Recent Cases of EU Banking Resolution - Liquidation One Rule Does Not Fit All 03 July 2017 Commentary Carola Saldias Senior Director Financial Institutions Analytical Team carola.saldias@dagongeurope.com Evgeni Petkov Associate Director Financial Institutions Analytical Team evgeni.petkov@dagongeurope.com DAGONG EUROPE - www.dagongeurope.com
TABLE OF CONTENTS 1. INTRODUCTION 2. COMPARISON OF THE APPLICATION OF THE SINGLE RESOLUTION MECHANISM 3. CASE OF BANCO POPULAR 4. CASE OF BANCA POPOLARE DI VICENZA AND VENETO BANCA 5. SIMILARITIES, DIFFERENCES AND CONCLUSION 2
1. INTRODUCTION The application of the Banking Recovery and Resolution Directive (BRRD) has been tested in practice in the last weeks with two very different cases. On one hand, the case of Banco Popular Español SA (headquartered in Spain) followed the process of resolution action and sale to avoid adverse effects on financial stability. On the other hand, the cases of Banca Popolare di Vicenza SpA and Veneto Banca SpA (both headquartered in Italy) will follow a liquidation process under Italian insolvency procedure; however they will also involve the sale of some parts of both banks and use of national funds to mitigate the impact on the real economy of the regions where the banks are most active. In this brief commentary, we introduce key financial highlights and background information on the three banks that were affected by the Single Resolution Board, we summarize the decisions for each case and we provide conclusions on the differences and similarities of the process. Ex. 1: Key financial highlights and ratios for the case study banks Key Financials YE-2016 (EUR Bn) Banco Popular Español SA Banca Popolare di Vicenza SpA Veneto Banca SpA Total Assets 147.9 34.4 28.0 Total Gross Loans 104.3 27.3 19.2 Total Deposits 82.8 14.3 20.0 Senior Debt 15.0 3.4 6.3 Subordinated Debt 2.0 0.645 0.624 Common Equity Tier 1 10.8 1.6 1.2 Key Ratios Gross Non-Performing Loans 18.8% 35.8% 38.5% Net Non-Performing Loans 9.9% 22.8% 26.3% Common Equity Tier 1 Ratio 12.1% 7.5% 6.4% Loans Market Share 7.8% 1.5% 1.0% Deposits Market Share 6.1% 1.0% 1.0% Source: Banks annual reports Important Note: Dagong Europe does not have ratings assigned to the banks mentioned in this commentary and comments on the solvency of the entities discussed below is beyond the scope of this document. 3
2. COMPARISON OF THE APPLICATION OF THE SINGLE RESOLUTION MECHANISM Ex. 2: Comparison of the Single Resolution Mechanism application for the banks Single Resolution Board Decision Banco Popular Español SA Banca Popolare di Vicenza SpA and Veneto Banca SpA (*) Effective date 07/06/2017 23/06/2017 ECB declaration ECB determined that the bank was failing or likely to fail. The significant deterioration of the bank s liquidity situation in recent days led to a determination that the entity would have, in the near future, been unable to pay its debts or other liabilities as they fell due. ECB determined that the banks were failing or likely to fail as they breached supervisory capital requirements. The ECB had given the banks time to present capital plans, but it has been unable to offer credible solutions going forward. SRB declaration Buyer Process Additional conditions / measures Conditions for resolution met, resolution scheme adopted. Banco Santander S.A. for the price of EUR 1. Sale subject to normal merger and regulatory review. Existing shares and Additional Tier 1 instruments written down. Tier 2 instruments converted into new shares and transferred to Banco Santander S.A. for the price of EUR 1, or effectively written down. In accordance with the regulations, the SRB obtained a valuation from an independent expert. The valuation estimated a negative economic value of EUR 2Bn in the baseline scenario and EUR 8.2Bn in the most adverse scenario. The necessary actions must be implemented by FROB, the national resolution authority. No losses for senior debt holders and depositors. No state guarantees and no transfer of public funds to the acquiring bank. The single resolution board has decided that resolution action is not warranted. The winding up of the banks will take place under national proceedings launched by the national authorities. Intesa Sanpaolo SpA (Intesa Sanpaolo) for the price of EUR 1. Liquidation and assets-liabilities transfer supported by the Italian government. Italian authorities will wind up the banks under the Italian national insolvency procedures. Existing shares and subordinated debt written down but subordinated bonds issued before June 12th, 2014 held by retail investors will be subject to reimbursement. No losses for senior debt holders and