# The warrants explained



## goosebump (22 Sep 2009)

*Re: The Government were right not to nationalise AIB and Bank of Ireland*



Brendan said:


> Kaplan - That was my original understanding as well. But I have seen quite a few people claiming that we own 25% of the banks so we will benefit from the uplift. If the banks can buy back the preference shares, so our warrants diappear?



Warrants attach to the Preference Shares that can be converted into ordinary shares at discounted strike prices. These warrants can only be exercised after 5 years and within 10 years.

Conversely, the banks has the option to buy back the preference shares at par within 5 years and at 125% of par after 5 years.

As such, it a mechanism to encourage the banks to raise new capital, and not really an ownership mechanism.

That said, the arrangement does allow the State the right to appoint Directors, so it retains some of the benefits of ownership.

However, it can't be seen as an investment in the normal sense of the word. Furthermore, the banks may well use the NAMA funds to immediately buy back the preference shares, which would immediately reduce the NAMA bill by €7bn.


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## Brendan Burgess (22 Sep 2009)

I copied this from another thread, as I think this important issue needs clarification. 

I have read, and accepted, that the government "owns" 25% of the banks and so will benefit from any upturn. But if there is a dramatic upturn within 5 years, the banks will repay the preference shares and the warrants will be worthless. 

If there is no dramatic upturn, then the preference shares will not be repaid, but the warrants won't be worth anything either. 

I supported nationalisation initially but changed my mind partly because the taxpayer was due to benefit from 25% of the increase in value of the shares anyway. 

So why not just give the taxpayer straightforward options on the banks anyway as part of the NAMA deal? This could be instead of the warrants or as well as them? 

Brendan


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## Sunny (22 Sep 2009)

Don't forget that the preference shares paying a dividend of 8%. Thats a decent return to the taxpayer.

Also the banks can't use NAMA cash to buy back the preference shares. They must use privately sourced core tier 1 capital which means the banks will only be able to buy them back if they can successfully carry out a rights issue or through retained earnings.


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## Brendan Burgess (22 Sep 2009)

Hi Sunny

I don't agree that the 8% is a particularly good return for Preference shares. It seems high, but it's very risky capital, with no potential upside.

AIB is paying 12.5% to ordinary punters for 2019 bonds 

Maybe the warrant compensates for the difference? 

brendan


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## Sunny (22 Sep 2009)

Brendan said:


> Hi Sunny
> 
> I don't agree that the 8% is a particularly good return for Preference shares. It seems high, but it's very risky capital, with no potential upside.
> 
> ...


 
The pricing of these things are a bit above me Brendan. I agree that 8% could have been higher but if you remember at the time, it was a conscious decision not to charge too much because of the burden it would place on the banks. From what I can remember, the UK charged 12% on it's preference shares but didn't take warrants and the programme was criticised. The US I think charged 5% but took warrents. 
I think EU guidelines on State Aid indicate a dividend of between 7 and 9%.

When I say the National Pension Fund is getting a good return, I simply mean we are getting around €500m a year in dividends. It's a lot of cash and more than it would probably have earned anywhere else. You could argue that the banks should have been charged 12% but the banks probably could have argued that to afford paying those dividends would have put too much pressure on it's earnings. 12% equates to €480m from BOI and AIB alone. You would have been taking significant earnings out of the bank at the same time that they were trying to build up capital. 

I do agree though that I wouldn't call it an investment. It is a loan from the taxpayer to the banks. There is no benefit to the taxpayer from any share price upside.


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## z109 (22 Sep 2009)

And the taxpayer doesn't actually own any percentage of the banks until and unless the warrants are exercised. 

One bit I am not clear on. Do the warrants cover a set percentage of shares, a monetary value or a set amount of shares?


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## Sunny (22 Sep 2009)

yoganmahew said:


> And the taxpayer doesn't actually own any percentage of the banks until and unless the warrants are exercised.
> 
> One bit I am not clear on. Do the warrants cover a set percentage of shares, a monetary value or a set amount of shares?


 
*Form:* 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.
*Strike Price**:* The strike price of the Core Tranche of the Warrants shall be €0.975 for Allied Irish Banks and €0.52 for Bank of Ireland. The strike price of the balance of the Warrants granted to the State shall be €0.375 for Allied Irish Banks and €0.20 for Bank of Ireland.
*Anti-dilution**:* Market standard anti-dilution protection will apply. 
*Voting**:* The State will vote no more than 50% of the votes associated with the ordinary shares which it receives through exercise of the Warrants. If the State transfers the ordinary shares to a non-State third party, full voting rights will be restored to these shares.


