Rushed Popular resolution casts long shadow over Europe's banks

IFR 2287 8 June to 14 June 2019
16 min read
Gareth Gore

Banco Popular

At 8:33am on Monday June 5 2017, an email landed in a mailbox at Banco de Espana. A bank run was underway at Banco Popular, one of Spain’s biggest banks. Barely three minutes into the working week, the situation was already critical – Popular was running out of cash, and fast.

The email contained a formal request: Popular was appealing to the Spanish central bank for €1.9bn in emergency liquidity assistance.

For officials at Banco de Espana, the request was not unexpected. They had been working for more than two months with a team from Popular to prepare for this moment, ever since an internal audit at the lender had uncovered financial irregularities totalling hundreds of millions of euros at the end of March, irregularities that included a web of Luxembourg companies designed to hide the extent of Popular’s bad loan problem.

By 11:41am the same morning, the money was with Popular. The injection came just in time – according to people involved, the bank wouldn’t have survived another half an hour. But any relief was short-lived. As deposits continued to pour out, it soon became clear the bank would need more help. At 3:32pm, Banco de Espana received another email from the bank, this time requesting an increase in ELA to €9.5bn.


Although high, the amount was within the limits previously discussed. Popular had €40bn of unencumbered assets available, and Banco de Espana had earlier indicated that €26bn of those would meet its secretive ELA criteria. Once haircuts – of between 35% for the best assets and 90% for the worst – were applied, officials calculated the central bank could lend Popular just over €10bn, albeit at a penal interest rate of more than 12%.

But, first, approval was needed from the European Central Bank, which had to sign off on any ELA request greater than €2bn. Despite it being a public holiday in Germany, the ECB governing council discussed the matter by phone. Popular was confirmed as solvent, and the request was approved. But what happened next came as a shock: Banco de Espana turned down the request, citing incomplete paperwork.

Popular staff worked through the night to meet the central bank’s last-minute demands, which were threatening its access to vital ELA. The bank still had €21bn of acceptable collateral left - €5bn had been used to secure the first tranche of ELA - and these issues with the paperwork hadn’t been flagged before. Banco de Espana eventually gave the green light to a further €1.9bn the next day, but it was too little, too late.

“It was embarrassing,” said one person involved. “In March we started discussions – in March! We were doing trial runs, going back and forth with the collateral. They had checked it. But the truth is they were absolutely determined not to take it. By the time they realised they had to, they just weren’t ready. We started hitting all these little hiccups, and then suddenly they told us they couldn’t do anything more.”

Popular available collateral and ELA

Popular had €26bn of collateral, entitling it to €10bn of ELA

Source: Banco de Espana

The sudden denial of ELA has puzzled many since.

“Crucially, the bank was still solvent,” said Jerome Legras, head of research at Axiom, an asset manager that focuses on banks and owned a small amount of Popular bonds. “They mostly had a cash problem. If it was possible to lend €80bn of ELA to Greek banks to keep them afloat when they were completely insolvent, then why couldn’t they do the same with Popular? There is a real problem of consistency.”

By the end of the day on Tuesday, Popular bosses concluded the bank simply could not open the next day. They notified the ECB, which declared Popular – a bank it had deemed solvent a day earlier – as “failing or likely to fail”. That morning Popular become the first, and to date only, bank to be put into resolution using new European rules brought in after the 2008 financial crisis to make bank failures more orderly.


The mess around ELA is just one in a series of mishaps in the Popular case that have raised questions about whether the system to deal with failing banks is fit for purpose. Through dozens of interviews and a trove of confidential documents totalling thousands of pages, IFR has pieced together what happened during Popular’s final days. It is clear that, despite the bank’s problems being flagged many months in advance, when the crisis finally hit authorities found themselves ill-equipped and ill-prepared to adequately deal with the situation.

Indeed, far from being an orderly resolution, the Popular case has since become a legal quagmire. European institutions including the ECB and Single Resolution Authority, which was set up in 2015 specifically to plan for and oversee the resolution of failing banks, are now defendants in more than 100 legal cases. One common theme is that, despite plenty of warning and years of preparation, the approach of authorities was piecemeal and ad hoc.

The issue goes much wider than just Banco Popular; it has implications for the health of the entire European banking system. Since the resolution of Popular, there has been a dramatic increase in the cost of borrowing for even the healthiest of banks. While a multitude of factors is doubtless in play, many believe that the way the Spanish bank was dealt with is the biggest contributor. Investors no longer trust that failing banks will be dealt with in an orderly and legalistic way.

“It is absolutely critical that the law is complied with,” said Richard East, a lawyer at Quinn Emanuel, which is representing a group of disgruntled bondholders. “The SRB cannot make up the rules as it goes along. The EU legislator took years to design and lay down these rules in the wake of the financial crisis. Investors cannot invest with confidence if they see that the regulator is acting outside of its own rules.”

Former shareholders and bondholders of the failed Spanish bank are leading the charge for answers – and change. The two groups were hit hard: all shares were annulled, while €2bn of bonds were bailed in then written down to zero. The bank was then sold to Santander for a token €1. Investors argue that the resolution process, overseen by the SRB, was flawed. They are seeking billions of euros in compensation.


Like Banco de Espana, the SRB missed vital opportunities in the run-up to Popular’s collapse that left it critically unprepared. It is clear that, as early as April, the resolution body was so concerned about the situation that, during a routine visit to visit Spanish banks in Madrid, it thought it prudent to move its long-standing meeting with Popular from the bank’s own offices to Banco de Espana, so as not to arouse any suspicions.

