In January 2010, Banco Popolare offered its shareholders the option to subscribe to newly issued convertible bonds on the following terms: a nominal value of €6.15 per bond, an annual interest rate of 4.75%, maturing on 24 March 2014. Eighteen months after the issue, and therefore from 24 November 2011, bondholders are entitled to request early conversion, receiving in exchange a number of Banco Popolare shares equivalent in value to the nominal value of the bonds plus a premium of 10%. At the same time, the bank has the right to redeem the bonds, including in cash, to cover any shortfall in the value of the shares at the time of redemption. To service the loan, Banco Popolare’s shareholders had approved the issue of approximately 277 million new shares. In this way, the holders of the convertible bonds were, to a certain extent, protected against a possible future market crash… or at least that is how it appeared when looking at the markets in January 2010.
It is, unfortunately, plain for all to see that the situation has changed dramatically in the meantime: the FTSE Italia Banche index has plummeted by 58% since 24 March 2010 (the date of issue of the convertible bonds) and European banks are once again being forced to turn to the market to raise fresh capital (according to the EBA, the European Banking Authority, as much as 106 billion euros, of which at least 15 billion relates to Italian banks). Without wishing to delve into the merits of whether there is a genuine need to request further capital from shareholders, it is clear that Banco Popolare now finds itself in the precarious position of being forced to repay the holders of the convertible bonds, for the most part in cash, given that it is unlikely that the market value of the share will, in the medium term, be greater than or equal to the nominal value of the bonds, thus facing a cash outlay that is, to say the least, prohibitive for the bank in its current situation.
On 25 November, the shareholders of Banco Popolare will be asked to approve authorisation for the newly formed Board of Directors (which will be appointed at that meeting) to increase the number of new shares to be issued in connection with the convertible loan to up to 1.5 billion, which would almost double the 1.8 billion shares that make up the current share capital: a figure that far exceeds the 20% threshold for outstanding shares considered acceptable by the majority of corporate governance analysts! But will the resolution, which is bound to raise a few eyebrows, really cause harm to existing shareholders? Given current market conditions, which are unlikely to remain stable until 24 March 2014 (the bond maturity date), we can estimate that the Bank’s potential additional outlay to repay bondholders will exceed 800 million euros, on top of the issue of 277 million new shares.
We can expect several negative recommendations on the proposal to issue such a substantial amount of new shares, as well as on the proposed amendment to the loan conditions, given the opposition to our voting guidelines. However, such an approach risks being an example of one of the most common mistakes that advisors can make: applying the same analysis criteria to every issuer in any market context. The implicit risk of such an attitude can lead to research moving away from the contextual reality being analysed.
Any analysis should, instead, take full account of the environmental conditions and the specific characteristics of the issuer, adopting a degree of flexibility that, on the one hand, upholds the fundamental principles of good governance, whilst at the same time always having the long-term interests of investors as its paramount objective. When faced with an issuer that has suffered a 30.7% year-on-year collapse in profits in the last quarter and for which the EBA has required the establishment of a capital buffer of €2.8 billion, the potential outlay required to redeem all the convertible bonds could deal a severe blow to Banco Popolare’s balance sheets, and consequently to the financial interests of all its shareholders. Furthermore, it must be borne in mind that the convertible bonds were offered as an option to shareholders, who we can expect to constitute the largest proportion of current bondholders: if this were the case, the entire transaction would amount to a mere technical exchange, with no real impact on the interests of shareholders and bondholders.