Robert Anderson in Prague -

The privatisation of Citadele banka, which was finally completed on April 20, symbolises Latvia’s belated recovery from the collapse of the Baltic economic miracle.

The failure of the bank – then named Parex – during the global financial crisis in November 2008 forced Latvia to seek a €7.5bn bailout from the International Monetary Fund and the EU, and came close to breaking the lat’s fixed exchange rate peg. “It happened at exactly the wrong time,” recalls Morten Hansen, head of the Stockholm School of Economics in Riga.

More than six years on, Latvia has recovered strongly (though real GDP is still 6% lower than before the crash) and it was able to join the Eurozone in January 2014.

Latvia’s turnaround was a key draw for the winning bidder, Ripplewood Advisers, a US private investment company led by Tim Collins, famous for his buyout of Japan’s insolvent Long Term Credit Bank in 1999. Ripplewood brought in 12 co-investors, reportedly including Paul Volcker, former chairman of the US Federal Reserve, James Wolfensohn, former head of the World Bank, and Egyptian construction billionaire Nassef Sawiri.

However, the failure to sell the rump of Parex until now demonstrates both the depth of the bank’s problems and the challenges of doing banking deals in Central and Eastern Europe since the global financial crisis.

Preserving value

Parex, founded in 1992 by Valery Kargin and Viktor Krasovitsky, had grown to become Latvia’s second largest bank by assets through servicing Russian capital flight. But it also extended risky loans to clients from the former Soviet Union, and became overexposed to the Latvian property bubble. In the global financial crisis, it was unable to secure wholesale funding and, as rumours grew, it suffered a run on deposits and the state was forced to take it over. The state put in €1.75bn of aid, including guarantees, while in April 2009 the European Bank for Reconstruction and Development (EBRD) agreed to inject €84m of equity, plus €22mn of subordinated debt.

In August 2010 the bank was divided into a good bank, renamed Citadele, in which the state held 75% and the EBRD 25%, and a bad bank called Reverta. Shareholders were wiped out, but all bonds were honoured, with the exception of €76mn of subordinated debt.

In 2011 the state made its first attempt to sell the bank, using Nomura as an adviser. But the process was abandoned in November after the collapse of Snoras Bank in neighbouring Lithuania and the deepening of the Greek debt crisis.

A second attempt was launched in July 2013, this time with Societe Generale as adviser. The financial climate was initially much more propitious, but it worsened again in early 2014 as Russia annexed Crimea, and the EU investigated whether Latvia had breached state aid rules in rescuing Parex. “The clouds appeared and it started to rain,” says Vladimirs Loginovs, chairman of the Latvian Privatisation Agency.

Hard sell

By mid-2014, a year into the new process, Societe Generale was faced with two serious time constraints. Latvia was to hold general elections in October, which would inevitably politicise the deal. Even more worryingly, though the EU had cleared Latvia of breaching state aid rules, it was still insisting that a buyer had to be found by September. “We were standing with our back against the wall and the investors knew that,” says Loginovs.

A share purchase agreement (SPA) was eventually drawn up by the EU deadline, but Loginovs’ predecessor at the privatisation agency resigned in October rather than sign it, further delaying the deal. The SPA was finally signed in November, once the government had been re-elected. Prime Minister Laimdota Straujuma said the price was “the best we could hope for”.

The sale process has always been controversial and remains so (a parliamentary inquiry is still ongoing). “I have rarely seen a process under such scrutiny, both at the local and EU levels,” says Stanislas Lecat, who ran the process for Societe Generale. “It was quite staggering.”

Partly this reflects the fact no well known strategic bidders took part in the tender. Latvia is a small banking market already dominated by Swedbank and SEB of Sweden. Banks already present in Central and Eastern Europe are currently more in the business of downsizing than expanding, while newcomers to the region are unlikely to start with a punt on an insolvent Latvian bank. “Banks are trying to decrease the geographies they are operating in,” says Loginovs. “Everybody is trying to concentrate on where they are strong.”

From the original 14 potential bidders who received the information memorandum, three finally submitted binding offers. “The Ukraine crisis was another constraint in managing the process, and played a role in reducing the appetite of some of the bidders,” says Lecat.

Ripplewood discounted the impact of the Ukraine crisis. “The mismatch between market perceptions [of risk] and reality creates interesting opportunity for people like us,” says Elizabeth Critchley, Ripplewood’s managing partner. 

Under an “investment club” model, Ripplewood agreed to take a 22.4% stake, and recruited 12 investors to buy the remaining 52.6%. The EBRD agreed to keep its 25% stake to provide comfort to the buyers, and extended its subordinated debt.

Price was the second main source of controversy. According to local media, Ripplewood’s bid was not the highest, but Loginovs says the three final bids were within 10% of each other, so other criteria were the deciding factors.

The price of €74m for the state’s 75% stake represents around 0.6-times book value. Even at today’s depressed valuations, that looks pretty cheap for a bank in which the bad assets have been carved out. However, this is partly explained by the fact that Citadele was undercapitalised because of EU restrictions. Its Tier 1 capital at the end of 2014 was 10.4%, compared with an average of 17.9% for the rest of the sector.

What made the sale even more stormy was that details of an EBRD put option, agreed in 2009, were leaked just a few months before the SPA was signed. In the event, on completion the state instead compensated the EBRD for the loss in value of its 2009 investment, which the development bank then reinvested in Citadele. The net result was that the state had to give the EBRD €74m, wiping out its proceeds from selling its 75% stake. The state had in effect sold its stake for nothing.

The final balance

Yet despite the fact the sale took six years, the rescue of Parex did end successfully, especially considering the constraints the government faced. “If Parex had not been saved, it would have been an avalanche for the entire [banking] sector,” says Loginovs. He estimates that of the original €1.7bn in state aid, €1.2bn will eventually be recovered.

Moreover, Citadele has now been rebuilt as one of the strongest locally-owned players, with a relatively low exposure to non-resident deposits. It is the sixth largest bank overall, with €2.33bn of assets, compared with €4.9bn before Parex collapsed.

Now the EU restrictions are lifted, Ripplewood has ambitious long-term plans to increase the bank’s market share in the retail and small business segments, and to expand its footprint in Lithuania and Estonia, possibly by acquiring the operations of retreating Scandinavian banks. “If you put together the direct and indirect impact, the taxpayer can be quite happy,” argues Guntis Belavskis, Citadele’s executive chairman.