On June 7, 2017, the European Central Bank informed the Single Resolution Board that Banco Popular was “failing or likely to fail”, after the bank had suffered heavy outflows of deposits in the preceding days and weeks.
The SRB and the Spanish national resolution authority (FROB) then quickly put the Spanish firm into resolution and approved its sale to Santander for €1, wiping out all of Popular’s additional tier one (AT1) and tier two debt in the process.
This is still the one and only example of a bank having been put through a resolution in Europe, with the three other banks deemed “failing or likely to fail” since the SRB’s creation in 2015 having all been wound up under their respective national insolvency laws.
The Popular case is therefore just as relevant as it was a year ago in terms of showing market participants how the BRRD, and a bank’s capital structure, will kick into action when a bank faces financial difficulty.
Here GlobalCapital looks at what has happened since Popular’s collapse and examinesfour of the key issues that are still outstanding.
1. Has the resolution process been transparent enough?
The Single Resolution Board has published a summary of its resolution decision, as well as a copy of the initial valuation reports conducted by Deloitte, which were used to justify putting Popular through a resolution process.
These documents were heavily redacted because of what the SRB sees as the need to ensure the "protection of the public interest as regards the stability of the financial system".
But those who lost their investments during the resolution argue that the EU has not published enough information.
A particular bone of contention is the fact that there is still no sign of what is called the 'no creditor worse off' report, which Elke König, chair of the SRB, had said to expect in early 2018.
Deloitte’s 'no creditor worse off' report is the accountancy’s firm’s first estimate of what creditors would have received in the Popular resolution had the bank put into liquidation rather than resolution.
If it is found that investors were made any worse off in resolution than they would have been had Popular been liquidated, the SRB is required by law to provide compensation for the difference. This is a key principle underpinning the BRRD.
A bondholder group including Anchorage Capital and Algebris, and a shareholder group led by Mexican businessman Antonio del Valle — all of which lost their investments after Popular failed — have so far concentrated their efforts during an ongoing legal battle in pushing both EU and US courts to grant access to the documents that explain why and how the FROB, the SRB and the European Commission resolved Popular and approved its sale to Santander — including the 'no creditor worse off' report.
"It is striking that one year after the resolution of Banco Popular, the SRB, the Spanish government and Banco Santander all are continuing their dedicated effort to avoid transparency with regard to the resolution process and the basis on which the resolution was ordered," said Javier Rubinstein, a lawyer for Kirkland & Ellis representing the Mexican shareholder group.
"Investors will nonetheless continue their fight to achieve the transparency that they deserve and to hold the EU and Spanish government accountable."
Some 99 cases have been filed against the SRB and the European Commission at the EU general court, contesting Popular’s resolution decision.
There is no timeframe for the court decisions to be finalised in Europe, or in the US, where bondholders and shareholders have both filed actions against Santander in an effort to obtain “discovery” of information regarding the resolution decision.
“If Europe wants a credible and strong Banking Union it needs to strengthen and restore trust towards the resolution regime, one of its most important pillars,” said Richard East, lead partner at Quinn Emanuel, which represents Popular’s major bondholders.
2. Did the Popular resolution change the way investors assess the value of bank debt?
During the Popular resolution, all of the bank’s AT1 and tier two bonds were “cancelled” in order to effect a sale to Santander for €1.
One of the first things that struck investors was the fact the two asset classes were treated in exactly the same way by the resolution authorities, implying that the loss given default on any capital instruments should be assumed to be 100%.
Despite a mass of ensuing conversations between investors and debt capital markets bankers about whether tier two debt should therefore be valued cheaper, closer to AT1s, in the months following the Popular resolution, AT1s instead began to trade tighter versus tier two paper.
"If you think that within six months of Popular having written off its AT1 and T2 in its resolution and sale to Santander, Nordea printed a benchmark euro AT1 at 3.5%, that speaks volumes," said Peter Mason, head of financial institutions and co-head of FIG EMEA banking at Barclays.
"The investor base just glanced off the resolution as an isolated and idiosyncratic incident."
Nordea's 3.5% coupon is the lowest paid on any debt instrument issued in the AT1 market, where the average coupon is about 6.4% for bonds sold in euros.
But Popular’s resolution did have some influence over the way in which buyers of European bank debt assign value within the sector.
