the government to eventually recover the amount, the government needed to own Parex (FCMC 2009b).

To restore the bank’s capital, Latvian authorities also authorized subordinated loans up to LVL 200 million on November 10, 2008. In approving this instance of State Aid, the EC noted on November 24 that no other market economy operator was willing to provide subordinated loans on comparable terms (EC 2008a). However, Latvian authorities did not use this authorized measure of subordinated loans until May 2009 (EC 2009b).

Amended Investment Agreement

According to the IMF, Latvian authorities thought that the initial intervention would convince nonresidents to keep their deposits at Parex. However, deposit outflows continued (IMF 2009).

After November 10, the two majority shareholders did not receive the consent of two-thirds of the senior syndicated lenders to fulfill the conditions set forth in the initial investment agreement. However, the senior syndicated lenders indicated that they would only agree to refinance the loans if LHZB acquired all of the shares owned by Kargins and Krasovickis. According to the FCMC, the IMF, the EC, and Sweden’s central bank also insisted that Latvian authorities take all the shares owned by Kargins and Krasovickis and remove the two from management. This prompted Latvian authorities to amend the investment agreement (FCMC 2009a).

On December 3, 2008, the Cabinet of Ministers decided to amend the investment agreement to acquire all the remaining shares owned by the two majority shareholders, bringing the government’s total stake to 85%, to make sure that the State Aid would be properly utilized and recovered (EC 2008a; FCMC 2009b). However, the amended agreement removed Kargins and Krasovickis from the board, and they no longer had the right of first purchase of the government-owned Parex shares (EC 2009a; Reuters 2008).

Capital Injections

The bank’s total shareholders’ equity fell by 65% to LVL 77 million by the end of 2008 owing to increased loan loss provisions and losses on the securities portfolio. Thus, Parex’s CAR of 4.1% was well below the regulatory minimum. The previously approved measure—up to LVL 200 million in subordinated loans—would not sufficiently raise Parex’s CAR to 11%. Also, on March 25, 2009, the FCMC raised the minimum CAR from 8% to 11% for Parex to ensure operation during the rescue phase (EC 2009b; FCMC 2009b).

On March 29, 2009, Latvian authorities made a request to the EC to change the form and amount of capital injections authorized by the EC decision on November 24, 2008, to achieve a CAR of 11% during the rescue phase. Latvian authorities requested to change the amount of previously authorized subordinated term debt^FThe EC had approved changes to the interest rate mechanism for subordinated term debt on February 11, 2009 (see Key Design Decision No. 3, Legal Authority, and Key Design Decision No. 8, Capital Characteristics) (EC 2009a; EC 2009b). and requested new permission to inject Tier 1 capital in the form of ordinary shares. To minimize the use of state funds, a certain proportion of Tier 1 to Tier 2 capital would be maintained (see Key Design Decision No. 8, Capital Characteristics). While Latvian authorities anticipated capital injections totaling LVL 191 million, the EC gave permission to inject more capital to maintain a CAR of 11%, provided that the terms remained the same. The EC approved these measures on May 11, 2009 (EC 2009b).

EBRD Participation

The government began negotiations with the EBRD in late November 2008 to reassure shareholders, given the EBRD’s reputation and experience in bank restructuring (Parliament of Latvia 2015). The EBRD would be a long-term investor and participate in the development of the bank; the ultimate goal was to return Parex to the private sector (EBRD 2009a; EC 2009c). The EBRD said in its 2009 report that its participation “was designed to improve confidence, ease the financial burden on the Latvian government and assist in the restructuring process ahead of a transfer back into private ownership” (EBRD 2009b, 184). See Key Design Decision No. 15, Exit Strategy, for more information on the EBRD’s participation.

Broad-Based Liquidity Measures

From the end of August until the end of November 2008, the BOL sold EUR 900 million in foreign currency to defend the peg of the lat to the euro, because of concerns about liquidity and access to outside private capital markets. During this time, BOL official reserves fell by 20% to EUR 3.4 billion, one-third of short-term external debt and more than 100% of base money (BOL 2009; IMF 2009).^FIn 2008, Latvia was a member of the European Union but had not yet adopted the euro as its currency. Nonresident deposit runs on Parex played a large role in systemwide outflows. According to the IMF, any change in the nominal exchange rate would have immediately diminished private sector net worth in Latvia, because the majority of deposits and loans were foreign currency denominated (IMF 2009).

