Introduction
Directive 2014/59 on the recovery and resolution of financial institutions and Regulation 806/2014 on establishing the single resolution mechanism stipulate that if state aid is granted to a bank, it is automatically considered to be “failing or likely to fail” and it must be either resolved, if it is a systemic institution, or, otherwise, liquidated. The only exception is precautionary recapitalisation of solvent banks.
During the covid-19 pandemic banks acted as intermediaries through which aid in the form of subsidised loans and guarantees flowed to final beneficiaries. That raised the question whether there was indirect aid to banks, which could trigger the provisions for resolution or liquidation of Directive 2014/59 or Regulation 806/2014. Therefore, the Temporary Framework which later became the Temporary Crisis and Transition Framework explicitly stated that banks were not considered to be recipients of state aid for the purpose of preserving or restoring their viability. Therefore, Directive 2014/59 and Regulation 806/2014 were not activated. They were also not activated when banks themselves received state aid to remedy the harm caused by the pandemic primarily under Article 107(3)(b), but also under Article 107(2)(b).
Of course, there is also the possibility that injection of capital by a public authority into a bank does not qualify as state aid because the transaction is carried out on market terms. Although rare, it is not impossible, as attested by two recent recapitalisation measures both of which were found by the Commission to be free of state aid. Both concerned Romanian financial institutions: Exim Banca Românească [SA.11597] and CEC bank [SA.11598][1].
In both cases, the absence of state aid was primarily demonstrated by the fact that the cost of equity [i.e. the minimum return that would be acceptable to a private investor] was below the internal rate of return of the invested capital. Alternatively, the net present value of the invested capital, discounted at a rate equal to the cost of equity, was shown to be positive.
I. Recapitalisation of Exim Banca Românească
Exim bank is incorporated under private law and is virtually wholly state-owned [99%]. It is established as a specialised institution whose main objective is to provide credits for export or import operations, to enable investments from abroad and carry out other banking operations.
According to the Commission decision, “(17) Exim has a distinct status from other Romanian banks as it has a specific activity model through its two main roles:
(a) As a State agent, Exim performs specific activities in the name and on behalf of the Romanian State. Hence, the Bank intermediates the placement in the economy of funds allocated by the State budget for supporting the Romanian business environment through specific financing, guarantee and insurance products (’State activities’); and,
(b) As a commercial bank, the Bank carries out activities in its own name and account, providing legal entities and individuals with a broad range of banking products and services. These include, in particular, deposit-taking, lending, payment services, foreign exchange operations, and other standard financial services, offered under conditions of market competition with the other banks in the Romanian banking sector (’Commercial activities’).”
Exim sought to strengthen its capital base, improve its performance and raise its profitability. For this purpose it prepared a comprehensive business plan with the help of outside consultants – PWC. This plan foresees a significant injection of fresh capital.
The capital injection was notified for legal certainty, as Romania considered that it conformed with the market economy investor principle [MEIP] and therefore it was free of state aid.
The recapitalisation measure
“(33) According to the proposal presented by the Romanian authorities, the capital injection will be carried out through a direct recapitalisation in the amount of RON 1 250 million (ca. EUR 245 million), with the Romanian State purchasing maximum 205.96 million new shares with a value of RON 6 per share to be issued by the Bank, thereby increasing the share capital (initially composed of 128.75 million registered shares with a value of RON 6 per share).” In other words, the Romanian will own 99% of the new shares.
The business plan
It covers the period 2023-2032 and its based on projected earnings and costs identified in PWC’s report. “(37) The Report features four scenarios:
(a) Base-case scenario with capital increase,
(b) Base-case scenario without capital increase,
(c) Worst-case scenario with capital increase,
(d) Worst-case scenario without capital increase.”
“(40) Since growth targets exert pressure on the Bank’s available capital buffers, achieving the Bank’s strategic objectives under the base-case scenario requires a capital injection of RON 1 250 million (ca. EUR 245 million). The main version of the Business Plan addressing the strategic goals represents the base-case scenario with capital increase.”
“(42) The Report provides an estimation of the Cost of Equity (’CoE’) of the Bank, which it puts at [10-15]% for all scenarios. The formula for establishing CoE in the Report is based on the Capital Asset Pricing Model (’CAPM’) that considers a risk-free rate, a country-risk premium, a beta coefficient estimate for the banking sector in Central and Eastern Europe and an equity market risk premium.”
In the base-case scenario with capital increase, it expects “(51)(d) increase[d] ROE from 4.4% at end-2024, first to [7-9]% at end-[year] and then to [10-15]% at end-2032 in line with increasing profits, surpassing the average for comparable Romanian banks (average ROE for mid-sized Romanian banks: 10.1%). Following the capital injection in 2025, retained earnings will represent the main element forming the Bank’s equity. No distribution of dividends is foreseen for the period until [year].”
