Banco Santander (SAN) , Spain's largest lender, surged the most in U.S. trading this year after agreeing to take over its failing rival, Banco Popular Espanol (BPESY) . 

Santander, which won the bidding for Banco Popular in an auction conducted by regulators, will pay €1 for the smaller lender but is also raising  €7 billion ($7.88 billion) to cover reserves for unpaid loans by Banco Popular customers and meet capital requirements set by regulators. The buyer's shares climbed 2.5% to $6.52 at the close of trading in New York, the largest increase since Nov. 7.

Both the European Union's Single Resolution Board, created in 2015 to ensure the orderly wind-down of failing lenders, and a comparable agency in Spain decided the sale was necessary to protect depositors and ensure financial stability.

Banco Popular's stock has fallen 63% over the past month amid concerns that billions of euros in delinquent loans might force it to seek a government rescue, a possibility that Wednesday's deal averts. The lender was ordered to turn all its shares and capital over to Madrid-based Santander after the European Central Bank said it was "failing or likely to fail."

Once Santander finishes raising capital, which it plans to do via a rights issue that gives existing investors the chance to buy additional stock at a lower price, its common equity Tier 1 capital ratio -- a key regulatory gauge of a bank's liquidity -- will be unfazed by the deal, executives said in a statement.

The combination will start to boost earnings by 2019 and generate a return on investment of as much as 14% in 2020, Santander said. Through the acquisition, which will add €89.2 billion in loans to Santander's balance sheet in Spain, the company's share of the country's lending market will grow roughly seven percentage points to 19.5%.

The ECB steps in on Banco.
The ECB steps in on Banco.

Santander will "work hard" to keep serving Banco Popular customers "at the highest standards through the transition and beyond," the company's executive chairman, Ana Botin, said in the statement. 

Banco Popular had been moving quickly to shed assets and potentially find a buyer for its business as its capital position eroded, despite raising more than €5.5 billion in a series of share sales over the past five years.

The bank was one of the few European lenders to fall short of the European Central Bank's minimum capital thresholds in 2016 stress tests, with a common equity ratio of 6.6% versus an 8% floor. It reported a net loss of €137 million in the first-quarter, even as provisions against bad dept improved slightly. 

Santander said about €7.2 billion of the post-transaction reserve increase will be devoted to real estate assets, increasing coverage from 45% to 69% -- well above the industry average of 52%. CEO Rami Aboukhair plans to trim Banco Popular's real-estate holdings significantly, just as Santander has done with its own portfolio.

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