On October 24, 2008, the BOL lowered reserve requirements, thereby releasing LVL 200 million in liquidity to the banking system (BOL 2008a; IMF 2009). The BOL lowered the reserve ratio for bank liabilities with two-year maturities from 6% to 5% and for other liabilities from 8% to 7% (BOL 2008a; BOL 2009). The BOL further lowered reserve requirements in November and December 2008, which released an additional LVL 380 million (IMF 2009).

In a January 2009 report, the IMF says that the BOL provided LVL 555 million (3.5% of GDP) in liquidity to the entire banking system to meet deposit runs. Of the total LVL 555 million, LVL 195 million was for operations backed by domestic Treasury bills specifically issued for liquidity support to Parex (IMF 2009). The author interprets the IMF and BOL documentation to mean that the BOL released a total of LVL 1.1 billion in liquidity from August 2008 to January 2009.

Support from the IMF, EU, and European Countries

From November 17–23 and December 5–18, 2008, senior government officials (including opposition party leaders), social partners, and representatives of financial institutions met with the IMF to discuss an SBA for approximately one-third of Latvia’s GDP (EIU 2008; IMF 2009). According to Reuters and the FCMC, the IMF said that it would grant more support if the Latvian government took full control of Parex (FCMC 2009b; Reuters 2008). On December 23, 2008, the IMF announced a 27-month SBA for 1.5 billion special drawing rights (SDR; EUR 1.7 billion) under its Emergency Financing Mechanism (EFM). Additional support totaling EUR 7.5 billion came from multilateral organizations and other European countries (see Figure 2) (IMF 2009). In the interim between the announcement and when the loans took effect, Latvia used already-established short-term swap facilities up to EUR 500 million with the central banks of Denmark and Sweden (EIU 2008). The SBA was extended to 36 months at the time of the second review (IMF 2013).

Figure 2: Commitments to Latvia by Multilateral Organizations and Other European Countries as of January 2009

Source: IMF 2009.

Latvian Legal Authority

The parliament revised its laws on November 14 to enable the Treasury to lend funds to the LPA for that recapitalization (Parliament of Latvia 2009a, art. 8.1; Parliament of Latvia 2009b, art. 6; Treasury 2010).

On, November 14, 2008, the parliament revised the Law on Budget and Financial Management, Section 36, Paragraph 6, to allow the finance minister to extend state loans, based on a decision by the Cabinet of Ministers (Parliament of Latvia 2009a, sec. 36[6]). According to the Treasury’s annual reports, this was the legal basis for the loans provided to the Treasury from the LPA to fund Parex’s recapitalization (Treasury 2010; Treasury 2011).

EC Decision-Making

Article 88 of the European Commission Treaty (EC Treaty) obligates member states to obtain EC approval of State Aid affecting the common market (EC 2002b).

Latvian authorities placed behavioral constraints on Parex to avoid undue distortions of competition for EC compliance, which the EC noted in its decision on November 24, 2008 (see Decker 2024) (Competition Council 2008; EC 2008a).

On November 24, 2008, the EC decided Latvia’s aid measures were compatible with the common market; the EC did not raise objections. The EC evaluated Latvia’s intervention according to Article 87 of the EC Treaty (EC 2002a, art. 87; EC 2008a). The EC said the partial nationalization of Parex did not constitute State Aid to Parex’s shareholders, because the Latvian government paid a symbolic LVL 2 and the EC was not aware of any obligations that the existing shareholders had against the bank or its creditors of which they would have been relieved due to the transaction. Meanwhile, the EC said that the subordinated loans to Parex and government guarantee of Parex’s senior syndicated loans did constitute State Aid: these measures allowed Parex to strengthen its position compared to those of its competitors in Latvia and other member states, thus distorting competition and affecting trade (EC 2008a).

On February 11, 2009, the EC did not object to Latvia’s amended measures surrounding LHZB’s 85% stake in Parex, as the amended measures were “practically identical to the original ones, and the situation on the financial markets has not improved” (EC 2009a). The EC also approved changes to the interest rate mechanism for subordinated term debt (EC 2009a; EC 2009b).

