ECB holds Popular’s feet to the flames

By:
Dominic O’Neill
Published on:

Even after a third capital raising in June, the difficulty funding Banco Popular’s real estate spin-off shows how much uncertainty remains in Spanish banking. As new CEO Pedro Larena attempts another rescue, a sale could be the only answer. But any rescue-by-merger will need sweeteners for the acquirer.

Pedro Larena flames-600
Illustration: David Manion

 

IN ADDITION



After Italy’s Monte dei Paschi di Siena, Spain’s Banco Popular is fast becoming the favourite southern European bank stock to short. Investors are losing patience with the lack of action to increase provisioning and offload non-performing loans, despite a €2.5 billion rights issue in June that was supposed to help it do just that. 

Popular’s shares have dramatically underperformed the sector as it posted new losses in its second- and third-quarter results, sparking fears that the capital raising was not enough to cover the holes in its balance sheet. Since the summer, its market capitalization has dropped by an amount not far off the capital raising, around €1.8 billion. This comes after the bank raised a similar amount from investors in 2012 and only three years after a €450 million capital increase from new Mexican investors. 

Popular’s rights issue in June – the biggest Spanish primary market equity deal of 2016 and led by UBS and Goldman Sachs – was oversubscribed. A discount of 47% to the previous market close helped. In hindsight it was remarkably good timing, coming just before the Brexit vote led to a renewed sell-off in European shares. 

But Popular still appears the most risky of the big banks in the third-quarter Euromoney Bank Risk survey for Spain, which collects the views of equity and debt analysts across 14 criteria. Popular’s lowest score is for asset quality at just 3.2 out of 10.

Compared with Italy, Spain took relatively rapid action after the eurozone crisis to clean up its banks’ balance sheets and improve its judicial framework for bad-loan workouts. This partly explains why its economic recovery has been surprisingly robust.

"The banking environment in Spain is benefiting from one of the fastest-growing economies in Europe and a declining level of unemployment," says Rami Aboukhair, Spain country head at Santander.

Spain’s average overall Euromoney bank risk score is 6.9, well above Italy (5.7) and Portugal (4.2), though lower than Turkey (8). Banco Popular’s predicament drags down Spain’s score and shows how risks remain, particularly at the mid-tier and small Spanish banks. 

This is despite the fact that government-supported M&A deals have drastically reduced the number of regional savings banks. Banks still held around €120 billion of Spanish non-performing loans in mid-2016. 

When I attend the board meetings, I don’t see any fighting. We are doing everything needed to make the plan work
 
- Pedro Larena,  Banco Popular

Banco Sabadell, another mid-tier lender, comes second to bottom of the EBR survey, also scoring particularly badly for asset quality (if much better than Popular). Sabadell has managed to reduce bad debts more rapidly than Popular, bringing its Spanish bad-debt ratio below 10% this year.

"Investors can see beyond our legacy exposures, as we’re reducing them faster and our revenues are more resilient than other banks," says Albert Coll, Sabadell’s head of institutional policy and market relations.

On the other hand, analysts who responded to the survey express fears that a global economic or domestic political crisis could bring Spanish bank risks back to the fore, triggering another fall in local real-estate prices and transactions and a subsequent halt to the reduction of non-performing assets. In a worst-case scenario some wonder if the state-backed bad bank itself, Sareb, could go bust.

Emergency

Banco Popular's CEO of just three months’ standing, Pedro Larena, is already facing an emergency, as the ECB pressures him to deal with a non-performing loan ratio of 16.5% in the third quarter and a well-below average coverage ratio of 39%.

Trying to give upward momentum to Popular’s shares after its most recent results announcement, Larena announced 2,600 lay-offs and 300 branch closures in late October. But perhaps even more important to Popular’s survival is a plan he discussed at the same time to spin-off €6 billion of its least-rotten real estate assets, potentially including its real-estate servicing company Aliseda. The hope is that the spin-off will give the market confidence that the bank can reach its aim of reducing real-estate exposures by €15 billion by 2018.

PEDRO LARENA-600
Banco Popular's CEO Pedro Larena

Popular will fund a mezzanine tranche, while the market must provide senior debt to the spin-off, which could be listed, and will aim to be profitable in around two years as its disposals gather pace. But the ECB must be satisfied Popular is really getting rid of the assets for the plan to work, while the spin-off’s investors will want Popular to shoulder more of the risk.

In late 2016, the bank had determined neither the proportion of funding from each tranche, nor the cost. It was still in discussions with global investment banks that might underwrite the senior debt issuance. Deutsche Bank, Larena’s previous employer, is advising and could be one of the financiers.