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## z109 (22 Sep 2009)

Thanks Sunny. These are pretty good warrants then. Realistically speaking, it is in the state's interest to keep BoI and AIB zombie like for the next few years and exercise the warrants...


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## Brendan Burgess (22 Sep 2009)

> These are pretty good warrants then.



For the bank shareholders maybe, but not for the warrant holders.

If the banks recover, which we all hope that they will, then the warrants will be worthless as the banks will simply void them by paying off the Preference Loans. 

if the banks don't recover, they will be worthless anyway.

Straightforward share options would give the taxpayer much more upside. 

Give the options to NAMA. 

Brendan


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## z109 (22 Sep 2009)

Brendan said:


> If the banks recover, which we all hope that they will, then the warrants will be worthless as the banks will simply void them by paying off the Preference Loans.


Careful with the all, as I said above, the warrants have more value if the banks don't recover.



> if the banks don't recover, they will be worthless anyway.


Well, maybe. If the warrants convert the preference shares to equity, that will result in a balance sheet improvement for the banks as a liability has been converted to an asset. No?



> Straightforward share options would give the taxpayer much more upside.


I agree. But it is too late for that.



> Give the options to NAMA.


I disagree - give them to the NTMA - a body that is, at least, a bit more transparent than NAMA is looking at the moment and that has the capabilities of managing equity stakes. Adding more stuff to NAMA is a bad idea. The chances of it being able to run the largest REIT in the world are already slim. Adding further complexity won't help.


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## Duke of Marmalade (22 Sep 2009)

Guys I think we are getting this a bit skewways.


			
				Government Announcement of Prefs said:
			
		

> 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.


This facility to cancel the warrants only exists until December this year and even at that is somewhat limited. The idea was to give the banks a bit of time to replace the prefs with privately sourced capital. In practical terms I don't think this is going to happen, therefore the Government is indeed sitting on some nice in the money warrants/options.


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## Sunny (22 Sep 2009)

Duke of Marmalade said:


> Guys I think we are getting this a bit skewways.
> This facility to cancel the warrants only exists until December this year and even at that is somewhat limited. The idea was to give the banks a bit of time to replace the prefs with privately sourced capital. In practical terms I don't think this is going to happen, therefore the Government is indeed sitting on some nice in the money warrants/options.


 
Very good point. I thought that since the warrants were attached to the preference shares, they go when the preference shares are bought back by the banks but that does not appear to be the case. Well spotted.


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## Brendan Burgess (25 Sep 2009)

Thanks Duke and Sunny

That is the great thing about Askaboutmoney and discussion forums generally. 

I claim that the government owns 25% of the banks and has made a big profit. 
Sunny "corrects" me. 
Duke corrects Sunny with the verbatim quote. 

This is the appendix to the press release



> Warrants​ Form: 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.
> 
> 
> Early redemption: If the bank redeems up to €1.5bn 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% (the “Core Tranche”) of the existing ordinary shares of the bank.
> ...



So the government has a core option to buy 15% of AIB at €0.975 per share and 15% of Bank of Ireland at €0.52 per share. 

The government has a further option to buy 10% at €0.375 and €0.20. If Bank of Ireland raises €1.5 billion before the end of this year, they could extinguish this option. 

At a share price of €3 Bank of Ireland is worth €3 billion. 
In simple terms, the government can buy  €300m (10%) of this for €20m making a profit of €280m. (The option is worth much more than this as it has up to ten years to be exercized and has no carrying cost)

If the Bank raises €1.5 billion, it wll get an immediate 18% return on its money. 

If the loans are sold off to NAMA before the end of the year, as seems likely, then the Bank will have to give this serious consideration.

The problem is that the Bank has to raise €1.5 billion anyway to restore its capital ratios after the property loans write-offs.  So getting another €1.5 billion would be very difficult.

Brendan


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## GSheehy (25 Sep 2009)

What would be the consequences for banks & shareholders if the Government excercised the options in both banks at current share prices?


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## Brendan Burgess (25 Sep 2009)

The banks would get another €300m capital injection - I am not sure of the exact figure. 

The shares would be diluted and so the share price would fall - however, this has already been reflected in the price. 

Brendan


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