On March 29, 2009, Latvian authorities made a request to the EC to change the form and amount of capital injections authorized by the EC decision on November 24, 2008, to achieve a CAR of 11% during the rescue phase. Regarding the subordinated term debt previously authorized on February 11, Latvian authorities requested new permission to inject Tier 1 capital in the form of ordinary shares. To minimize the use of state funds, a certain proportion of Tier 1 to Tier 2 capital would be maintained (see Key Design Decision No. 8, Capital Characteristics). While Latvian authorities anticipated capital injections totaling LVL 191 million, the EC gave permission to inject more capital to maintain a CAR of 11%, provided that the terms remained the same. The EC approved these measures on May 11, 2009 (EC 2009b).

On September 15, 2010, the EC found that the restructuring plan was compatible with Article 103(3)(b) of the Treaty on the Functioning of the European Union (TFEU) and properly addressed viability, burden sharing, and competition distortion (EC 2010).

On March 6, 2012, Latvian authorities sent a request to the EC to amend the restructuring plan. The EC allowed these changes on August 10, 2012 (see Decker 2024) (EC 2012).

On October 1, 2013, Latvian authorities requested another amendment to its State Aid authorization. Latvia wanted to postpone the deadline to divest Parex’s wealth management business per the September 2010 EC decision (see Decker 2024). In corresponding with Latvia, the EC discovered that Latvia took certain actions without notifying the EC: extending the maturity of some subordinated loans in pre-split Parex and later Citadele in addition to exceeding the maximum authorization of liquidity support to Reverta. In July 2014, the EC issued a decision responding to these violations of State Aid. On the divestment of Citadele’s wealth management business, the EC recognized the difficulty in finding interested buyers given Latvia’s market conditions at the time. The EC noted Latvia’s proposal to sell Citadele’s wealth management business with the good bank itself to increase market interest and thus increase the likelihood of Citadele’s sale. On the maturity extensions, the EC acknowledged that Latvia’s changes better aligned subordinated debt amortization under Basel II rules and Latvia regulators’ changes to the CAR requirement during the rescue phase. On the breach of maximum liquidity support to Reverta, the EC noted that Reverta had a lower asset quality than expected in addition to slower than expected recovery of collateral and litigation with debtors. Moreover, Reverta’s loss of its banking license in 2011 meant that the bad bank did not need to convert further liquidity support into capital. Considering the difficulty in asset recovery and the unconverted liquidity support, the EC concluded that Reverta’s emergency liquidity was limited to the minimum necessary for its resolution (EC 2014b).

See Figure 3 for a timeline of EC decision-making.

On November 3, 2008, negotiations commenced among the FCMC, Ministry of Finance, BOL, and Parex (FCMC 2009b). On November 10, 2008, the two majority shareholders, Parex, and the Latvian government signed an investment agreement (EC 2008a).

Financial and Capital Market Commission

The FCMC supervised and issued regulations pertaining to the activities of banks, credit unions, insurance undertakings and insurance intermediaries, and private pension funds (FCMC 2009b). To this end, the FCMC regularly estimated banks’ minimum capital requirements and the amount of capital necessary for each bank to cover its losses. Taken together, these estimates established the amount of capital needed to cover: interest rate risk in the nontrading portfolio and concentration risk in the loan portfolio, among others (FCMC 2010). From August 18 to October 3, 2008, the FCMC inspected Parex’s loan portfolio and credit risk management, which led to the detection of “material weaknesses” (FCMC 2009b).

The FCMC was managed by a board consisting of five members: a chairperson, a deputy, and three council members who were also directors of the FCMC’s departments (FCMC 2009b; Parliament of Latvia 2002, art. 13). The chairperson and deputy were appointed by the parliament on the advice of the finance minister and BOL president. The chairperson and deputy served for terms of six years. The chairperson appointed other members in coordination with the finance minister and BOL president (Parliament of Latvia 2002). The council adopted decisions by a simple majority vote. In the event of a tie, the chairperson’s vote was decisive (Parliament of Latvia 2002, art. 16).

Latvian Mortgage and Land Bank

LHZB was established on March 19, 1993, as a state-owned commercial bank based on a decree by the Cabinet of Ministers. Latvian authorities used LHZB to develop Latvia’s mortgage lending system and mortgage-backed securities (Baltic Legal n.d.; LHZB 2010).

From November 10, 2008, to February 25, 2009, LHZB held the government’s shares in Parex (EC 2008a; Parex 2009b). When the Cabinet of Ministers decided to acquire the two majority shareholders’ 85% stake, the Cabinet required LHZB to divest itself of Parex within one year. Thus, LHZB had to seek sale advisors and interested buyers right away (FCMC 2009a).

