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Santander braces for Popular legal fallout

Madrid-based Banco Popular Español SA is facing several potential lawsuits related to its recent decline and fire sale, but new owner Banco Santander SA should be cushioned from any material fallout by its sheer size and geographical diversification, analysts say.

Shareholders and bondholders were wiped out when Santander, Spain's largest bank by assets, agreed on June 7 to acquire Popular for the symbolic price of €1 after the European Central Bank deemed that it was "failing or likely to fail." It marked the first time that Additional Tier 1, or AT1, bonds had been "bailed in" since their creation in the wake of the financial crisis.

Investor representatives have already filed several "complaints" — the first stage in potential legal proceedings. Spanish consumer protection organization OCU has filed a complaint against the executives responsible for the bank's €2.5 billion capital increase in 2016, as well as the bank's auditor, PwC, alleging that they misled investors and falsified accounts. Meanwhile the Spanish Association for Minority Shareholders filed a complaint on June 8 against Popular's management, blaming ex-chairman Emilio Saracho and board member Antonio del Valle for a precipitous fall in the share price ahead of the Santander deal.

This latter complaint will allow the shareholder association to build a legal case around the regulatory implications of the bail-in, the behavior of management and the bank's volatile trading prior to the takeover, according to Alberto Ruiz Ojeda, a lawyer at Cremades & Calvo-Sotelo. Ruiz Ojeda is representing the association.

"[We are] starting to ... check the legal effects of the operation," he told S&P Global Market Intelligence in an interview. "This case is very relevant because this is the first case of bail-in principles."

Resolution test case

AT1 bonds, created as a way to avoid a repeat of crisis-era taxpayer bailouts of banks, can be converted to equity or written off if the issuer's capital levels breach certain thresholds. In the wake of the Popular takeover, investors will be focusing on the implications for other AT1s and the point at which their issuers become "nonviable." Popular had €500 million of low-trigger AT1s — which typically require a bank's common equity Tier 1 ratio to fall below 5.125% before being bailed in — and a further €750 million of AT1s with a 7% CET1 trigger; the bank's CET1 ratio stood at 10.02% on a phased-in basis, and at 7.33% on a fully loaded basis, at the end of the first quarter.

ABN AMRO fixed-income strategist Tom Kinmonth, in an analysis, said low-trigger AT1 bonds may not actually be safer "if AT1 investors suffer full write-downs before the trigger is reached."

Nevertheless, AT1 investors would be hard-pressed to make a legal case against Popular, Kinmonth said in an interview.

"It was clear that there was a point of non-viability," he said.

Popular's shares had tumbled to historic lows and its riskiest debt had fallen to distressed levels before the bank's sale, as investors fretted over its inability to clean up its €36.8 billion pile of nonperforming assets. Its fire sale was triggered by liquidity concerns as worried depositors withdrew their savings from the bank.

Liabilities

Larissa Knepper, a senior bank analyst at debt market research group CreditSights, had another view, saying there is "bound to be" some litigation risk from institutional investors in Popular's AT1 debt.

"[They] will ask the question of how Popular suddenly got there if not by some prior failure of regulation," she told S&P Global Market Intelligence on the sidelines of a London conference on June 13. AT1 investors will want to know why the bank was allowed to carry toxic assets on its balance sheet for several years without appropriately provisioning for them, she said.

A spokesman for Popular declined to comment for this story. A Santander spokeswoman also declined to comment when asked about the potential impact of legal claims against Popular.

Roughly €780 million of Popular's subordinated debt was erased in the resolution process, and between €400 million and €450 million of that was held by individual retail investors who are likely to allege mis-selling and seek compensation in court, CreditSights President John Raymond said in an interview at the London conference. He pointed out, however, that Santander has likely reserved for it, and that in the worst case it will be no more than €450 million.

Kinmonth said he also expected a legal risk from retail investors holding Popular's Tier 2 debt, with claims potentially related to legal contracts or mis-selling. The process, he said, could be long and drawn out such as in the case of Royal Bank of Scotland Group Plc, which has just settled claims from its 2008 cash call.

Santander also faces the prospect of further shareholder suits, with law firms Fonfría Abogados and Durán & Durán Abogados also having filed complaints, and others holding information sessions for Popular investors.

Shareholders who bought shares on the open market would not be able to make claims, but others those, for example, who bought shares in the bank's €2.5 billion rights issue in 2016 may be entitled to do so if they were not fully informed about potential risks, said Carlos Baos, a lawyer at law firm White & Baos. Santander is taking over Popular's liabilities so would potentially be on the hook, he said in an interview.

Jordi Ruiz de Villa, a lawyer at law firm Jausas, likened Popular's case to that of Bankia SA, another Spanish bank that was the subject of multiple investor lawsuits following its ill-fated IPO in 2011 and subsequent EU-backed rescue the following year. De Villa has been involved in lawsuits against Bankia.

Because the Popular sale was decided in a matter of hours and investors had not been informed of the process, they might have a case on the grounds of not being treated fairly, he said in an interview.

There is no suggestion that investors were misinformed about potential risks, were treated unfairly, or were mis-sold securities.

A limited impact

Bankia's former top management and advisers have been named as defendants in a fraud trial, and Ruiz Ojeda, the lawyer for the association of minority shareholders, said he did not expect the same repercussions against Popular regarding its 2016 capital increase because it was not the same situation as the former's IPO. The Popular issuance was done "to more consistent standards," he said.

Furthermore, Santander's scale could protect it against the fallout. Kinmonth stressed that any legal costs would be minor, given its size and diversification. Santander, which has major operations in Brazil and the U.K., has total assets of €1.4 trillion, compared to Popular's €147 billion.