|Illustration: David Manion|
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.
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.
|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.
The bank hopes to ask the ECB’s permission for the structure and then complete the spin-off early next year. It has already decided what will go in the portfolio, says Larena. But investors will have to have gained confidence in the spin-off’s five-year business plan. That means a degree of certainty over the valuations ascribed to the portfolio’s assets.
Many in Madrid’s financial sector are sceptical.
“Spinning off a lot of under-provisioned, low-quality and difficult-to-finance assets will be very tricky,” says one banker. Strategy execution, indeed, is another category in which the bank scores especially badly in the EBR survey.
Larena admits Popular has already been working on a spin-off for most of this year: “The first structure didn’t work as the aim is to deconsolidate [the assets] – otherwise we wouldn’t do it.”
Ironically, as Popular’s core franchise is small and medium-sized enterprises, it is at the forefront of the very segment much healthier banks are falling over themselves to expand into because of the record low margins in mortgages and corporate lending. Popular is particularly strong among the smaller SMEs, which in Spain make up the bulk of SME banking.
|Albert Coll, Sabadell’s head of institutional policy and market relations|
Largely because of it SME strength, without provisions, Popular would be one of the most profitable banks in Spain. Its net interest income is already more or less equal to Bankia’s, although by assets it is half Bankia’s size.
Larena says Popular’s problems date from the mid-2000s, when other banks were marking large profits in the real estate sector.
“Popular didn’t want to lag behind on the growth opportunity,” he says.
As a result, it strayed from its traditional businesses, buying up “what the rest of the market didn’t want”, when banks with more experience in corporate lending were already starting to withdraw.
“The bubble was just about to burst,” he says.
Real estate now constitutes around a quarter of Popular’s loan book and more than a third of its risk-weighted assets. Higher provisioning has been easier for bigger, more diversified and better capitalized banks – and for banks that started funding the property development boom earlier, those whose assets have consequently experienced less dramatic falls. Yet mistakes have continued since the crisis. Popular should have raised capital earlier and provisioned according to regulatory requirements, says Larena, rather than voluntarily taking deeper write-downs.
As the shares have continued to underperform after the capital raising, Larena is well aware of investors’ desire for the bank to get on and implement higher provisioning in its non-performing real-estate portfolio. By year-end, he says, the bank will reach almost 50% coverage – in line with the market average. He says the bank was, until recently, waiting to hear details on provisioning rules from the Bank of Spain and the ECB.
If the spin-off is not possible, the bank will have to rely on more gradual means to reduce its real-estate portfolio, including sales at branch level, which Larena says will gain a good price, or through institutional placements, or by taking management control of developers. But that could be too slow; bankers say the lack of market confidence in Popular’s management makes it essential for the bank to demonstrate urgent action.
Popular’s CEO from 2013, Francisco Gomez, became the fall guy for the last three years of disappointment when he ceded to Larena this summer. Larena could be seen to herald change as an outsider. He previously headed Deutsche Bank’s international retail and commercial banking business (the Spanish unit of which is rumoured to be for sale). Before that, between 2002 and 2009, he was in charge of retail banking at the SME-heavy Santander unit Banesto.
Although Gomez left earlier, Angel Ron, Popular’s chairman for almost a decade and a half, remained in place until the announcement of his succession by former JPMorgan banker Emilio Saracho Rodríguez de Torres in early December. Popular still scored poorly in Euromoney’s survey for depth and quality of management, operational risk controls and board oversight, in the third quarter.
Less patient, more activist
Among the core investors, Allianz kept its stake in Popular at 3% in the rights issue. It has other reasons for supporting the bank, namely an asset management and insurance joint venture. According to a banker who knows the relationship, Allianz might be less active in pressuring the chairman if it endangered that agreement. France’s Credit Mutual, which maintained its stake at 3.9% in June, similarly has more than just its share ownership of the Popular group to consider, as the latter jointly owns the French lender’s Spanish retail banking business, Targobank.