The expected “(55) internal rate of return (‘IRR’) will be [13-17]% meaning that the value of the share capital injection would be recovered from incremental cash flows over [7-10] years. Conversely, if loan growth aligns with the market level average over the tested period, the IRR will stand at [12-14]%.
In the base-case scenario without capital increase, the “(60)(d) ROE from 4.4% at end-2024 is expected to improve, but less than in the base-case scenario with capital increase, to [8-12]% at end-2032 (versus [10-15]%) close to comparable banks. Retained earnings will represent the only element forming the bank’s equity and no distribution of dividends are foreseen for the period until [year].”
In the worst case scenario with capital increase, “(60) the IRR […] is estimated at [13-15]% which means that the value of the share capital injection would be recovered from incremental cash flows over [5-8] years.”
Commission assessment
Since Romania claimed that the measure did not involve state aid, the Commission only had to examine and confirm that it did not confer any advantage to Exim bank; i.e. it conformed with the MEIP.
First, the Commission explained how it would assess conformity with the MEIP and to this extent it referred to its own 2016 Notice on the Notion of Aid. There are broadly three methods: comparison with an actual co-investor [the pari passu method]; comparison with the return obtained by private investors in similar situations; and assessment of the expected profitability of the actual investment.
“(83) The Commission assesses whether a market economy investor would have made the same investment in the Bank under the same conditions as Romania intends to do. For that purpose, the Notice on the notion of aid (‘the Notice’) provides various methods. Paragraph 101 of the Notice notably highlights that the compliance with the MEIP can be established among others on “the basis of a generally accepted, standard assessment methodology”. By using that methodology, the Commission ascertains the measure’s economic rationale by assessing whether, in the same circumstances, a private investor would have invested a comparable amount in Exim.”
“(84) In the absence of a co-investor, the Commission could assess the investment by benchmarking against investments into comparable banks carried out by private investors. However, since no comparable transaction has been identified, this method is not deemed appropriate.”
“(85) Therefore, in the present case, the Commission has used a methodology that primarily relies on a set of relevant quantitative indicators to assess the IRR or the Net Present Value (‘NPV’) of the proposed investment.”
Then the Commission observed that “(86) as the Romanian State is already the majority shareholder of Exim and will remain so after the capital injection, the IRR calculation needs to take into account the prior exposure of the Romanian State (already present in the Bank as investor) and consider the counterfactual without the capital increase. To assess whether the equity investment is made on market terms, the IRR, stemming from the difference between the capital increase scenario and the scenario without the increase, must be higher than the expected market return, i.e. the Bank’s CoE. Equivalently, the NPV of the capital injection, when discounting at the CoE, must be positive, or expressed differently, the equity value of the firm must increase by more than the invested funds.”
“(87) Furthermore, to assess the longer-term viability of the Bank, a prudent market investor would consider the ROE that the Bank can generate over the Business Plan period. As the ROE reflects the maximum return that the average investor holding the Bank’s shares would obtain, the Bank is considered profitable if it can generate enough income to adequately remunerate its shareholders by the end of the Business Plan. Concretely, this means that the Bank’s ROE needs to be higher than its specific CoE towards the end of the Business Plan period, i.e. before 2032. However, that approach alone does not take into account the specificities of the investment. As such, the ROE serves to complement the IRR and NPV approaches for a broader assessment.”
Furthermore, “(88) As described in paragraph 101 of the Notice, the robustness of the valuation should be “corroborated by performing a sensitivity analysis, assessing different business scenarios, preparing contingency plans and comparing the results with alternative evaluation methodologies”.”
Assessment of the CoE
“(92) The Commission considers the [10-15]% CoE, as established in the Report, to be in line with Exim’s risk profile following the standard methodology of a CAPM that considers the country-specific risk of Romania. This CoE figure reflects (i) the yield of the Romanian government bonds with a remaining maturity of 10 years; (ii) the country-specific risk premium for investing in Romania as an emerging economy, which is reflected by the differential between the Romanian government bond and the “safe interest rate”, as approximated by the German bond yield; (iii) the inflation differential of the Romanian Leu to the Euro, which is assessed by comparing the rates of Romanian 10-year government bond issued in Euro and in Leu; and (iv) the sector-specific risk of investing into the banking sector in Central and Eastern Europe, which is assessed by calculating the co-movement of stock prices of banks in this sector with the overall market (the so-called “equity beta”). The estimated CoE of [10-15]% then represents the third quartile of a range from [10-15]%, which is the CoE calculated using the 1st quartile of estimated equity betas, to [10-15]%, which is the CoE calculated using the 3rd quartile of estimated equity betas. The Commission finds it to be reasonable to choose the third quartile of this range for Exim, as the Bank is below the average compared to the overall Romanian banking sector in terms of profitability, net interest rate margin, cost efficiency, non-performing loans and capitalisation. As such, it is prudent to compare Exim to the riskier peer firms in the analytical sample.”