Prominent funds will now often profess to be much more enthusiastic about investing at the very riskiest levels of banks they deem to be the safest credits, rather than fishing for returns by buying safer products at riskier institutions — implying that probability of default now trumps loss given default when making investment decisions.
"If there is any lasting impression in the market after Popular’s resolution, it is probably that the differential between the national champion banks and the second and third tier names has widened," Mason said.
Before and since Popular failed, European banks have cracked on with raising new forms of senior debt designed specifically with the aim of helping to smooth a resolution process.
Non-preferred senior debt and senior bonds sold at holding company level count towards a bank’s minimum requirement for own funds and eligible liabilities (MREL) and are supposed be available to recapitalise a bank if bailed-in when the firm is facing financial trouble.
Banco Popular had none of these instruments outstanding, as the proper legal framework for issuing them was not in place in Spain at the time. This raises questions about how EU authorities would treat MREL senior bonds in a resolution, and to what extent their holders would face losses.
"Had there been any non-preferred senior at Popular, I believe that it would have been bailed in along with the capital instruments," said Mason. "The fact that we have seen such a large volume of issuance in the non-preferred and holdco formats since the resolution would suggest that, in general, investors feel like they are getting adequately compensated for those risks."
3. Do bank capital products do what they are designed to do?
AT1s were conceived of as a product that would allow banks to take a hit while continuing to run as a “going concern”, by converting debt into shares or writing it down completely.
But some observers were disappointed that “going” and “gone” concern capital were mixed up in Popular’s resolution process, when the bank’s AT1 and tier two creditors suffered exactly the same losses at exactly the same time.
“The Popular resolution had an outcome for AT1 bondholders that didn’t necessarily represent what the products were designed to do,” said a bank capital expert. “It is supposed to be a going concern instrument where you can switch off coupons or write the principal down to recapitalise the bank, but that didn’t happen here.
“We saw with Popular that banks blow up quickly.”
This has led to scepticism about the in-built triggers in European bank AT1 instruments, which can either force action when a firm’s common equity tier one (CET1) ratio has dropped below 5.125% or 7%.
Though Europe runs according to a backward-looking assessment of solvency, as far as the market was concerned Popular was well in excess of these ratios when it failed.
Investors have nonetheless continued to invest in AT1 with what now look to be irrelevant loss-absorption triggers. Of the 28 AT1s issued in major currencies since the Popular resolution, more than half of them have been sold with a 5.125% trigger.
Doubts about the functionality of AT1 have fed into new conversations about whether there is space in the market for a more genuinely “going concern” capital instrument, however.
Investment banks are working on a design for what has been (rather exoticly) termed an “anytime coco”, which could be structured like senior or tier two debt and absorb losses at the discretion of the issuer.
No bank has yet issued anything like an “anytime coco”, but GlobalCapital understands that investment banks have fielded good interest in the concept from investors and some issuers. It remains unclear what the regulator might think of these developments.
4. How and when should authorities provide liquidity to solvent banks?
The debate about the role and desirability of European authorities providing liquidity to firms in financial distress has picked up in the wake of the resolution of Banco Popular.
Popular was initially denied access to Emergency Liquidity Assistance and subsequently failed because of a “stressed liquidity situation”, despite remaining a fundamentally solvent bank according to the relevant measures.
“Is resolution the right answer for a bank that is otherwise solvent but is facing a short term liquidity crisis, which is essentially driven by panic?” said a lawyer involved in financial markets. “That is the fundamental policy issue arising from this case that the authorities have yet to figure out.”
Because resolution tools such as bail-in do not provide liquidity in a resolution scenario, the SRB is building up a Single Resolution Fund (SRF) that could eventually be used to smooth the process of a bank rescue.
The SRF is made up of contributions from EU financial institutions and is expected, by the end 2023, to hit its target level of 1% of the covered deposits of all credit institutions in the Banking Union — roughly €60bn, according to one European Commission estimate.
But the SRB’s Elke König said in April that the SRF would never be the “sole answer” to the question of how to ensure that a firm in resolution can continue to run with enough liquidity to meet its obligations.
“This leaves an important role for central banks, in particular, the European Central Bank,” König said.
Thus far, the ECB has steered well clear of the task of resolution financing, arguing that the source of this funding must ultimately come from governments acting through their national central banks.