Banco Popular: An Avoidable Drama

Banco PopularBanco Popular

Aristóbulo de Juan | The fifth anniversary of the so-called resolution of Banco Popular has just passed. A historic event where the new European mechanisms and the FROB were the protagonists. I believe that what happened deserves a reflection based on a recap of the events over the ten long years that put an end to a bank that had been a model until the end of the last century. It is never too late.

In the early 2000s, there was a gigantic real estate bubble with its lethal effects on the financial systems of many countries.  Its end, like that of any bubble, was inexorable. But no one wanted to admit it or spoil a party that benefited and brought prestige to many. 

In Spain, the bubble was embodied in numerous savings banks and some banks. Their balance sheets, their networks, their staff, their expenses and their risks grew violently. But the risks were masked by the then abundant liquidity and a striking lack of transparency.

In July 2007, an international liquidity crisis broke out, causing severe tensions and turbulence. Alarm bells began to ring.

In Spain, the growing risk taken by banks was already being felt. In fact, as early as 2005 and 2006, the Association of Bank of Spain Inspectors wrote to the then Minister of Economy and Finance, criticising the complacency of the institution in the face of the acceleration of risks that were already beyond the scope of its inspection reports. These letters went unheeded.

In September 2007, the Spanish banking system only had a non-performing loan ratio of 0.5%. The reality was radically worse, but this indicator acted as a reassurance and justified in some people their lack of reaction. The supervisor argued that it was understaffed. It is worth remembering here that we came from a few years in which Spain boasted of being “amongst the Champions”. Its financial and supervisory system “was the best in the world”.

The reaction of the Spanish authorities focused on measures that could alleviate liquidity strains. But I know that some institutions acknowledged internally that they had serious problems. And some supervisors privately confessed that they were beginning to sleep badly.

In the meantime, most banks stopped provisioning their bad assets, under the illusion that the problems would be temporary. A view shared by the Bank of Spain.

In September 2008, the bankruptcy of Lehman Brothers, an American flagship, already brought to the surface an international crisis of colossal dimensions.

Recognition of the crisis in Spain was now inevitable. The Spanish government’s own economic office warned the presidency of the crisis, but its warning signal was dismissed as pessimistic.

A lack of political will at the highest levels prevailed. In any case, there was a promise to avoid any damage to the treasury. Mission impossible.

In fact, it was only in June 2009, two years after the turmoil began, that insolvency was addressed by the creation of the FROB, intended as a general rule to deal with fundamentally sound institutions. This did not happen. In fact, the FROB acted on insolvent institutions, injecting capital prior to the appropriate intervention of the institutions. The treatment was limited to savings banks, because the slogan was that this was the only sector affected. This avoided highlighting the problems of the banks, a policy which could lead to lightweight or inconsequential supervision.

Popular was already heavily undercapitalised. According to an expert report, issued in 2019 in a criminal case by two inspectors of the Bank of Spain, the bank had accumulated losses of 2 billion euros already in 2008 and almost 3 billion in 2010. As is logical to think, losses of such a volume do not occur suddenly, but had been growing over the previous years. However, as they were not recognised in the accounts, they were not provisioned. Taking advantage of the looseness of regulations and voluntary supervision, imaginative accounting was applied, almost always in the form of refinancing the worst credits with terms that avoided their formal default. Another mechanism would be to shift them to uncontrolled vehicles or special purpose vehicles.

But it so happens that credits thus disguised always generate new current losses and growing liquidity problems. Because they do not produce income, but their financing produces expenses and cash outflows. The financial statements were thus misleading for investors, who base their decisions on public information.

Supervisors were living with the situation, there was a lack of experience in similar situations, and the presumption prevailed that these were temporary problems that did not require measures that would disrupt the alleged stability of the system.

In addition, supervisory mechanisms had changed in those years. Thus, the verification of accounts would be replaced by the remote analysis of mathematical models constructed by the institutions on the basis of their own valuation of assets. PWC had been auditing Popular since the 1980s and had been issuing clean reports year after year.

In fact, in 2012, the newly appointed Minister of Economy, disagreeing with the Bank of Spain’s diagnoses, imposed an additional 60 billion euros in provisions on the banks. He also imposed the consultancy firm Oliver Wyman in the constitution of the SAREB, as a substitute for inspection.  This did not fail to provoke a strong reaction from this body.

In February of that year, with the consent of the supervisor, Banco Popular decided to buy Banco Pastor. It did so for a price higher than the stock market value and more than 1.7 billion euros more than the equity value of the bank, according to an adjustment made later by Banco Popular itself. But this loss was capitalised by Banco Popular as “positive goodwill” and was never provisioned.

That same year, Banco Popular made a capital increase of 2.5 billion euros, thus improving its liquidity, its precarious results and the volume of accumulated losses. But this capital hike was intended to amortise underlying losses, without constituting a cushion for future losses. Santander initially considered subscribing to a part. To this end, it obtained information about the bank and did not subscribe.

In 2013, the Bank of Spain appointed a veteran inspector who had been very incisive with Popular as Secretary General of the Deposit Guarantee Fund.

Some time after the resolution, Joaquín Almunia, former European Commissioner for Competition, publicly stated that in 2012 and 2013, Banco Popular “got away from us”.

