January 25, 2017 / 2:50 PM / in 2 years

Banco Popular at pains to protect AT1 coupons

* Bank confident will pay coupons

* Erosion of ADIs

* Bonds hold steady in secondary

By Alice Gledhill

LONDON, Jan 25 (IFR) - Spain’s Banco Popular is being forced dip into reserves to ensure it can pay coupons on its Additional Tier 1 bonds in 2017 as the threat of significant losses looms large.

Banks pay coupons on their AT1 bonds, the most subordinated debt they can sell, out of a pool known as Available Distributable Items (ADIs). In Banco Popular’s case, that stood around 3.5bn at the end of 2015 (the most recently reported).

However, the Spanish lender told IFR that its ADIs would be reduced on the back of expected losses in Q4 2016, but remains confident that it will able pay the coupons.

“As discussed with a number of market participants in the past, we can and will transfer share-premium to reinforce the level of ADIs so that the overall volume remains unchanged versus September’s level even after the extraordinary losses of the quarter,” a spokesman said. “Thus, it won’t be an issue.”

The share premium is the difference between the nominal value of a share and the price paid for it. Moving equity between reserves in this way is unusual, and rules vary by country, but there is precedent from the likes of Santander.

Spanish press reports of 3bn accounting losses for 2016 - higher than the 2.5bn consensus - have stoked fears that the 3.5bn ADI pool could fall short to make the approximate 120m of AT1 coupon payments due in 2017.

The bank also said this week that it expects to make a 229m provision to reimburse mortgage customers.

“Our base case is that it should be able to continue to service its AT1 coupons,” CreditSights analysts wrote in a note. “Its ADIs could, however, become uncomfortably small, and conceivably be wiped out.”

Banco Popular’s move is the latest example of a bank going to great lengths to make sure that it can make interest payments on its Additional Tier 1 debt even though optional, non-cumulative coupons are meant to provide lenders with breathing room in hard times.

In early January Italian lender UniCredit set itself a tight timeline to raise 13bn of capital, which will enable the bank to pay coupons on its AT1 debt so long as it is completed on time.

Debt investors will be keeping a close watch on Banco Popular’s ADI disclosure in its upcoming full year results, almost exactly a year after concerns around Deutsche Bank’s ability to pay AT1 coupons sent that market into a tailspin.

HANGING IN THERE

Despite speculation around a potential coupon skip, Banco Popular’s outstanding AT1 bonds have rallied in recent weeks and remain bid well above their low of 72 at the height of last February’s sell-off. The 750m 8.25% perp non-call 2020s were bid around 90 on Tuesday afternoon.

But the lender, rated Ba1/B+/BB- and saddled by toxic assets, is seen as the weak link in Spain’s banking sector. It raised 2.5bn of equity last May to increase coverage of bad assets from 38% to 50%, but its clean up efforts remain lacklustre.

“The back-and-forth with the Banco de Espana on the setting up of the bad bank has been rather disappointing,” said Filippo Alloatti, a senior credit analyst at Hermes Investment Management.

Another rights issue a year on from the last looks unlikely, however. “I think they better should put a sticker on their front-door saying ‘for sale’,” he added.

The bank must also address its shortfall of Tier 2 to boost its total capital ratio and give more comfort around future AT1 coupons, analysts said.

“We, as many other European financial institutions, will have to issue Tier 2 capital eventually, we are not under any pressure to do so,” Banco Popular’s spokesman said.

“We will do so whenever we deem the market conditions are right and there is more clarity around MREL [minimum requirement for own funds and eligible liabilities].” (Reporting by Alice Gledhill, editing by Helene Durand, Sudip Roy)

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