The bank-bailout business rages on.

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

During the first week of 2017, Spain’s “most Italian bank”, Banco Popular, got off to a flying start as its stock outperformed all other major Spanish banks. By Jan 5th its shares had even crossed the €1-line for the first time in nearly a month. But Popular’s New Year fairy tale was not made to last.

Its upward momentum, if that’s the right term, was brought to a halt by a bombshell report from UBS that concludes that Popular’s stock, which already lost three-quarters of its value last year and is down over 90% since 2008, is still overvalued by 20%. In less than an hour, Popular’s shares were back under a euro. That’s life in the penny-stock lane.

According to the report, Popular has a provision deficit of €1.9 billion. In other words, it has nonperforming loans and other toxic assets on its books whose losses would amount to €1.9 billion. But it has not yet booked (or “recognized”) those losses. If it did finally recognize those losses, it could end up with a €2.4 billion capital gap. That’s the equivalent of roughly 60% of its current market cap.

The UBS analysts acknowledged that their previous forecast of the bank’s capacity to absorb loss provisions had been “too optimistic”, with the new estimates showing a lower coverage ratio (46% compared to the previous 50%) and capital ratio (10% instead of 10.8%).

UBS also poured cold water on the idea of Banco Popular further expanding its bad-debt provisions, since doing so would “permanently depress” its profitability, limiting its capacity to create new capital and increasing its regulatory risk. This is bad news for a bank that continues to drown in its own toxic soup eight years after the burst of Spain’s mind-boggling real estate bubble.

Many of Spain’s biggest banks, including Santander, BBVA and La Caixa, have spent the last eight years quietly unloading a large share of their most toxic real estate assets, much of them on to the international markets. But Popular has been caught napping. Either that or its assets are so noxious that investors will not go near them at just about any price.

Even now it’s estimated that over 30% of the bank’s loans and property assets are nonperforming. As such, the only way for it to remain a going concern for the foreseeable future is if it dumps a large part of that toxic baggage. But as The WSJ pointed out, that’s easier said than done:

Its real-estate assets are of such poor quality that it would have to divert revenue toward more provisions to cover loan losses. Alternatively, it could sell some property assets at a loss. Either way, profits would take a big hit.

Alas, Popular has no profits to speak of.

At last count the bank was expected to announce total losses of over 3 €billion for 2016 as a result of billions of euros of provisions. But that was before the European Court of Justice’s ruling, in mid December, that 40 out of Spain’s 42 major banks , including Popular, would have to refund all the money they had surreptitiously overcharged borrowers as a result of the so-called “mortgage floor-clauses” that were unleashed across the whole home mortgage sector in 2009.

And now UBS has warned that provisioning for more future losses is no longer an option. Its pie-in-the-sky plan to spin off €6 billion worth of dodgy assets into a separate investment vehicle is also looking increasingly unlikely, leaving the bank’s new management with an unenviable choice: either it raises more capital, in the process further diluting its penny shares, or it looks for a buyer of last resort. It could also do both of course: first, expand its capital, in order to spruce up its balance sheets, and then sell itself to that buyer of last resort.

The problem with expanding its capital base is that, much like Italy’s Monte dei Paschi, it has already tried that — not once but twice — and with the same amount of success. The last time was just seven months ago. With the hired help of some of the world’s biggest investment banks (Goldman, Barclays, Citi, Deutsche Bank, Morgan Stanley, HSBC, Credit Suisse, Société Génerale and Nomura), Popular raised €2.5 billion of fresh capital, much of which was promptly wiped out in the ensuing rout of the bank’s shares.

As happened with MPS, shareholders will probably be loath to sign up for a third drubbing. Which leaves the option of a last-minute merger. According to UBS, the only Spanish bank that would make a good match for Popular is Bankia — a convenient finding given that Bankia is 92.5% state-owned, having received over €20 billion in taxpayer funds since its untimely collapse in 2011.

But Bankia is prohibited by the ECB from engaging in any merger or takeover activity, at least until June this year. What’s more, there is already a potential target waiting in the wings: small, state-owned Banco Mare Nostrum (BMN), whose balance sheet is apparently so compromised that the government hasn’t dared to even try to launch it publicly.

Despite only being in the “study stage,” this Bankia-BMN merger has already received the blessing of Spain’s Finance Ministry and central bank, as well as rating agency Standard & Poor’s, which has promised not to downgrade Bankia’s credit rating once it has absorbed BNM’s impaired assets and liabilities. Also on board is a motley crew of European and U.S. investment banks. They include Morgan Stanley, which predicts that the deal could add as much as €300 million to Bankia’s profits by 2018 or 2019, something taxpayers and shareholders have heard before!

Now, one of Europe’s biggest, most influential banks is recommending that 92.5% state-owned Bankia should use its “capital surplus” to take over 100% private-owned Banco Popular, warts and all. If it doesn’t, one of the big boys, foreign or domestic, may have to step in. And the only way that will happen is if Popular’s balance sheets are given a thorough spring cleaning beforehand, paid for by Spain’s long-suffering taxpayers. In other words, brand new year, same old story. By Don Quijones, Raging Bull-Shit.

And in Italy, the bank bailout evens conform to a well-established script. Read…  Who Exactly Benefits from Italy’s Ballooning Bank Bailout?

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