In 2014, an important milestone was reached. The European Union set up a Single Resolution Mechanism (SRM), in addition to the Unified Supervisory Mechanism (SSM), which has since been assigned to oversee major national banks. This includes Banco Popular. Surveillance now focuses on regulatory capital and governance. But the reference capital is not the net worth of the institutions, a key mechanism for identifying real solvency. Instead, a concept of capital is used that as such computes some items without economic content and others that entail a cost. Both features are inappropriate with regard to what is real capital. Good governance is indeed a key factor, but not as a substitute for verification of data, as its oversight does not ensure a good credit policy or good accounting practices. Moreover, the new doctrine contains a worrying principle: it is not the present situation that matters, but forecasts for the future. A principle that ignores the fact that the problems of the present, when left unaddressed, are exacerbated.

In this context, in November 2016, Banco Popular issued a new 2.5 billion euros capital increase to amortise underlying losses. But it did not provide a cushion for the future either. Moreover, the information in the issue prospectus was misleading and the capital increase was partially financed by the bank itself.

The bank’s situation led to strong tensions amongst the bank’s board, which had been joined by representatives of major shareholders, with the supervisor not standing in the way. As a result, the bank’s chairman and CEO are replaced. The chairmanship falls to a former executive of the Santander Group, who will take office in January 2017.

In its first quarter 2017 report to the CNMV, under the new leadership, Popular claims to have a net worth of 10.7 billion euros and regulatory capital of 11.9%. It also claims to have its problems under control. In April, the bank adjusts its accounts by 354m.

But market confidence, disturbed perhaps by certain statements by the new management, had begun to cause a drop in the share price and an outflow of deposits. This accelerated considerably in April and May, driven by the fall in the share price itself, by the withdrawal of large sums by major institutions and possibly by the statements made by the chairman of the SRB to Bloomberg, in which she said she was paying special attention to Banco Popular.

Even so, on 11 May, in an important note to the CNMV, the bank reaffirmed that its net worth exceeded 10 billion euros.

But the violent outflow of deposits continued and the ECB decided not to inject funds of last resort. Because the bank had no assets to guarantee them. All of this a symptom.

The chairman of Popular informed the ECB that it was not viable and the latter, on 6 June, formally declared it so. As a result, on 7 June the SRB decided to submit Popular to the new resolution mechanism. This would turn out to be the only case in the eight years since its creation to date.

The instrumentation corresponds to the FROB, whose vice-chair and four of the members of its governing board are senior officials of the Banco de España, together with one more from the CNMV. On the same day, the FROB organises an express auction, which is unsuccessful. The second auction is only attended by Santander. On that date, the stock market value of the bank was 1.3 billion euros. However a diagnosis was missing and the auction did not establish minimum exit conditions, but allowed bidders to freely propose their own conditions. Santander, which would later state that it already knew the bank, presented its proposal on the same day in record time. It based its proposal on an estimated loss of 12 billion euros, the replacement of which it proposed as a condition. The JUR and the FROB awarded Popular to Santander, legally validating Santander’s estimated losses. These are charged to all the shareholders and part of the bondholders. The former would see their shares redeemed. The securities of the bondholders – whose issue prospectus did not declare them convertible – were converted into shares and also redeemed. A healthy Popular was sold to Santander for the price of one euro.

The FROB had commissioned a valuation report on Popular from Deloitte, the firm that had been auditing the Santander group until 2016. The audit firm was to issue an interim and a final report within a month. In the provisional report, it acknowledged that time pressure had prevented it from doing an accurate job and estimated its losses at between 2 billion and 8.2 billion euros. The final report was never made public. But on 30 June the resolution was published in the Official State Gazette.

Already as owner of Popular and still in June 2017, Santander establishes the accounts of this, reflecting losses of 12.4 billion euros. Price, which was now Santander’s auditor, would recognise similar losses. All this after the aforementioned capital increases, which totalled 5 billion euros. 

After the acquisition of Popular, Santander makes a capital increase of 7 billion euros.

The large volume of losses now established by some and by others were in stark contrast to the assets declared by Popular to the CNMV, barely a month before the auction. There was only one explanation: the multiple supervisory mechanisms, national and European, had not worked.

The fact is that the resolution gave enforceable force to the estimate of losses that had been ignored by all.  Managers, auditors and supervisors. Investors had been misled by information that was far removed from reality, but they were charged with losses.

This story can be used to assess the actions of the various players and to draw conclusions. It also shows that, while the resolution was triggered by illiquidity, the cause of the crisis was hidden insolvency, which had led to the illiquidity. 

History tells us that when insolvency is not corrected until it is made obvious by the violent illiquidity it causes, the consequences are serious. It generates instability and distrust in the system. It perpetuates and even encourages mismanagement. It confuses the market and makes solutions more expensive.

Success, therefore, is not a matter of “in extremis” closing the terminal phase of an untreated ailment. On the contrary, it is a failure of preventive medicine.

Success is about tackling ailments while they are still curable and avoiding the final drama.

About the Author

The Corner
The Corner has a team of on-the-ground reporters in capital cities ranging from New York to Beijing. Their stories are edited by the teams at the Spanish magazine Consejeros (for members of companies’ boards of directors) and at the stock market news site Consenso Del Mercado (market consensus). They have worked in economics and communication for over 25 years.