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Lessons from Popular

12 May 2017 by Felipe Villarroel

Banco Popular has been in the news for all the wrong reasons over recent times and particularly in the last few weeks. Unsurprisingly in fixed income, the mark-to-market selloff has been most painful in their two outstanding AT1 securities. Both the POPSM 8.25% and POPSM 11.5% perpetual bonds are down circa. 16-points since the beginning of April. Adverse headlines started back in April with the disclosure that internal auditors had required a number of adjustments to be made to the accounts, effectively questioning the adequacy of the provisions. As a result Total Capital in the Q1-2017 earnings release were adjusted down from 13.1% to 11.8%, leaving the bank dangerously close to the MDA (Maximum Distributable Amount) threshold, thereby threatening AT1 coupons. Pedro Larena, Popular’s CEO, resigned. A few days later U.S. based investors announced the possibility of legal action on the back of the adjustments. Rating downgrades followed as the agencies cited weak capital generation and outright weak capital levels. Subsequently the market has been immersed with headlines about takeover speculation, asset sales, declines in deposit base, capital raises and mergers.

This episode is interesting to us for two reasons.

Firstly, it highlights yet again the importance of stock selection in the AT1 space. We did take a look at Banco Popular at the time of the first AT1 issuance in October 2013 and again at the second issue in 2015 but decided both times that a considerable amount of improvement was required before we could get comfortable enough to invest in their bonds, despite the attractive coupons being offered. This was despite our positive views on Spain’s macro recovery.

Secondly, we note that contagion across other AT1 securities has been far more muted this time. In Q1-2016 Deutsche Bank was undergoing considerable scrutiny and causing serious concern among investors and this created a severe selloff across the whole AT1 sector. Despite the problems being very much those of Deutsche Bank, and not systemic across the wider European banking sector, we had to endure weeks of painful volatility before common sense prevailed and markets returned to normality. Although we acknowledge that Banco Popular is not as strategically important as Deutsche Bank, our feeling is that had these Popular headlines hit the market in Q1-2016 the contagion would have been a lot worse than we currently see. We attribute this to the better macro environment in part, but also to the significant positive news on the regulatory front that we witnessed last year; such as AT1 coupons ranking above dividend payments, Pillar 2 capital requirements being split into “Requirements” and “Guidance”, and also on the wider investor base and a better understanding of the general sector. Recognition that the coupons are more protected than previously considered, and as the sector matures, the overall contagion effect of isolated incidents becomes less prominent which is hopefully what we are seeing in this latest unfortunate story.

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