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Popular Bond Wipe-Out in Shareholder Hands: Corporate Finance

Popular Bond Wipe-Out in Shareholder Hands
Banco Popular Espanol SA’s Bondholders are counting on the Spanish lender’s equity investors rescuing them from being wiped out on $6.4 billion of junior debt.. Photographer: Angel Navarrete/Bloomberg

Banco Popular Espanol SA’s bondholders are counting on the Spanish lender’s equity investors rescuing them from being wiped out on $6.4 billion of junior debt.

The bank wants to raise as much as 2.5 billion euros ($3.2 billion) in shares to avoid seeking state aid that would trigger losses on subordinated bonds under European Union rules. Popular’s 5.702 percent junior notes due 2019 rose 15.8 percent in the past month to 7O cents on the euro, according to Bloomberg prices, compared with an average 1.93 percent increase for securities in the Bank of America Merrill Lynch Euro Financial Subordinated & Lower Tier-2 Index.

Failure to raise funds through a share sale could mean Popular having to conduct a restructuring under the eyes of regulators, cap salaries and dispose of assets. The lender is a victim of Spain’s real estate collapse, failing the latest government stress tests which revealed the Madrid-based lender has a 3.22 billion-euro capital shortfall.

“The share sale is the last hope for Popular subordinated bondholders since a failure would mean that the state would have to step in,” said Ignacio Victoriano, head of fixed-income at Renta 4 SGIIC, which manages 1.5 billion euros of assets including some Popular subordinated bonds. “We are confident that they will get the deal done.”

King Alfonso

Popular traces its roots back to 1926 when King Alfonso XIII oversaw the start of operations. The nation’s fifth-largest lender now has 161 billion euros of assets and 2,500 branches in Spain after absorbing Banco Pastor SA in February.

The lender has a BB rating from Standard & Poor’s, two levels below investment grade, and is ranked one step higher at Ba1 by Moody’s Investors Service. Popular’s Tier 1, or subordinated notes, which are first to absorb losses after equity, are graded CCC+ by S&P, which put the securities on “negative watch” on Oct. 16 after the ratings firm downgraded Spain by two levels to BBB-.

A Madrid based official for Popular, who asked not to be identified citing bank policy, declined to comment.

Spain is following Ireland in making subordinated bondholders pay for the mistakes of its banks. Irish lenders imposed losses of as much as 90 percent on their junior debt investors as the government injected or pledged 64 billion euros to rescue them following that country’s real estate collapse.

Losses Imposed

Before losses were imposed on Bank of Ireland Plc junior bondholders, credit-default swaps insuring 10 million euros of the notes for five years cost 4.5 million euros in advance and 500,000 euros annually. That compares with an upfront fee of 2.3 million euros fee that swaps sellers demanded to insure Popular debt yesterday, signaling a 52 percent chance of default.

A total 944 credit-default swap contracts are outstanding covering a net $348 million of Popular’s debt, according to the Depository Trust & Clearing Corp. There were nine trades worth a gross $79 million of the bank’s bonds last week.

“The Popular share transaction could be a once-in-a-lifetime opportunity,” said Javier Bernat, a Madrid-based financial analyst Bankia Bolsa BV. “Despite the challenges, the board is backing the transaction and if it carries a good marketing campaign among its depositors the deal can be done.”

Burden Sharing

Investors in junior debt of Spain’s Bankia group are still waiting to hear their fate after the nation’s bank-rescue fund, known as FROB, recapitalized the lender. A memorandum of understanding on the terms of the bailout said Spanish authorities will “require burden sharing measures from hybrid capital holders and subordinated debt holders in banks receiving public capital.”

Bonds sold by Spanish banks outperformed debt from lenders in other peripheral countries in October. Debt of Bilbao-based Kuxtabank Bank returned 4.09 percent, Banco Espanol de Credito SA made 2.45 percent and Banco Santader SA gained 2 percent. That compares with an average 1.27 percent for the Bank of America Merrill Lynch Euro Periphery Financial Index.

Not all investors are confident that Popular will succeed in sidestepping a bailout. Jean-Luc Lepreux, senior bank analyst at Societe Generale SA in Paris, advised clients in an Oct. 29 note to avoid Popular debt because of the risk of losses.

“Raising 2.5 billion euros when your market capitalization is 2.6 billion euros will be hard without running the extra mile,” Lepreux said in an interview. “Subordinated debt holders should be prepared to face high haircuts for banks needing public funds, up to 100 percent for fully nationalized institutions.”

Customer Goodwill

Popular wants its customers to buy 60 percent of the new shares being offered because Chief Financial Officer Jacobo Gonzalez-Robatto said Oct. 1 that “the bank has enormous goodwill of its customers.”

The stock was at 1.20 euros today and has slumped 29 percent since the day before the share-sale announcement on Oct. 1, valuing the lender at 2.6 billion euros.

Bankia followed the same strategy in July last year when it tapped about 347,000 individual investors as it was seeking to boost capital. Bankia stock has fallen almost 70 percent since then.

Popular’s third-quarter profit fell to 75.6 million euros from 98.6 million euros in the same period a year earlier, the lender said Oct. 26. That surpassed the 42 million-euro median estimate in a Bloomberg survey of nine analysts.

Loan Defaults

Net loans newly classed as in default jumped to 2.02 billion euros in the third quarter from 1.08 billion euros the previous period. Bad loans as a proportion of total loans jumped to 7.81 percent from 6.98 percent in June, the bank said.

Popular’s business plan, which includes provisions of 7.5 billion euros for loans to real-estate developers and 5.4 billion euros for foreclosed assets, amounts to a “massive clean-up,” Gonzalez-Robatto said. The bank said on Oct. 1 that it was set to book a 2.3 billion-euro loss this year, compared with a previous estimate of 400 million euros in profit, because of the accelerated clean-up plan.

Gonzalez-Robatto said as many as 12 banks had come forward to offer underwriting services for the share sale, which would be priced at a discount of at least 40 percent, and the bank had received underwriting commitments of 7.5 billion euros.

“We think the share sale is doable if the discount is big as Popular is signaling” said Francisco Salvador, a strategist at securities broker FGA/MG Valores. “There is a lot of interest from investment banks to arrange the transaction, so it’s likely that, at least in the short term, they manage to sidestep public help.”

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