depositors. Existing shareholders and subordinated debt holders have fully contributed to the costs, reducing the costs of the intervention for the Italian state. Both banks will be wound up in an orderly fashion and exit the market, while the transferred activities will be restructured and downsized by Intesa Sanpaolo. The subsequent deep integration by Intesa Sanpaolo will return the sold parts to viability. The European Commission confirmed that the measures do not constitute aid to Intesa Sanpaolo, because it was selected after an open, fair and transparent sale process. Cash injections of EUR 4.7Bn to Intesa Sanpaolo to maintain its CET 1 ratio unaffected by the integration (EUR 3.5Bn in cash injection and EUR 1.3Bn for integration costs); EUR 4Bn in performing loans not classified as deteriorated yet but that are of high risk and can be returned up to 3 years from the transfer. Guarantees for up to EUR 5.3Bn (EUR 6.3Bn after the due diligence) Additional guarantees of EUR 1.5Bn to cover potential fulfilment of legal obligations transferred; Both guarantees and cash injections are backed by the Italian state's senior claims in the assets of the liquidation mass. (*) The liquidation and sale process applicable for Banca Popolare di Vicenza SpA and Veneto Banca SpA does not differentiate both banks and it is presented as an aggregate transaction. 4
3. CASE OF BANCO POPULAR ESPAÑOL SA Background: Banco Popular Español SA (BPE) is a Spanish bank ranked 6 th by total assets in the country, with significant market shares in loans and deposits. It had been listed on the stock exchange, with ownership widely spread. BPE had a very large real estate exposure for which it had to build large loan loss reserves, leading to losses of EUR 3.6Bn in 2016 and EUR 137Mn in 1Q17. Capital ratios also deteriorated further in 1Q17 (CET 1 to 10.0% and total capital ratio to 11.9%), albeit remaining within the regulatory requirements. On April 10, 2017, during the Annual General Meeting, the bank announced that it would be looking for a capital increase, triggering a sharp slump in its share price. On April 19, 2017, the Spanish Minister of Economy, affirmed that BPE had neither solvency nor liquidity issues. Between May 11 and May 16, 2017 the bank issued 3 statements denying, or clarifying, negative news coverage. News reports published on May 31, 2017 reported that the bank would be wound up if it fails to find a buyer. That information exacerbated the outflow of deposits and market funds which had started already. On June 6, 2017 the European Central Bank (ECB) informed the Single Resolution Board (SRB) that the entity was failing or likely to fail. On June 8, 2017, the ECB commented that the decision had been triggered by a liquidity run and was not a matter of assessing the solvency of the bank. Decision taken by the SRB 1 : On 7 June 2017, the SRB took resolution action in respect of BPE. The SRB assessed that the conditions for resolution, were met, namely: a) The entity is failing or likely to fail. b) There was no reasonable prospect that any alternative private sector measures or supervisory action would prevent the failure of the Institution within a reasonable timeframe. c) Resolution action would be necessary in the public interest, in two aspects: i) the significant market shares of BPE in deposits and loans, specifically SME loans and ii) to avoid adverse effects on financial stability. The SRB has assessed that the winding up of BPE under normal insolvency proceedings would not meet those resolution objectives to the same extent. As the conditions for resolution were met, the SRB adopted a resolution scheme providing for the application of the sale of BPE. Under the resolution scheme, following a marketing process, the SRB has decided to transfer BPE to Banco Santander S.A. (Santander). The SRB decided to exercise the power of write-down and conversion of capital instruments prior to the transfer, to address the shortfall in the value of BPE. In particular, all the existing shares (Common Equity Tier 1), and the Additional Tier 1 instruments were written down, while the Tier 2 instruments were converted into new shares, which were transferred to Santander for the price of EUR 1. Senior debt and deposits were not affected. The resolution action allows for the continuation of the provision of critical functions and services to individuals and SMEs by BPE, and, in particular, the deposit-taking and lending services. The necessary actions must be implemented by Fondo de Reestructuración Ordenada Bancaria (FROB), the national resolution authority. Market Reaction: After the announcement of the BPE transaction