During the meeting, Popular’s worsening liquidity situation - more than €5bn of deposits would leave the bank that month - was discussed. That should have been cause for concern, given that almost all the SRB’s routine planning for a resolution of Popular had revolved around potential solvency issues - not liquidity problems. Despite that, the SRB critically saw no need to start a “special dialogue” with the bank at that stage.

Perhaps one reason was because the SRB knew it was seriously under-tooled to deal with a liquidity crisis. Due to a slow phase-in of funding for the resolution agency, and despite having been set up more than two years previously, the SRB had only €10bn of funds to fight a crisis, less than a quarter of its planned firepower. Internal rules also severely limited how those funds could be used.

“This was the first case in our history and all the elements were not in place,” said one person involved with the resolution process. “We built our strategy on the bail-in tool. But due to the characteristics of the crisis, it would have been difficult to implement. And we were not sure that all the tools would have been available from a liquidity perspective. At that moment, the available amount was limited.”

The person said that the SRB quickly realised that only one of the potential options in its resolution toolbox was really available: a sale of Popular to a healthier bank that could inject liquidity. Even then, it waited until May 23 to begin any serious work, when it commissioned Deloitte to put together a detailed valuation of Popular, which would inform any future sale of the bank.


On May 28 the SRB ordered Deloitte to “strictly prioritise … focusing only on key assets and liabilities where there is considerable valuation uncertainty”. Three days later it called to say it that the accountancy firm had only two more days to complete its work.

As a result of the compressed timeline, when Deloitte completed the report, it warned that its findings were “highly uncertain”. It further prefaced its work with the warning that it had “not had access to certain critical information”. Reflecting this uncertainty, Deloitte’s report estimated Popular could be worth as much as €1.8bn in a best case, a negative €8bn in a worst case and a negative €2bn in a “best estimate” scenario.

Deloitte letter to Single Resolution Board

Deloitte letter to Single Resolution Board

Source: Single Resolution Board

Despite the caveats, the negative €2bn number formed the basis for the sale of the bank and tallies exactly with the losses later imposed on bondholders.

On June 3, while Popular and Banco de Espana were doing final checks on the doomed ELA process, resolution authorities made contact with Santander and BBVA, piggybacking on a failed sales process (that involved five interested parties) Popular had run earlier in May. After signing non-disclosure agreements the next day, the two spent Monday and Tuesday going over Popular’s books. When Popular was declared “failing or likely to fail” on Tuesday evening, both were invited to submit binding offers.

Only one bid arrived: from Santander, for €1, but only on the condition that shareholders, AT1 holders and Tier 2 holders were bailed in.


With insufficient liquidity of its own to support Popular, and having already concluded that a winding up of the bank under normal insolvency proceeding would pose risks to financial stability, the SRB was left with little option but to accept the offer. Reports in the Spanish press allege that Santander’s own lawyers took the purchase agreement drawn up by resolution authorities and rewrote it.

“The auction was organised so quickly that it was difficult for anyone to make a serious offer, and the valuations they used to justify the sales price were also difficult to understand,” said Axiom’s Legras. “The range was enormous and the methodology looked more like doing a firesale on the entire balance sheet. With that sort of approach, any bank, even the most solid one, will look very weak.”

Critically, investors allege that the situation clearly compromised the SRB and its obligation to ensure that shareholders and bondholders were dealt with fairly. Santander had been given access to Popular’s financials as part of the private sales process for weeks, and internal presentations show it had considered paying up to €1.6bn for Popular just a few weeks before, but it held off on making an offer.

A man withdraws money from an ATM at a Spanish Banco Popular branch in Madrid

One person involved in that failed sales process said that because Popular was suddenly no longer working with its own advisers to arrange a deal, Santander held all the cards.

“Suddenly you change your counterparty from professional M&A bankers, with a whole structure of corporate governance and a board and shareholders to convince, to civil servants of something called the resolution authority who have never ever done anything like this,” said the person.

“These civil servants, who barely have the capabilities to understand how a bank is valued, are called in during the very last days with a mission – a mission impossible – to dispose of assets according to rules that were thought up years before and completely detached from the reality of the way things work and the speed at which things happen. Santander must have thought, ‘we have a great negotiating hand here’.”


European lawmakers at least foresaw the possibility of a rushed resolution, and within the rules governing the SRB is a requirement to conduct an “independent” valuation of a bank after the event to determine whether or not shareholders and bondholders were short-changed, and whether they might have seen a better outcome in an insolvency. If so, compensation is due.

While the SRB says such an assessment was made, investors believe it was not “independent”. Deloitte, the same firm that did the first assessment, was asked to do it, which investors say is a clear conflict of interest. The second Deloitte report concluded that shareholder and bondholder losses would have been much greater under a normal insolvency process.

“This is the safety valve of the entire regime,” said East, the lawyer at Quinn Emanuel. “The SRB is simply making things up as it goes along; it doesn’t really seem to know what it is doing.”

“Unless there is serious and thorough review of the Banco Popular case by the EU General Court, no lessons will be learned,” he said. “This is our only hope because the SRB has vigorously denied shareholders and bondholders access to documents and data for the last two years … and will not admit that anything it did was wrong.”

The risk of botched resolutions will remain as long as the current regime remains in place, others believe.

“The process gives so much leeway and flexibility to authorities that they pretty much can do anything they want,” said Legras. “And the result is that you can end up with something that is fairly reasonable and well managed – or the exact opposite. There are very few safeguards for investors and stakeholders. It’s an open bar for the authorities.”

Banco Popular
A man withdraws money from an ATM at a Spanish Banco Popular branch in Madrid
Popular available collateral and ELA
Deloitte letter to Single Resolution Board
Evolution of deposit outflows
Banco Popular’s final weeks