“(93) A CoE of [10-15]% is consistent with a pricing of Exim’s newly contracted subordinated loans”.
“(94) The Commission acknowledges that the [10-15]% CoE appears to be an appropriate value that likely approximates the opportunity cost of investing in the Bank’s equity. As such, in line with paragraph 103 of the Notice, the Commission considers the MEIP test is met if the IRR, based on plausible and well-elaborated predictions for future cash flows generated by the investment, exceeds the CoE or if, equivalently, the NPV when using the CoE as discount rate is positive. A long-term ROE that exceeds the CoE further suggests profitability in the long run.”
The Commission also assessed the capital injection according to financial metrics. “(97) The submitted Report with a private investor test based on the Business Plan states that the capital increase will have an IRR of [14-17]% (in the high-growth scenario). In addition, Exim will achieve by the end of the investment horizon, a ROE above the Bank’s CoE of [10-15]%. The discounted equity value of the Bank would increase from RON [500-1,000] million to RON [2.5-3.5] billion (an increase larger than the value of the capital injection of RON 1.25 billion). These financial forecasts would meet the expectations of a private investor and thus the capital injection would be compliant with the MEIP.”
The Commission also examined and accepted the quantitative sensitivity analysis whose purpose was to test the proposed capital injection’s profitability. It also carried out a qualitative assessment of the business plan and considered the plausibility of the various assumptions and projections on which the business plan was based.
Overall, the Commission concluded that the recapitalisation of Exim bank conformed with the MEIP.
II. Recapitalisation of CEC bank
CEC bank is fully owned by the Romanian state, but it has no development or promotional arm. It is a commercial bank that used to be based on a rather simple business model of taking deposits and granting loans. However, over the past two decades it has transitioned from a savings bank to a universal commercial bank, competing in retail, small and medium enterprises and corporate banking segments. It offers a wide range of products to both individuals and businesses.
In 2019, the CEC was also recapitalised by Romania with an injection of about RON 940 million (EUR 200 million). That capital injection sought to accelerate the loan growth of the bank and upgrade its aging IT system. The Commission found the 2019 recapitalisation to be free of state aid as it conformed with the MEIP [SA.53869].
The Commission noted in its 2025 decision that CEC had above average non-performing loans [NPL] and below average profitability and net interest income. [paragraph 18]
The 2025 recapitalisation is to be carried out through an injection of “(21) RON 1 billion (ca. EUR 200 million), with the Romanian State purchasing 10 million new shares with a value of RON 100 per share to be issued by the Bank, […] Romania will remain the sole shareholder of the Bank.”
The recapitalisation is justified by an ex ante business plan which is based on two scenarios: “base-case scenario” and a “worst-case scenario”. CEC formulated the business plan with input from an external consultant who prepared a report outlining the two scenarios. “(28) The Report is elaborated under the following four sets of assumptions:
(a) Base-case scenario with capital increase,
(b) Base-case scenario without capital increase,
(c) Worst-case scenario with capital increase,
(d) Worst-case scenario without capital increase.”
“(33) The Report provides an estimation of the Cost of Equity (‘CoE’) of the Bank, which it puts at [10-15%]. The formula for establishing CoE in the Report is based on the Capital Asset Pricing Model (‘CAPM’) that considers a risk-free rate, a country-risk premium, a beta coefficient estimate for the banking sector in Central and Easter Europe and an equity market risk premium.”
Commission assessment
The Commission decision reiterates largely the same methodological approach as in the case of Exim bank.
“(72) To assess its profitability, the Commission, following the Notice, could, in the absence of a private co-investor, assess the investment by benchmarking against investments into comparable banks carried out by private operators or through other assessment methods, such as the calculation of the Internal Rate of Return (’IRR’) or the Net Present Value (‘NPV’) of the proposed investment. Since benchmarking for a mid-sized non-traded bank, these other assessment methods are more appropriate for assessing compliance with the MEIP.”
“(73) Accordingly, regarding the return on investment to be made by Romania, the Commission has assessed the recapitalisation on the basis of common financial methods such as the IRR. As the Romanian State is already the sole shareholder of CEC and will remain so after the recapitalisation, the IRR calculation needs to take into account the prior exposure of the Romanian State (already present in the Bank as investor) and consider the counterfactual without the capital increase. To assess whether the equity investment is made on market terms, the IRR, stemming from the difference between the capital increase scenario and the scenario without the increase, must be higher than the expected market return, i.e. the Bank’s CoE. Equivalently, the NPV of the recapitalisation, when discounting at the CoE, must be positive, or expressed differently, the equity value of the firm must increase by more than the invested funds.”
