Wiped-Out Spanish Bank Notes Turn Lottery Ticket for Traders

  • Banco Popular bonds are quoted above zero cents on the euro
  • Law firms said to be planning challenge to bank rescue deal

The European bond market is offering the closest thing to a lottery ticket: wiped out Banco Popular Espanol SA securities that promise massive gains if noteholders pull off a legal upset.

Though there’s little chance of recovery because the bonds were forcibly written off by regulators, a few are betting on a successful legal challenge. Some traders are buying the bank’s riskiest notes, which are quoted at about 1 cent on the euro, as well as higher-ranking Tier 2 bonds, which are quoted at 4 cents, according to people familiar with the matter, who asked not to be identified because the information is private.

The crisis at what was Spain’s sixth-largest lender came to a head last week when it became the first European lender to suffer a forced sale under the European Union’s Single Resolution Board to Banco Santander SA. Several law firms are approaching bondholders and trying to challenge the deal, which was structured to protect taxpayers from rescuing the bank, according to different people familiar with the matter.

“When things trade as low as this, it’s virtually a free option,” said Mark Holman, chief executive officer at TwentyFour Asset Management LLP in London, which doesn’t hold the notes or plan to buy them. “There might be an ability to sue management or go after Santander.”

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Cairn Capital Ltd. told investors it incurred losses in its 130 million euro ($145 million) subordinated financials fund because of its Banco Popular holdings and that it’s considering legal action.

The fund had a 7.4 percent exposure to Banco Popular through bonds and derivatives, according to an investor letter dated June 13 seen by Bloomberg News. Cairn sold the most-junior additional Tier 1 securities for about 2 cents on the euro and is holding onto higher-ranking Tier 2 notes because they may be more eligible for compensation, it said in the letter.

Officials at Cairn, which manages $2.9 billion in total, declined to comment on its holdings or plans.

Litigation is unlikely to be successful because bondholder protections are weakened when a regulator decides a bank is likely to fail, as the European Central Bank did before imposing losses on the notes, according to Carlo Mareels, a London-based strategist at Mitsubishi UFJ Financial Group Inc. As recently as April, the roughly 2 billion euros of junior notes written off by regulators were trading at face value.

“I don’t think that any litigation can be successful here,” he said. The regulator has “broad powers to do what it wants.”

Mounting Debt

Banco Popular’s bonds were wiped out after three capital increases in the past five years failed to offset mounting bad debt tied to the country’s real-estate collapse.

The debt may be trading for a small premium on hopes of a partial recovery related to litigation, said Tom Kinmonth, a credit strategist at ABN Amro Group NV in Amsterdam. He said the speed of the resolution and fire sale to Santander was a “shock,” in contrast to weak Italian lenders, which have been allowed to issue state-guaranteed bonds to replace deposit outflows from clients.

“Banks in Italy have been allowed to shore up liquidity. Bondholders in Spain didn’t have that chance,” he said. Owners of Tier 2 bonds could also argue they were left worse off than under a hypothetical liquidation of the bank, breaching European Union bank rules, he said.

“We have been already contacted by several law firms and so now we’re assessing what’s the path to follow,” said Luis Arenzana, a fund manager at Ronit Capital, a London-based hedge fund, which owned some of the bank’s 1.25 billion euros of AT1s. There are many “aggrieved parties,” he said.

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