On December 3, 2008, when LHZB acquired an 85% stake in Parex, the Cabinet of Ministers also issued Decree No. 820. This decree set LHZB on the course of transformation from a commercial bank to a development bank (LHZB 2010).

Latvian Privatization Agency

On February 25, 2009, per the direction of the Cabinet of Ministers, LHZB transferred the government’s 85% stake in Parex to the LPA for further capital increases and the potential sale of the bank (LPA 2009; Parex 2009a; Parex 2009b). Thus, the LPA bought Parex’s shares from LHZB for LVL 2.01. The FCMC said the Cabinet of Ministers made this decision because the LPA had experience in selling state-owned bank shares, pointing to the examples of JSC Latvijas Krājbanka and JSC Latvijas Unibanka (FCMC 2009a).

The LPA performed all capital injections into Parex, Citadele, and Reverta (Citadele 2011a; EC 2009b; EC 2010; Parex 2011).

The LPA board managed the agency’s day-to-day activities (Cabinet of Ministers 1994). The LPA board organized the privatization of state-owned property and approved regulations for the privatization of specific state-owned property after the LPA council issued an opinion (Cabinet of Ministers 1994). The LPA board met at least once per week and made decisions by a simple majority vote. In the case of a tie, the board chairperson’s vote was decisive (Cabinet of Ministers 1994).

LPA board members were appointed for a maximum period of three years, and they could be reappointed. At least half of the LPA board members had to be Latvian citizens; the remaining board members had to be permanent residents of Latvia for at least 21 years. The chairperson of the LPA was also the general director, approved by the Cabinet of Ministers on the recommendation of the trustee. The general director managed the activities of the LPA board. Upon recommendation of the general director, the LPA board approved the deputy general director (Cabinet of Ministers 1994).

The council of experts was a consultative body whose members evaluated specific privatization undertakings and presented these findings to the LPA board before the latter made a decision (Cabinet of Ministers 1994). Members of the council of experts were recommended by the LPA board and approved by the LPA council (Cabinet of Ministers 1994).

Sell-Side Advisers

On March 3, 2009, Parex announced that the Latvian government had appointed Nomura International PLC as a strategic, sell-side adviser (Parex 2009c). Nomura submitted a restructuring plan to the Cabinet of Ministers, which approved the plan on March 23, 2010 (Parex 2011).

In October 2013, the Cabinet of Ministers approved measures to hire Société Générale as a financial advisor and Linklaters as a legal adviser in the LPA’s sale of Citadele (Citadele 2013a; OECD 2016). Advisory firms submitted applications to a special commission with representatives from the Ministry of Finance, Ministry of Economics, LPA, Citadele’s council, and the EBRD; the special commission selected the best firm (Citadele 2013a).

Latvian Privatization Agency

The LPA council governed the LPA’s activities (Cabinet of Ministers 1994, arts. 3[10], 3[20]). Five members comprised the LPA council, appointed by the Cabinet of Ministers on the recommendation of the trustee and each parliamentary faction (Cabinet of Ministers 1994, arts. 3[10-11]). LPA council members could serve a maximum of three years (Cabinet of Ministers 1994, art. 3[14]). At least two-thirds of the LPA council had to be Latvian citizens. If noncitizens served, they had to be permanent residents of Latvia for at least 21 years (Cabinet of Ministers 1994, art. 3[13]).

The LPA council had to issue an opinion on the privatization of a specific state-owned property before the LPA board could issue subsequent regulations. The LPA council received a report on the LPA’s activities from the board once per quarter (Cabinet of Ministers 1994, art. 3). The trustee appointed sworn auditors to check the LPA’s activity and produce a report (Cabinet of Ministers 1994, art. 7).

The Ministry of Economics owned 100% of the LPA’s shares, and the LPA board’s activities were ultimately subject to the Cabinet of Ministers (Cabinet of Ministers 1994, art. 4; LPA 2009).

Parliamentary Investigations

On February 24, 2011, the Parliament of Latvia launched an investigation commission on possible illegal activities in the process of taking over and restructuring Parex (Parliament of Latvia 2011a). The commission issued its report on June 9, 2011. The investigation commission stated that its report was not sufficiently exhaustive, because parliament did not vote to extend the length of the investigation. The commission said that it was not convinced that the government’s majority stake in Parex and other rescue funds in Parex’s resolution were safely and effectively used in the best interest of Latvian citizens (Parliament of Latvia 2011c).

