What Everybody Knew about Banco Popular, but Nobody Dared to Say

Only two months after acquiring Banco Popular, Santander has sold a majority stake in Popular’s real estate portfolio to Blackstone. The private equity firm will pay around $6 bio for 51% of the bank’s real estate assets, valued at $11.7 billion. The book value of the assets (that is, the historical cost at which the assets were entered on the accounting books of the bank) amounts to $35.2 billion or three times as much as their market value. Or put differently: assets were sold at a 66% discount to book value.

The benefits for Santander are twofold. On the one hand, the Spanish bank will receive an enormous injection of liquidity. On the other hand, the sale will reduce Santander’s risk-weighted assets, which will have a positive impact on the bank’s Tier 1 capital ratio. In other words, the bank will see both its liquidity and solvency positions improve thanks to the deal.

The heavy discount at which the real estate assets were sold sheds light on the poor state of Popular’s left side of the balance sheet, which ended up causing its collapse. But when did problems start for Banco Popular?

The Banking Crisis in Spain

In mid-2012, the conservative government officially requested financial aid from the European Union to recapitalize several semi-public financial institutions that had suffered the impact of the housing crisis. The Eurogroup provided a line of credit of up to $117 billion (through the so-called European Stability Mechanism), of which $66.5 billion were employed to bail out the poorly-managed banks. The deposit insurance scheme (FGD) contributed with an additional $26 billion. In total, the financial bailout cost taxpayers $93 billion ($70 billion if we take into account the amount that the government expects to recover by selling the nationalized assets).

The capital was injected into banks through a public entity (FROB) created to handle the restructuring of troubled financial institutions. Bailout banks were forced to transfer their toxic assets to the SAREB (the Spanish bad bank) as a condition to receive the capital injections. SAREB’s shareholder structure is formed by the FROB (45%) and several private financial institutions (55%). Its goal is to sell the assets within 15 years.

The Beginning of the End

At the time, Banco Popular declined to receive capital from the European Union. Instead, it kept the toxic assets on its balance sheet and obtained private funding from the market via successive secondary equity offerings, the last of which was partially financed by loans granted to the bank clients themselves (an unusual practice).

In the following years, Ángel Ron, CEO since 2006, failed to clean up the bank’s balance sheet. Rather than undertaking a serious restructuring, he dove in headfirst without a clear business plan to overcome the problems stemming from the housing boom. As a result, Popular’s market value declined by 85% between the onset of the financial crisis until his resignation in 2017. When the new CEO took over in February 2017, it was already too late. The loss of confidence in the bank pushed depositors to retire their savings, which led to a liquidity crisis that ended up in the acquisition of the bank by Santander for 1 euro.

Source: Assignment Point

When asked how a liquidity crisis could result in the de facto failure of a bank, Danièle Nouy, Chair of the Supervisory Board of the ECB, rightly pointed out that Popular’s liquidity problems were just “the manifestation, the ultimate step of disease”. In effect, the bank run was the symptom of an underlying solvency problem that was not adequately addressed in the past.

Bail-out Avoided, Bail-in Implemented

In December 2013, the European Parliament approved a directive whereby shareholders and creditors are obliged to bear the losses resulting from a bank’s failure (a resolution mechanism known as bail-in). This directive, which took effect last year, is aimed at preventing taxpayers from bailing out failed banks. Unfortunately, this directive leaves the door open to the use of public funding in exceptional circumstances. The Italian Government has been the first European country to take advantage of this exception by injecting $6 billion into bank Monte dei Paschi di Sienas.

The good news is that, this time, Spanish taxpayers did not pay the bill. Instead, Popular’s shareholders and junior creditors bore the brunt of the losses. When the ECB declared that the bank “was failing or likely to fail”, the Single Resolution Board (the supervisory authority) took the reins and sold the bank to Santander. As a result of the deal, equity holders and holders of hybrid instruments (convertible debt) and subordinated debt were wiped out to face bank losses. Depositors and senior debt holders emerged unscathed from the takeover.

The sale of Popular’s real estate assets at such a large discount confirms what many of us suspected: the bank’s balance sheet was so full of unproductive assets that the financial entity had been on the verge of bankruptcy for months.

Hopefully, next time a European bank finds itself in trouble, a similar resolution mechanism will be put in place. Taxpayers should never pay for the mistakes made by investors. Otherwise, we will never take the moral hazard out of the banking system.

Luis Pablo de la Horra

Written by

Luis Pablo is a Ph.D. Candidate in Economics at the University of Valladolid. He’s interested in macroeconomics, monetary theory and finance.

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