“(74) Furthermore, to assess the longer-term viability of the Bank, a prudent market investor would consider the Return on Equity (‘RoE’) that the Bank can generate over the Business Plan period. As the RoE reflects the maximum return that the average investor holding the Bank’s shares would obtain, the Bank is considered profitable if it can generate enough income to adequately remunerate its shareholders by the end of the Business Plan. Concretely, this means that the Bank’s RoE needs to be higher than its specific CoE towards the end of the Business Plan period, i.e. before 2032. However, that approach alone does not take into account the specificities of the investment. As such, the RoE serves to complement the IRR and NPV approaches for a broader assessment.”
Assessment of the CoE
“(79) The Commission considers the [10-15%] CoE, as calculated/established in the Report, to be in line with CEC’s risk profile following the standard methodology of a CAPM with country risk. This CoE figure reflects (i) the level of interest rates in Romania of 5.6% at the time of the assessment, which was end-of-year 2023; (ii) the country-specific risk of investing in Romania as an emerging economy, which is reflected in its 10-year government bond spread over the “safe interest rate” approximated by the German 10-year bond; (iii) the inflation differential of the Romanian Leu to the Euro, which is assessed by comparing the rates of Romanian 10-year government bond issued in Euro and in Leu; and (iv) the sector-specific risk of investing into the banking sector in Central and Eastern Europe, which is assessed by calculating the co-movement of stock prices of banks in this sector with the overall market (the so-called “equity beta”). The estimated CoE of [10-15%] then represents the midpoint of a range from [10-15%], which is the CoE calculated using the 1st quartile of estimated equity betas, to [10-15%], which is the which is the CoE calculated using the 3rd quartile of estimated equity betas. The Commission finds it to be reasonable to choose the midpoint of this range for CEC, as the Bank is close to the average of the Romanian banking sector in terms of profitability, net interest rate margin, cost efficiency and capitalisation”.
At this point it should be noted that at the time of the Commission decision, the German 10-year bond yield was 2.1%, while the Romanian 10-year government bond yield was 5.6%. Moreover, the inflation differential, as revealed by the difference in nominal rates between Euro and Leu bonds, was 0.7%.
The Commission went on to acknowledge that “(80) the [10-15%] CoE appears to be an appropriate value that likely approximates the opportunity cost of investing in the Bank’s equity. As such, in line with paragraph 103 of the Notice, the Commission considers the MEIP test is met if the IRR, based on plausible and well-elaborated predictions for future cash flows generated by the investment, exceeds the CoE or if, equivalently, the NPV when using the CoE as discount rate is positive. A long-term RoE that exceeds the CoE further suggests profitability in the long run.”
“(84) The submitted private investor test based on the Business Plan states that the capital increase will have an IRR of [15-25%] (in the base-case scenario, with capital increase). In addition, CEC will be able to increase its NPV, and achieve, already in 2025, a ROE above the Bank’s cost of equity of [10-15%]. The equity value of the Bank would increase from RON 6.3 billion to RON [5-15] billion (an increase larger than the value of the recapitalisation of RON 1 billion). These financial forecasts would meet the expectations of a private investor and thus the recapitalisation would be compliant with the MEIP.”
“(85) Under the assumptions in the Commission’s sensitivity analysis, […], the investment’s IRR reduces to [10-20%], which is still above the Bank’s CoE. The reason is that the Bank is currently profitable and thus, even without strong loan volume growth, the capital increase could support lending to the growing Romanian market. Likewise, the NPV of the recapitalisation is positive even if loan growth is in line with expectations for the Romanian market. Lastly, CEC’s ROE path in this scenario still surpasses its CoE of [10-15%] in 2025 and remains above this threshold value thereafter until 2032. The equity value of the Bank would increase to RON [5-10] billion, which is an increase of RON [0-5] billion and thus larger than the recapitalisation of RON 1 billion. Accordingly, even under the less favourable assumptions of the Commission’s sensitivity analysis, less optimistic than those in the submitted Report and Business Plan, the financial forecasts would meet the expectations of a private investor and thus the recapitalisation would be compliant with the MEIP.”
The Commission, as in the case of Exima bank, also carried out a qualitative assessment of the CEC’s business plan and concluded that it supported the results of the financial calculations.
Therefore, it decided that the recapitalisation of CEC was free of state aid.
[1] The full text of the Commission decision can be accessed at:
https://ec.europa.eu/competition/state_aid/cases1/202521/SA_115898_61.pdf