On November 13, 2014, the Parliament of Latvia launched another investigation into the progress of Citadele’s sale process. The investigation considered the sale price, resale bank period, provisions contained in the share sale agreement, expense of sell-side advisors, and expense of public relations services. The parliament released its final report on Citadele’s sale process in December 2015 (Parliament of Latvia 2015).

Communication

In early November 2008, Prime Minister Ivars Godmanis spoke to the press and presented a binary choice: either take control or Parex or allow it to enter bankruptcy. He said that the government had to protect Parex due to its size and importance in the Latvian banking system as a whole (AP 2008; Lannin 2008a).

BOL Governor Ilmars Rimsevics said: “This was an attempt by the Latvian authorities to step in earlier rather than later” (Anderson 2008). Latvian authorities said that Kargins and Krasovickis would not be excluded from the sales process once the liquidity crisis was over (Lannin 2008b).

The Ministry of Finance promised to publicly publish parts of the 77-page takeover agreement that did not contain confidential information (FCMC 2009b; Petrova 2008). Research has not uncovered any portion of the takeover agreement.

In a press release also in early November, the BOL said that the government would begin talks “in the nearest future” with private investors to return Parex to private ownership (BOL 2008b).

Disclosure

In a document dated May 2009, the FCMC said authorities initially limited information by classifying documents as “secret” or “restricted use information” according to the Law on the State Secret and Information Disclosure Law (FCMC 2009a, 1). The FCMC said this was to protect the interests and legal rights of those receiving financial services (for example, depositors), the state, and business participants—while acknowledging that this choice led to a “variety of interpretations” surrounding Parex’s rescue (FCMC 2009a, 1).

According to a parliamentary investigation, many of the documents related to the sale process of Citadele were assigned the status “limited availability information” (Parliament of Latvia 2015, 5). The parliamentary investigation commission unsuccessfully tried to declassify these documents to inform the public of the sale process (Parliament of Latvia 2015).

After the split, Citadele and Reverta published annual reports containing information on share capital and the sales process.

As of the end of 2008, total shareholders’ equity fell by 65% to LVL 77 million mostly due to increased loan loss provisions and losses on the securities portfolio (EC 2009c).

In its decision on September 15, 2010, the EC said that Kargins and Krasovickis, the two majority shareholders, adequately bore the burden of Parex’s failure because they were wiped out as equity holders after the government acquired their shares for a symbolic amount of LVL 2. The minority shareholders also bore this burden when their shares were diluted from 15% to 3%, according to the EC. The EC said that this use of bail-in sufficiently addressed burden sharing and “[served] as a valuable signal against moral hazard” (EC 2010).

Depositors

Most of Parex’s deposits were paid out or later transferred to Citadele (Baudino et al. 2022). A small number of big depositors were paid out from Reverta after authorities completely lifted the December 2008 partial deposit freeze on January 2, 2012 (see Key Design Decision No. 2, Part of a Package) (Baudino et al. 2022; FCMC 2008; Parex 2012).

Senior Syndicated Lenders

The senior syndicated lenders remained with the bad bank after the split on August 1, 2010 (EC 2010). All the loans were repaid by May 2011: The first was repaid with government liquidity support, and the second and third were repaid from the bank’s own resources (IMF 2013).

Subordinated Debtholders

Subordinated debtholders ultimately received nothing for their investments (EC 2008a; EC 2014b).

Two Majority Shareholders

The FCMC, Ministry of Finance, BOL, and two majority shareholders met at the beginning of November 2008 to discuss the government takeover of Parex. Although it was possible for the government to forcibly take control, complex legal procedures would have protracted the process and delayed State Aid. Thus, Latvian authorities decided to engage the two majority shareholders, Kargins and Krasovickis, together owning 85% of the bank’s shares (FCMC 2009b).