The Mexican shareholder group, led by billionaire Antonio del Valle, is reputedly less patient and more activist. Del Valle and the group retained a stake above 4% in Popular after the capital raising (the stake in late March was 4.16%, according to Popular). Popular spent just under €100 million to buy 25% of del Valle’s Mexican banking business, Banco Ve por Más, as part of the 2013 deal when the Mexicans bought 6% of Popular for €450 million. But rumours of growing tension between del Valle and Ron appeared again in late September, when fellow Mexican Jaime Ruiz Sacristán (also from the Ve por Más group) replaced del Valle on Popular’s board.
Del Valle bought into Popular at a time when other Mexican investors were hunting for bargains in Spain after the eurozone crisis – although, so far, del Valle’s investment appears to have been in the wrong sector at the wrong time.
One Madrid-based investment banker says del Valle may be more worried about his reputation as a businessman back home than the financial hit to his fortune: “The Mexicans hate telling their friends in Mexico they’ve lost millions in Spain.”
Larena, for his part, acknowledges the repeat burden of the demands Popular has had to make of its shareholders, although he says they are supportive of him and his strategy.
“When I attend the board meetings, I don’t see any fighting,” he says. “We are doing everything needed to make the plan work.”
If the spin-off is not possible, however, some say the only way for the bank to gain enough capital will be through synergies created by an eventual acquisition or merger. The bank can at least play up its strengths in SMEs; an attraction for a bank like Sabadell with a similar SME base. Sabadell could grow its Spanish business to a size comparable with the big four Spanish banks if it merged with Popular. That could boost its pricing power.
We do not foresee a merger in the current market circumstances, and especially not if it requires raising capital
- Albert Coll, Sabadell
Others wonder if Popular could be an easier target for bigger banks, such as Santander, eager to grow its SME businesses. Asked if Santander might consider an acquisition of Popular, if it dealt with its legacy real-estate assets, Aboukhair recalls the 2004 takeover of Abbey National. The market had its doubts over the UK lender, but Santander managed a successful turnaround. Although he does not suggest Popular is a specific target, Aboukhair says Santander would “look out of curiosity” and such an acquisition could be a possibility were it to add value for shareholders.
Coll at Sabadell says: “We do not foresee a merger in the current market circumstances, and especially not if it requires raising capital.” A merger of equals would also not be feasible today, as Popular is far behind Sabadell by market capitalization and profitability.
Larena’s answer to this is that a merger would be more useful to the acquiring institution, rather than the best option for his shareholders. Particularly in its core SME market, he says, a merger could damage his business’ brand and human capital (he points to the 2012 merger of Banesto and Santander, and the subsequent combination of their brands).
“Popular has a good franchise in the Spanish banking market,” says Larena. “SMEs are a specialized business – it’s probably the most difficult part of banking. It is a very specific value proposition that we have here.”
SME banking needs a sense of how these businesses will evolve throughout their lifetime, as well as insights into sectors and even families, according to him: “The margins are high, but it’s dangerous if it’s not controlled.”
But others say if a deal does not happen it will be because Popular’s balance sheet is so toxic.
So far, Popular has had less help than others in dealing with the real-estate crash, whether from the state and the system, or international earnings, which supported both BBVA and Santander. Sareb took real estate developer loans from the balance sheets of Bankia and other banks later bought by the likes of CaixaBank. The asset protection scheme covered real-estate assets in Sabadell’s 2012 acquisition of Banco CAM (now a source of some confusion for analysts) as it did in CaixaBank’s acquisition of Banco de Valencia the same year.
For any merger to go ahead now, Popular may well need exactly that kind of help. If the spin-off is a flop, banks which could be asked to rescue Popular may refuse until there are sweeteners, perhaps including guarantees over its real-estate assets. Once the sweeteners are in place, however, banks would jostle to acquire it.
“That’s a dance that needs to be played out,” says one banker with experience of the sector’s restructuring.
