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LONDON (Reuters Breakingviews) - Spain’s model bank bail-in is leaving lasting scars. The resolution of Banco Popular used new European rules to ensure that creditors, not taxpayers, picked up the bill. Investors have responded by dumping debt issued by other small peers.
Popular’s speedy collapse and sale to larger rival Banco Santander left holders of its subordinated bonds with nothing. Investors in the debt of other small lenders have responded in two ways. First, they are pricing in a greater probability that healthy lenders will get into trouble. Second, they are assuming that, in that scenario, their investment will be worth very little, if anything.
Spain’s Liberbank shows the scale of the fallout. The Spanish lender’s Tier 2 bonds fell as much as 20 percentage points in the two days after Popular was resolved. They now trade at an 8 percent discount to their face value. Fearful of a vicious spiral of falling confidence, Spanish regulators on Monday imposed a ban on short-selling of Liberbank shares.
Investors are probably over-reacting about the possibility of Liberbank getting into trouble. True, the lender’s net dodgy assets are worth more than its equity, and the provisions it has set aside are up to 10 percentage points lower than the Spanish average. Yet the bank has a healthy-looking common equity Tier 1 capital ratio of 12 percent. Ratcheting up provisioning to the sector average would knock that down to a still-manageable 9 percent.
Yet the Popular example still offers grounds for caution. Regulators were quick to declare the bank non-viable when it lost deposits, whereas in the past they have kept lenders alive by offering emergency funds. Investors were also shocked by the discounted fire-sale of Popular’s assets to Santander, which wiped out shareholders and junior bonds. The conclusion is that small banks may fail more quickly, and leave creditors with bigger losses, than before.
The trauma could throw up some opportunities. Liberbank’s Tier 2 bonds now yield over 8.5 percent, some 2 percentage points more than riskier contingent convertible bonds issued by larger rival CaixaBank. That looks excessive. Yet when the dust settles, investors are likely to demand a bigger premium to hold capital instruments issued by small banks. That will push up funding costs, and further squeeze returns.
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