- Equity and subordinated debt wiped out, as senior holders are protected
- Large synergies, increased market share and diversification to Portugal
- NPL coverage to drastically increase, while Portugal bank fundamentals improve
- EUR 7bn equity raise, leads to a neutral CET1 impact overall…
- …potential slight credit negative for Banco Santander’s existing Tier 2 debt
- Although, we maintain our Overweight positons on selective Spanish debt
- Situation is hard to replicate in the Italian situation, as buyers remain distant
DISCLAIMER: This report has not been prepared in accordance with the legal requirements designed to promote the independence of investment research, and that it is not subject to any prohibition on dealing ahead. This report is marketing communication and not investment research and is intended for professional and eligible clients only.
Please find just our initial thoughts on the Spanish deal announced this morning.ABNAMRO- Financials-Watch-Banco-Popular-wiped-out-in-Santander-sale.pdf (272 KB)
Banco Popular abruptly comes to end, as investors face huge losses
A long awaited solution to the issue of Banco Popular came to an abrupt end today, when authorities took the driving seat. The ECB announced that the bank was ‘failing or likely to fail’ and that ‘supervisory action would prevent the failure of the Institution’. It was announced that the beleaguered Spanish leader would be sold to Banco Santander for one euro, while the existing Banco Popular subordinated debt holders would contribute fully to the sale. No state money will be used in the transaction, a benefit for the Spanish taxpayer. Banco Santander, the largest Spanish bank, takes the valuable SME (small and medium enterprises) loan portfolio, increases its exposure to Portugal and inherits a non-performing asset portfolio of roughly EUR 37bn. However, the subordinated debt holders of Banco Popular paid a hefty price. These investors saw the value of their holdings fall like a stone to almost zero, a drop of 96% in one day, in what could be the strongest resolution event ever conducted by European authorities. We remain positive on selective subordinated and senior debt of Santander and see the event as a positive for the banking sector in Spain.
The end of Banco Popular as authorities step in
‘On 6 June 2017, the European Central Bank (the “ECB”) has concluded that the Institution [Banco Popular] is failing or likely to fail on the basis of Article 18(4)(c) SRMR. There was no reasonable prospect that any alternative private sector measures or supervisory action would prevent the failure of the Institution within a reasonable timeframe. Resolution action would be necessary in the public interest.’
All of Banco Popular’s existing shares and Additional Tier 1 (AT1) instruments are to be fully written down to prepare the bank for the sale to Banco Santander. Crucially, no public funds are to be used. The Tier 2 instruments are to be converted into new shares, which are transferred to Banco Santander for the price of 1 EUR. Essentially this makes the AT1’s and Tier 2 debt of Banco Popular almost worthless. The markets have reacted with a drop in Banco Popular’s AT1s of roughly 47 points (to now price just about zero), while the drop in Tier 2 has been even larger at the bonds tumbled 67 points to near zero.
To complete the purchase, Banco Santander will perform a EUR 7bn equity raise, which will lead Banco Popular to become fully owned subsidiary of Banco Santander. The SRB actions will mean that the bank is wound down without disrupting financial stability and at no cost to taxpayers.
Large synergies, increased market share and diversification to Portugal
The two potential benefits on the deal concern Banco Popular’s loan exposure to both SMEs (small-medium enterprises) and Portugal. After the deal Banco Santander will become market leader in Spain for SME loans, an increase to 25% for Spanish SME loans. Simply, the SME loan book was too strong to ignore. Banco Santander will also increase its presence in Portugal, adding to their Santander Totta franchise. We see the diversification into Portugal as a positive, as we believe the banking fundamentals are improving in the country.
On the other side, the main area of risk is that Banco Popular has roughly EUR 37bn of nonperforming assets (NPAs), a combination of ‘pure’’ NPLs (roughly EUR 20bn) plus foreclosed assets. We feel that the Banco Santander plan to enhance the real estate coverage to 69% (far above peers) should be sufficient to stop any short-term profitability drag. Also the improved country fundamentals of Spain and the potential for house price rises should assist in the running down of the portfolio. The run-down time though to reduce ‘Popular NPAs to non-material levels in 3 years’ does look optimistic at this stage.
Looking at the costs. The firm hopes for EUR 500mn of synergies to be realised, which would be a 10% reduction in the costs overall for the joint entities. Banco Popular has significant overlap with Banco Santander, and therefore they wish that costs should be able to be materialised without a significant loss in customers. The bank overall hopes to have a 50% cost/income ratio for the Spanish business once the savings have been materialised.
Portugal diversification a good sign as the banking sector strengthens
The addition of Banco Popular will increase Banco Santander’s presence in Portugal, adding to the existing Santander Totta relationship. The deal is hopes to take advantage of the improving economies in both Portugal and Spain. The deal will make Banco Santander have a 17.5% share of the total loan market in Portugal, the second largest in the country.