Bankia transforms from Spain's worst to one of the best
It was born out of bust and bailout. Six years on, Bankia is seen as a safer institution than BBVA and Santander, despite its high exposure to low-margin Spanish mortgages
The design of the leaning twin towers at 189 Paseo de la Castellana in Madrid makes them appear as if they are about to topple. Appropriately, the institution they house has been transformed from an amalgamation of disasters that almost brought down the Spanish sovereign to what credit and equity analysts in the Euromoney Bank Risk Survey today see as the safest of the big Spanish banks. Bankia gains the top score for the depth and quality of its management, at 8.4 out of 10, slightly ahead of Santander.
Overall, Bankinter comes ahead of Bankia in the survey, with particularly high scores for quality of earnings and assets. But this is a smaller lender; a more specialized digitally focused bank, one that was partly saved by insurance.
That regained confidence could make it a good time for the state to start selling its 64% stake in Bankia.
Santander is another option for safest bank in Spain, says Javier Bernat, Madrid-based analyst at GVC. He points to the advantages of emerging markets businesses while Spain went down: “Diversification has proven to be an anti-cyclical cushion.” Santander is a “boring but predictable bank,” agrees its head of Spain, Rami Aboukhair. But both BBVA and Santander score much lower than Bankia for the strength of their capital position, even if they have higher scores for their ability to raise capital.
Since its creation in 2010, Bankia has more than doubled its tier-1 capital ratio to 13.3%. CFO Leopoldo Alvear says a 60% loan-loss coverage ratio is well above the 50% sector average, while its coverage of mortgages and loans to small and medium-sized enterprises is particularly strong, as other banks’ averages include loans to struggling real estate developers, which Bankia offloaded to Sareb. High capital provisioning has further helped Bankia offload €4 billion of non-performing loans through private NPL sales.
Bernat notes BBVA and Santander have almost two-thirds of their earnings in commercial banking in countries with high net interest margins and better loan-growth potential. Those two banks’ net interest margin is more than 2%, compared with a Spanish average of 1.2%. Yet Santander is exposed to risks in Brazil and over Brexit; and regulatory headaches at Santander Consumer USA have rumbled on this autumn.
BBVA scores lowest of the big four Spanish banks for corporate strategy. That rings truer now risks from Donald Trump’s election victory are added to an increasingly volatile political environment in Turkey, where BBVA owns 40% of Garanti. BBVA is Mexico’s biggest bank, and its US bank branches largely skirt the Mexican border, making Trump’s policy on trade and illegal immigrants a particular worry.
“Having 40% of earnings in one country is too large,” says Bernat discussing BBVA’s Mexican business just as the US went to vote.
But Bankia, like Santander and BBVA, also scores relatively poorly in the survey for quality of earnings. Almost two-thirds of Bankia’s business consists of Spanish variable-rate mortgages, where spreads have fallen below 2%. Its net profit fell 9% in the first nine months of 2016, largely due to a 17% fall in net interest income.
Bankia also has a particularly large bond exposure in its portfolio. Carlos Peixoto, bank analyst at BPI, fears the need to replace bonds as they mature with longer-duration and lower-yielding debt will leave Bankia exposed to future mark-to-market losses; either because base rates rise, or because of new pressure on government finances. He says bonds have increased relative to total assets sector-wide, perpetuating the risky sovereign-bank relationship.
Alvear counters Bankia is maintaining the same duration and risk of its bond portfolio. He adds that bond maturities in its asset-liability committee portfolio will fall from €7.5 billion in 2016 to €2.7 billion next year and €2 billion in 2018.
“Unless interest rates rise or there is a big increase in demand for loans, it will be very difficult for the sector to grow revenues in 2017,” says Alvear.
He says Bankia suffers the lowest average loan yield in the sector, and interest income will continue to decline in 2017 as it counts a full year of lower mortgage revenues.
“Bankia is particularly sensitive to interest rates,” he says. “Our revenues are suffering more than those of our peers due to our high exposure to mortgages, but if and when rates go up, we will be one of the most advantaged.”
As mortgages redeem, Alvear says higher-yielding consumer finance and SME loans can grow from a lower base as a proportion of Bankia’s business. Santander, by contrast, already gains a double-digit proportion of Spanish earnings from SMEs, although it is also focusing on growing that business and consumer loans.