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Banco Popular may have to choose between cash call and takeover

Chances that Banco Popular Español SA may have to raise more capital or merge with another lender are growing after the bank announced it would have to increase its provisions for past earnings, with all eyes on the April 10 shareholder meeting for clarification about the future strategy, according to analysts.

The Spanish bank — which had already booked €5.69 billion in provisions in 2016, leading to a €3.49 billion annual loss — announced April 3 that it had not provisioned sufficiently for €633 million in bad loans and other credits and that it would have to make adjustments to past earnings. It also said some of the provisions related to doubtful loans could potentially increase depending on the outcome of "further analysis."

Cash call possible

While Popular said the provision impact would not be significant, the announcement has raised concerns about the bank's capital ratios and whether it might have to go back to the market to boost capital, having raised €2.5 billion in a rights issue last June.

"Now that the audit thing has come out of the closet, that is worrying," Tom Kinmonth, a fixed-income strategist at ABN AMRO and a specialist in the Spanish banking sector, told S&P Global Market Intelligence.

He predicted the bank would have to conduct a cash call before 2019 to ensure that its fully loaded common equity Tier 1 ratio, which stood at 8.17% at the end of 2016, remains within regulatory requirements because it currently looks very unlikely that Popular will be able to amass enough profits to boost capital by then.

"Something needs to be done in the short term because 2019 is coming up soon," he added, noting that the lender's capital ratios are 200 to 300 basis points lower than those of its Spanish peers.

Popular estimated April 4 that its total capital ratio at March-end was between 11.7% and 11.85%, with research firm CreditSights saying that based on these assumptions, the bank's CET1 ratio would dip to between 9.95% and 10.1% at the end of the first quarter.

Popular's aggressive lending during Spain's housing bubble continues to weigh on its profits nearly 10 years on, as the bank has had to continuously provision against bad real estate loans, while the rest of Spain's largest lenders has made good progress in reducing nonperforming assets. Even though the bank said the earnings adjustment would not impact past statements, Reuters quoted a source on April 4 saying Popular would book additional losses for 2016 of around €240 million and that its capital adequacy levels would be negatively impacted by around 0.5 percentage point.

Takeover possibilities

The bank has previously said it would sell off nonstrategic assets to boost its capital levels. It is reportedly in talks with conglomerate Libra Group for the potential transfer of part of its real estate assets for between €350 million and €400 million in cash, and it has reportedly mandated investment bank UBS to sell off Miami-based unit TotalBank in a deal that could be worth $500 million.

Yet Kinmonth said the amount of money the bank can raise through asset sales is limited. "In theory, you could look at their NPLs because there are real estate assets they can sell, but there is not a great deal," he said in an interview.

But raising capital on the stock market may also be challenging for the lender so soon after its last rights issue, GVC Beka Finance banking analyst Javier Bernat told S&P Global Market Intelligence. The bank may have to seek additional capital through a combined debt-equity issue, he said.

"They might use some type of hybrid instruments to reinforce the bank's capital," he said. "If it is not able to tap the market for increased capital, then it has a problem."

Banco Popular has often been the subject of takeover rumors, with several of Spain's largest lenders including Banco de Sabadell SA and CaixaBank SA being cited as potential partners.

Bernat said other Spanish lenders would potentially be interested in the bank if it managed to put its nonperforming real estate loans in order. Popular has a strong underlying retail business, and the bank's 2016 net profit excluding nonrecurrent items at its main business was €1 billion, while the real estate business posted a loss, excluding one-off charges, of €813 million.

"As long as this bank is being cleaned up, the chances [of a takeover] are more likely," he said, adding that investors would be looking closely at Popular's AGM to learn which direction the bank plans to take.