We see strength in the banking fundamentals in Portugal, which have been significantly assisted by external investment over the last six months. For example, the BCP rights offering earlier this year, which was supported by the Chinese Fosun group. Indeed, Chinese firms have been exceptionally positive on Portugal assets. The money flowing in from China to the key Portuguese companies has been very strong. Indeed in 2014, Fosun (the same company from the BCP deal) bought 80 per cent of state-controlled Caixa Seguros Saúde (Portugal’s largest insurance group, which included Fidelidade). Followed by a stake in the hospital business Espírito Santo Saúde for EUR 461mn.
For Spain, we are positive on the outlook of the nation, with current growth and potential growth still being strong. Although the domestic situation from a bank situation is still rather static due to the large scale deleveraging that is still occurring in the economy, see here. In Spain, SME loans and private commercial lending is making up for the lacklustre returns of traditional mortgages.
Equity raise is Neutral on CET1 ratio, Banco Santander debt could lightly suffer
The purchase itself, is in essence a risk-on purchase. The takeover will lead to more exposure in SME loans (higher risk than mortgages) and increased exposure in Portugal (considered a higher risk country). We think the deal is strong for the Santander and gives a larger, stronger and diversified model going forward. The capital contributions from the Banco Popular AT1 and Tier 2 write-downs would have been a strong incentive for the purchase. Costs are likely to weigh on profitability in the short-term, however, the renewed business model should bring benefits in the longer term.
After the EUR 7bn equity raise, the deal will only be neutral on CET1 fully loaded ratio of Banco Santander. It is interesting that Banco Santander has chosen not to include an additional (small) equity raise that would have helped benefit their lower-than-peers 10.66% fully loaded CET1 ratio. They are clearly confident on their internal growth in the short term.
Essentially, the bank now has a higher risk profile but with broadly the same Tier 1 capital; indeed the MDA levels will now be in focus, and the CET1 buffer is in theory is slightly more volatile. This could be an item that could draw attention if NPA portfolio disposals begin to drag on..
These above downside risks for the combined entity, notwithstanding restructuring costs in the short term, is slightly credit negative for short-mid duration of Banco Santander’s existing Tier 2 debt. However, we do not think the negativity is large enough to remove our ‘Overweight’ view on selective Santander Tier 2 debt. We still think the debt class and institutions, despite the risks, offers suitable return versus other equivalents in the index. In fact the problems currently in Brazil (25% of revenue) and the business setup in the US (17% of revenue) could be larger drivers to Banco Santander spreads than the Banco Popular deal.
Subordinated debt wiped out, while traditional senior protected by authorities
In the purchase, senior bonds holders will be protected. Although, it would have been very interesting to have seen how this would occur if Senior Non-Preferred were involved. We would envisage as the action is constituted under a resolution action Senior Non-Preferred would have been impacted. Conversely, we think the mechanism that the SRB has adopted today adds further strength that traditional senior holders are in a very safe place in many resolution strategies.
What it does clearly show is that authorities are willing to remove total Tier 2 value in these scenarios. One area of interest will focus on the point of non-viability, particularly for Tier 2 debt and AT1 debt. In the case today we have had a write down of Tier 2 debt, without even a coupon being missed on an AT1 instrument. Indeed, the full write-down of the AT1 instrument was the first of its kind, and the coupon mechanism to assist a bank was not even applied. The use of (low) triggers on AT1 instruments seem rather redundant if AT1 investors suffer full write-downs before the trigger is reached. Overall, the actions today make the risks of subordinated bank very apparent and could bring questions to the use of low trigger AT1 instruments.
Focus now on Italy, although the Spanish solution is hard to apply
The resolution mechanism that has been used does show the ability authorities now have to step in and ultimately stop a bail-out. However, we could easily see potential legal cases as a number of Tier 2‘s are held by retail clients. Furthermore, Banco Santander could also face litigation from AT1 holders. This shows that although resolution tools are gaining traction and credibility, the legal documentation for the impacted capital instruments will have to be improved.
The Spanish deal is facilitated by the fact that Banco Popular is actually strong enough to have buyers. Especially their loan book and diversification to Portugal was of interest. Crucially, the deal could be performed without the need for state assistance, and this is likely to be a reason why the European authorities stepped in so quickly.
However, in Italy, the banks of Veneto and Vicenza do simply not have as strong balance sheets as Banco Popular. Particularly the senior debt of the Italian institutions does not seem as safe. Rumours circulating seem to indicate that if state aid was to be used in the Italian case, that senior holders would have to foot some of the bill.
Furthermore, it would seem that the large institutions in Italy would be unwilling to take over the banks without the interaction of the Italian state, either via the Atlante fund or via the recent Italian resolution fund. The question now is, if Banco Popular has now been stated as ‘failing or likely to fail’ by the ECB, what does this mean for the arguably weaker banks of Veneto and Vicenza banks. From a debt perspective, Italy still remains our key area of risk in Europe. We still expect that Tier 2 in Italy for the smaller banks will suffer, and we still prefer to choose mid-duration AT1s from core county market leaders as opposed to investing in the subordinated small bank debt in Italy.