On November 10, 2008, Parex’s majority shareholders transferred 51% of the bank’s shares to LHZB for LVL 2. The two majority shareholders pledged the remaining 34% of the bank’s shares to LHZB. Therefore, although the two majority shareholders still technically owned 34%, LHZB exercised the voting rights for this 34% of shares as well. At the request of LHZB or the government, Kargins and Krasovickis had to cover any losses that were not duly reflected in Parex’s financial reports at the closing date of the agreement (EC 2008a). PwC investigated the authenticity of financial statements submitted by the two majority shareholders under the initial investment agreement on November 10 (FCMC 2009b). Per the initial agreement on November 10, Kargins and Krasovickis were entitled to repurchase shares from LHZB for LVL 2, plus the sum equal to 1% of the whole amount of funds granted under the agreement to the bank, provided that:

• At least 12 months elapsed from the signing date of the agreement;
• Parex repaid all subordinated loans that it received from the government;
• All the guarantees provided by the government with respect to the liabilities of Pares had been released;
• Parex had covered all expenses of the government and LHZB with respect to the financial assistance it received per the initial agreement;
• The government had not already sold Parex’s shares to a third-party investor (EC 2008a).

On December 3, 2008, LHZB took over 85% of Parex’s shares, thus removing the two majority shareholders. After the amended agreement, the two majority shareholders were removed from the board and were no longer entitled to first purchase of their shares back from LHZB (see Key Design Decision No. 1, Purpose) (EC 2009a; Reuters 2008).

Minority Shareholders

The minority shareholders were not affected by the initial investment agreement on November 10, 2008 (Anderson 2008; EC 2008a). The Swedish fund manager East Capital and the Swedish bank Svenska Handelsbanken AB (Handelsbanken) were among the minority shareholders (Anderson 2008; FCMC 2009b).

The minority shareholders were not affected by the amended agreement on December 3, 2008, since LHZB specifically took the shares belonging to the two majority shareholders, Kargins and Krasovickis (Anderson 2008; EC 2009a). One of the largest minority shareholders, Handelsbanken, volunteered to sell its 0.3% stake to LHZB for one eurocent (FCMC 2009b; Kolyako 2008). According to the Baltic Course, Handelsbanken exited to avoid a conflict of interest in case the Swedish government’s loan was used to strengthen Latvian banks (see Key Design Decision No. 2, Part of a Package) (Kolyako 2008).

The subsequent state recapitalizations and the capital injections by the EBRD in September 2009 diluted minority shareholders to 3.7% (EC 2009c; EC 2010; Parex 2009d).

After the split into good and bad banks, Citadele and Reverta, respectively, the minority shareholders remained with the bad bank (Citadele 2011a; Parex 2011).

The minority shareholders ultimately received nothing for their shares (EC 2008a; EC 2014b).

To minimize the use of state funds, the total amount of Tier 2 capital would not exceed 50% of the total amount of Tier 1 capital per the EC decision and capital injection on May 22, 2009 (EC 2009b; Parex 2011). If subsequent capital injections were necessary to maintain a minimum CAR of 11%, these capital injections needed to maintain the aforementioned ratio^FCitadele’s annual report for 2011 suggests that the bank wrote down its Tier 2 subordinated debt if it breached 50% of total Tier 1 equity capital in order to maintain the ratio in question (Citadele 2012). of Tier 2 to Tier 1 capital (EC 2009b).

Tier 1: Ordinary Shares

On May 22, 2009, the LPA injected LVL 140.8 million in the form of ordinary shares with voting rights for LVL 0.72 per share, qualifying as Tier 1 capital (EC 2009b; Parex 2011). Latvian authorities used net asset value (NAV) per share as an estimate of their market value, since Parex’s shares were not tradable on the market after nationalization. NAV calculations accounted for all provisions made by Parex through the end of March 2009 and PricewaterhouseCoopers’ due diligence report. As such, the weighted average cost for one share was LVL 0.72, while the NAV per share following recapitalization was LVL 1.01. Thus, the LPA received a discount of 29% on ordinary shares (EC 2009b).

At the time of the injection, the EC said that Latvian authorities did not foresee distribution of profits as dividends “in the near future” for three reasons. First, the purpose of the injection was to strengthen the bank’s capital base. Second, private minority shareholders had a stake in the bank. Third, Latvian authorities anticipated the sale of Parex to a third-party investor (EC 2009b).

Latvian authorities based the remuneration of ordinary shares (in other words, the government’s sale of ordinary shares to a private investor) on the recommendations of the European Central Bank (ECB) for the pricing of recapitalization instruments, adjusting the fee element considering that Latvia was not a euro area member state. Remuneration was calculated as the total value of: (a) the real costs of Treasury loan funds (at the moment determined as an annual yield of government domestic T-bills), (b) equity risk premium of 5%, and (c) add-on fee of 1% (EC 2009b).