on June 7, Santander shares initially took a slight hit, but recovered almost fully during the day and gained more than 3% the next day. Santander senior unsecured issues were unaffected by the announcement. In our view that shows that market participants do not expect the acquisition of BPE to have a significant effect on the profitability and creditworthiness of Santander. Perpetual subordinated bonds of BPE, which had been trading above par until March 2017 and had gradually slumped below 60 until June 6, were wiped out. Cedulas issued by BPE were unaffected. Spanish government bonds gained slightly and the yield on 10-year bonds fell by about 9bp, indicating some relieve on the part of investors that public funds would not be used to bail out BPE creditors. European banks share prices gained slightly. 1 Source: Single Resolution Board: https://srb.europa.eu/en/node/315 5
4. CASE OF BANCA POPOLARE DI VICENZA SpA (BPV) AND VENETO BANCA SpA (VB) Background: BPV and VB were regional players in the Italian region of Veneto, both with market shares around 1.0% in terms of deposits and ranked 17 th and 20 th respectively, by total assets in Italy. Both banks had a traditional banking model, with loan portfolios mostly composed by local SMEs and retail clients from the north of Italy. They were created as Banche Popolare (Italian cooperative banks) and in 2016 launched capital increases that were subscribed by the Atlante Fund 2, owning 99.33% of BPV and 97.64% of VB. After the release of YE16 results, both banks presented CET 1 ratios of 7.5% for BPV and 6.4% for VB, which were above the minimum regulatory requirements but significantly below the latest SREP update requirement (10.25% and 8.75%, respectively). Following a series of recommendations and structural changes requested by the ECB, both banks presented their new strategic plans for the period 2017-2021 in which a merger between BPV and VB was proposed. In March 2017, both banks made requests to the Italian state for a precautionary recapitalisation 3 to address their capital shortfalls, which were then subject to discussions between the European Commission and the Italian authorities. Both banks had very high amounts of non-performing loans, high operating costs and have been recording losses for the last four years. In addition, the banks were not able to adjust their balance sheets to the requirements of the BRRD, which are aimed among other things at limiting the impact of resolution or orderly liquidation. As a result of their financial distress, the precautionary recapitalisation was subject to strict conditions, including that the state support was deemed only temporary and could not be used to offset losses that the banks have incurred or were likely to incur in the future. A bank that is declared as failing or likely to fail by the ECB is not eligible for a precautionary recapitalisation. Decision taken by the SRB 4 : The SRB decided on June 23 rd 2017 not to take resolution action in respect of BPV and VB. The SRB assessed that while the conditions for a resolution action were met, given the particular characteristics of the banks and their specific financial and economic situations, resolution actions were not necessarily in the public interest. The failure of the banks was not deemed likely to result in significant adverse effects on financial stability taking into account, in particular, the low financial and operational interconnections with other financial institutions. The banks will be subject to winding up under Italian insolvency proceedings and the decision is to be implemented by Banca d Italia, in its capacity as National Resolution Authority. The SRB reached this conclusion taking into account several elements, including the banks inability to raise sufficient additional private capital, the weaknesses and lack of credibility of their business plans, and the ineffectiveness of the application of the power to write down or convert capital instruments to remedy the breach of the capital requirements. Liquidation procedure implemented by the National Resolution Authority: The Italian government, after been informed by the Banca d Italia about the decision taken by the ECB and the SRB on the request for liquidation of BPV and VB, established that the liquidation of both banks could destroy the value of the banks. This could also generate significant losses for unprotected retail investors and disrupt the access to credit for companies and families in the region, with additional consequences for the economy. With this statement, the government approved on June 25 th 2017 a law decree that will allow a liquidation procedure for BPV and VB with a transfer of the performing assets and some liabilities of both banks to Intesa Sanpaolo for the price of EUR 1. The transfer is structured in a way that will allow Intesa Sanpaolo to receive the good assets and only the liabilities related to senior unsecured debt. The banks equity and subordinated debt, in addition with 2 Atlante Fund is a closed-end alternative investment fund regulated by Italian law with a size of EUR 4.2Bn and composed by 67 Italian and foreign institutions. 3 Extraordinary and temporary financial support from the Italian government, Law Decree no. 237/2016. 4 Source: Single Resolution Board: https://srb.europa.eu/en/node/341 6
