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Banco Popular suffers the PoNV treatment

7 June 2017 by Eoin Walsh

Leaving aside the demise of a bank incorporated in 1926, the new write-down process, which brings together a lot of the new powers of the European regulators, is an interesting story. The SRB this morning released a statement saying that “the SRB has assessed that the conditions for resolution, as referred to in Article 18(1) SRMR, were met”, and went on to state that the entity was failing or likely to fail. This means that the SRB determined that Banco Popular had hit its all important Point of Non Viability (PoNV), allowing it to intervene and to write-down the equity capital, Additional Tier 1 and Tier 2 bonds.  Both the AT1 and T2 bonds have been converted into equity, which effectively means they have been written down to zero; yesterday the AT1s were trading around 50c, while the T2 bonds were trading around 70c at yesterday’s close.

Subordinated bank debt has been one of our favourite sectors for quite a while, particularly AT1s, but we have continually stressed the need to be highly selective. In that regard, Popular’s AT1s (or T2 debt) never got past the first hurdle in our credit process, despite the seemingly attractive coupons of 11.5% and 8.25% when they were issued. However, as recently as the Q1 17 result presentation, the CET1 ratio was 10.02% and given the AT1s had a conversion trigger of 5.125%, readers can justifiably question why they are now worth zero. We, along with many AT1 analysts, have for a long time argued that the 5.125% trigger was too low and should not be relied upon as a hard threshold – indeed the UK and Swiss authorities demand a 7% trigger for AT1s, which is also probably too low. For us, the PoNV, where regulators step in to protect deposit and senior debt holders, was always regarded as being more important. It is clear that forcing losses on equity and subordinated debt holders while the bank is still a “going concern”, is a key element for regulators to protect deposit holders and taxpayers. Remember, the changes made to subordinated debt, which created AT1s at the expense of hybrid T1s, had just this type of scenario in mind, and to that end the process has worked as expected – equity holders and subordinated debt holders have taken losses, deposit holders have been protected, and perhaps most importantly, the Spanish authorities did not have to deal with either a run on the bank or banking system and not a single penny of taxpayers’ money has been put at risk. Enforcing the PoNV ahead of a trigger also keeps the regulators in control of the situation, even if AT1 and T2 bond holders will question the timing and also the statement from Banco Popular’s chairman, Emilio Saracho, on the 5th June, saying that they didn’t plan on requesting emergency liquidity assistance from the ECB as it wasn’t necessary. In addition, Popular never missed a coupon on its AT1s and in that regard we are surprised – we’d have expected to have had a missed coupon before we’d have seen a write-down of an AT1.

So how has the market reacted to this news? Bearing in mind that a little over 12 months ago, when investors began to question Deutsche Bank’s ability to pay a coupon, the AT1 universe fell by multiple points, and then fell further when DB confirmed it could and would pay its coupon! Well so far, contagion has been very limited – other Spanish bank AT1s were tested at approximately 2pts lower by market makers, but they were immediately lifted and are now at most, 25bps lower. Indeed the recent new issue from Sabadell, where the Popular situation was weighing on bonds, now seems to be bid higher than yesterday. Meanwhile, outside Spain, AT1s are unchanged – what a change from last year!

So what does the whole process tell us? As expected, the AT1 conversion triggers are fairly irrelevant; the PoNV is all important. Be very selective when choosing your subordinated bank exposure because regulators will force losses on subordinated debt holders to protect deposit holders and taxpayers. The AT1 market is maturating; unfortunately for Banco Popular, they won the title of being the first major borrower to suffer from the new regulatory powers, but defaults are a frequent occurrence in corporate bond markets and contagion is typically limited. So far today, the same is true for AT1s.

I haven’t touched in any detail on the deal that Santander is getting, but at first look, it appears attractive to us; Santander equity is unchanged, while its AT1s are higher.

Ultimately, this might be new ground for bank debt holders. However for other entities, if the business is no longer solvent, as a debt holder you were converted into equity or the value of the debt was significantly haircut in a restructuring – this is what fixed income investing is all about. In the past, governments were forced to step in and save banks to protect their banking system and by doing this, they unintentionally also saved subordinated bank debt holders. This is no longer the case; for us, investing in banks has had the same risks as investing in other corporates since the new rules came into force, this is simply the first time they have been used.

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