On October 29, 2009, the LPA increased Parex’s share capital by LVL 24.3 million; these shares did not have voting rights to maintain the proportion of Parex share capital wherein the EBRD had 25%+1 share of ordinary shares with voting rights (Parex 2011).^FIn providing comments on this case study, Latvian authorities said that these shares did not have voting rights to maintain the proportion of 25%+1 held by the EBRD.

After the split into good and bad banks on August 1, 2010, the Tier 1 equity capital already injected remained with the bad bank, renamed Reverta (EC 2010).

One July 29, 2010, the LPA increased Citadele’s share capital by LVL 99 million, thereby achieving LVL 103 million of voting shares. No dividends were proposed and paid during 2010 (Citadele 2011a).

On December 30, 2010, the LPA increased Reverta’s share capital by LVL 9.7 million (Parex 2011).

Latvian authorities recapitalized Reverta by LVL 39.8 million in 2011. In August, the LPA injected LVL 20 million into Reverta through ordinary shares with a nominal value of LVL 1 per share and voting rights. In November, the LPA injected LVL 19.8 million in ordinary shares with voting rights (Parex 2012).

Tier 2: Subordinated Term Debt

On May 22, 2009, the Latvian government injected LVL 50.3 million in the form of subordinated term debt, qualifying as Tier 2 capital, into Parex (EC 2009b; EC 2010; Parex 2011). The interest rate was 8.8% (Citadele 2011b). The interest rate was calculated at the date of issuance according to the total value of: (a) the one-year interbank lending rate, (b) a credit risk premium for five-year senior loans determined as the median value of current five-year credit default swap (CDS) spreads for the rating category BB, based on a sample of banks chosen by the Treasury, (c) an add-on fee of 50 bps, (d) a subordinated loan service fee of 25 bps to the Treasury, and (e) a credit risk premium of 200 bps to capture the subordination effect and increased risk of the loan (EC 2008a).

After the split into good and bad banks on August 1, 2010, the Tier 2 subordinated loans already granted were transferred to the new good bank, Citadele. Citadele did not receive additional Tier 2 capital after the split while owned by the state (Citadele 2014; EC 2010).

Conversion of Liquidity Support to Capital

On February 26, 2010, the Cabinet of Ministers approved the conversion of liquidity support (term deposits) to bank capital, thus recapitalizing Parex by LVL 31.5 million (Parex 2010). Reverta ultimately converted a total LVL 49.5 million to capital as of December 2011 after which point no further conversions took place (EC 2014b). It is unclear to the author which capital increases comprised the remaining LVL 18 million of conversions from state term deposits to bank capital.

After the split into bad and good banks, Citadele converted liquidity support (term deposits) into equity for a recapitalization of LVL 103 million (EC 2010; Treasury 2011).

According to the Treasury’s annual reports, the Treasury extended loans to the LPA to fund Parex’s recapitalization (Treasury 2010; Treasury 2011). The EBRD also injected capital into Parex (see Key Design Decision No. 15, Exit Strategy).

With the initial investment agreement on November 10, 2008, the government determined a maximum contribution of LVL 200 million into Parex via subordinated loans, qualifying as Tier 2 capital, with a maximum maturity of five years (EC 2008a).

The EC approved Latvia’s request on May 11, 2009, to amend the form and amount of capital injected (see Key Design Decision No. 3, Legal Authority) (EC 2009c; EC 2010; Parex 2011). The March 29 request assumed that Parex would receive an additional LVL 12 million in subordinated loans, but it does not appear that the LPA injected additional Tier 2 capital beyond the initial LVL 50.3 million (Citadele 2014; EC 2009c; EC 2010). The EC also gave Latvian authorities permission to inject the necessary capital to achieve a CAR of 11% throughout government ownership of the bank (EC 2009b).

In total, the LPA provided LVL 313.6 million^FThis figure may be inconsistent because of lack of clarity about recapitalizations as capital injections or as conversions from liquidity support. in Tier 1 capital and LVL 50.3 million in Tier 2 capital (Citadele 2011a; EC 2009b; EC 2010; Parex 2011; Parex 2012). Recapitalization was also achieved by converting state term deposits from the Ministry of Finance into bank capital: LVL 49.5 million converted in Reverta and LVL 103 million converted in Citadele (EC 2010; Parex 2010; Treasury 2011).

On November 10, 2008, Latvian authorities notified the EC of public support measures (EC 2008a). The EC approved the measures on November 24, 2008, including the authorization of subordinated loans qualifying as Tier 2 capital (EC 2008a).