their non-performing loans portfolios will remain in the entities under liquidation. However, there will be a mixed solution for subordinated bonds held by retail investors and acquired before June 12 th, 2014. They will be covered by the Solidarity Fund created in 2015. The European Commission was informed about the measures taken and approved the aid for market exit proposed for BPV and VB, stating that Italy considers state aid as necessary to avoid a market disturbance in the Veneto region. The European Commission allowed the use of national funds to facilitate the liquidation process and therefore to mitigate regional economic effects, as well as considered that the guarantees and cash injections made by the Italian state are backed up by the senior claims on the assets in the liquidation mass. Market Reaction: Since the announcement of the transaction, Intesa Sanpaolo shares posted gains for three consecutive days, totalling almost 6%. In our view that shows that market participants evaluate the transaction as positive for Intesa Sanpaolo, as it would gain some additional market share and good assets without being exposed to the risks of the existing nonperforming loans of the banks in liquidation. The perceived increased likelihood of state support for Italian banks, with the favourable effects on funding costs, also has an impact on share prices of Italian banks. European banks also posted gains, contrary to the movement of the aggregate European stock market. Subordinated bonds of BPV, which had already been trading below 20 until the announcement of the liquidation, were wiped out. Italian government bonds moved largely in line with the European government bond market, indicating most likely that the bail-out was expected and the impact on public finances priced-in. 5. SIMILARITIES, DIFFERENCES AND CONCLUSION KEY SIMILARITIES In all cases depositors and senior bond holders were unaffected, which allows to make a more detailed analysis of the optimal absorption capacity of a bank s own funds in cases of resolution/liquidation. KEY DIFFERENCES Liquidity versus solvency issues; In general it would be expected that institutions with liquidity issues would receive support from the ECB (through the Emergency Liquidity Assistance programme updated in May 2017) or from national central banks, while insolvent institutions would be subject to the Single Resolution Mechanism; Subordinated debt was completely wiped out in the case of BPE, but a more differentiated solution was implemented in the case of BPV and VB due to specific enforced laws at national level; No state aid/guarantees and no transfer of public funds to the acquiring bank in Spain; significant state commitments to support the sale of BPV and VB in Italy. CONCLUSION Since the implementation of the BRRD in Europe, the cases of fully applicability of the Single Resolution Mechanisms do not allow yet to define a level playing field for banks. The cases presented above show that there is still room for interpretation of systemic importance and national authorities have still the possibility to decide on their favoured solution in the case of liquidation. In our opinion, the actions undertaken in the BPE case were completely in line with the definitions stated by the Single Resolution Mechanism. The case of the Italian banks shows that there still exists a different view between the ECB and the national authorities with regards to systemic importance, liquidation process and the use of public funds in the public interest. The cases have implications for the application of the BRRD and for state support likelihood for issuers and for senior debt issues, but they are not straightforward. The different approaches taken highlight that the cases in which a resolution/liquidation procedure needs to be implemented are still subject to country specifics and a standard model and an even playing field are still not the case. 7
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