On March 29, 2009, Latvian authorities made a request to the EC to change the form and amount of capital injections authorized by the EC decision on November 24, 2008, to achieve a newly raised CAR of 11% during the rescue phase (see Key Design Decision No. 3, Legal Authority). The EC approved the amended measures on May 11, 2009 (EC 2009b).

The LPA made its first capital injections into Parex on May 22, 2009, 193 days after initial authorization from the EC and 11 days after amended authorization from the EC (EC 2008a; EC 2009b; Parex 2011). The LPA performed subsequent capital injections in Parex (before the split), Citadele, and Reverta (see Figure 4).

Figure 4: Timeline of Parex’s Recapitalization

Notes: The regulatory minimum for the CAR was 8% in 2008. On March 25, 2009, the FCMC raised the minimum CAR for Parex to 11% (EC 2009b; FCMC 2009b). The information in this figure may be inconsistent because of lack of clarity about recapitalizations as capital injections or as conversions from liquidity support.

Sources: Citadele 2011a; EC 2009b; EC 2010; Parex 2011.

The restructuring plan approved by the EC in September 2010 outlined a split of Parex into a newly-established good bank called Citadele and a remaining bad bank called Reverta (EC 2014a; Parex 2011). Citadele would focus on three core business segments in the Baltics: corporate, retail, and wealth management. Latvian authorities aimed to make Citadele profitable in a sustainable manner by reducing the size of its balance sheet. Reverta would keep all noncore and many nonperforming assets in addition to the senior syndicated loans and legacy subordinated liabilities (EC 2010). Reverta’s goals was to maximizes the recovery of State Aid. For more on the restructuring of Parex (see Decker [2024]) (Parex 2011).

Valērijs Kargins was the president and board chairman of Parex as well as one of the two majority shareholders (BBC 2008; Parex 2011). Viktors Krasovickis was also a board member and one of the two majority shareholders (FCMC 2009b; Parex 2011). They were removed from Parex’s management when the government partially nationalized the bank in November 2008 (BBC 2008; FCMC 2009b).

On July 30, 2010, Parex filed a claim against Kargins and Krasovickis for compensation for damages to the bank greater than LVL 62 million (Parex 2011; Republic of Latvia 2011). On August 16, 2010, the Riga District Court took up the claim and ordered Reverta to secure loss compensation that could have occurred from the enforcement of the decision. On November 15, 2010, Reverta (what was left of the bad bank) filed a request with the Riga District Court to reduce the security deposit (Parex 2011).

For more information on new management installed at Parex, Citadele, and Reverta, see Decker (2024).

For restrictions related to the government takeover and split of the banks, see Decker (2024).

After the split, the bad bank, Reverta, kept bad assets: Baltic nonperforming loans (NPLs), loans to legacy shareholders, Commonwealth of Independent States (CIS) leasing subsidiaries, and CIS NPLs. This was considered asset relief on the part of the good bank, Citadele. Per the restructuring plan, Citadele had to remunerate the state for asset relief. The remuneration was to be paid every year under government ownership in which Citadele’s CAR was at least 12%—as long as the relevant amount did not lead to losses in the relevant year (see Decker 2024) (EC 2010; EC 2012).

In March 2012, Latvian authorities told the EC that Citadele’s CAR may require an increase for compliance with Basel III, since the FCMC planned to implement Basel III rules as of January 1, 2013, without a transition period. Thus, Latvian authorities sought approval from the EC to change the threshold of the asset relief remuneration trigger, provided that the relevant amount did not lead to losses in the relevant year: The remuneration would be paid every year in which Citadele’s CAR was not lower than (a) the current minimum regulatory requirement as determined by the FCMC + 0.5% buffer, or (b) the future minimum regulatory requirements as determined by the FCMC up to one year before they are effectively in force + 0.5% buffer. The EC approved this change on August 10, 2012 (EC 2012).

Research did not uncover regulatory relief. In fact, Latvian authorities’ stated purpose for capital injections was to raise the respective CARs (EC 2009b; EC 2010).

According to an EC decision in May 2009, Latvian authorities said that they intended to sell the government’s ordinary shares as soon as the exit price was reasonable and achievable within three years of the initial intervention. Authorities simulated exit prices at different time periods to demonstrate that selling shares too soon would adversely impact remuneration (see Figure 5) (EC 2009b).