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Banco Espirito Santo Junior Bonds Slide as Bailout Forces Losses

By Joao Lima and Alastair Marsh
August 04, 2014 6:21 AM EDT 42 Comments
Bank of Portugal Governor Carlos Costa had sought to find private investors to inject the cash, and said government funds would only be a last resort.
Photographer: Mario Proenca/Bloomberg
Bank of Portugal Governor Carlos Costa had sought to find private investors to inject the cash, and said government funds would only be a last resort.

Banco Espirito Santo SA’s junior bonds tumbled to a record after the lender’s 4.9 billion-euro ($6.6 billion) bailout left holders facing losses they’re struggling to quantify.

The Bank of Portugal will take control of Banco Espirito Santo’s assets and deposit-taking operations by transferring them to a new company, Novo Banco, into which it will inject money from its Resolution Fund (BRAEAIA), the regulator said in a statement late yesterday. The fund will finance the rescue with a Treasury loan to be repaid by Novo Banco’s eventual sale.

While senior bondholders and depositors were left unscathed, subordinated bondholders face losses as European regulators try to avoid leaving taxpayers on the hook for losses caused by failed lenders. Shareholders and owners of the bank’s junior debt will be left with Banco Espirito Santo’s most “problematic” assets, including loans to other parts of the Espirito Santo Group and the lender’s stake in its Angolan unit, according to the Bank of Portugal.

“Who knows what the recovery will be on the subordinated bonds?” said John Raymond, an analyst at CreditSights Inc. in London. “You need to see what is left on the asset side of the balance sheet of Banco Espirito Santo, which is where they will be stranded, but given all you’ve got is loans to other members of the group and the shareholding in BES Angola, it’s likely to be quite small.”

The Lisbon-based bank’s 750 million euros of 7.125 percent subordinated bonds fell 12.6 cents on the euro to 23 cents, to yield 37 percent, according to data compiled by Bloomberg at 11:11 a.m. in Lisbon. Its senior unsecured 4 percent notes due January 2019 surged 10.4 cents to 99.4 cents on the euro, to yield 4.2 percent.

‘Toxic’ Bank

“The likelihood of recovery for junior bondholders is minimal,” said Nuria Alvarez, an analyst at Renta 4 Banco SA (R4), a Madrid-based financial services and brokerage firm. “They’re probably going to lose everything they invested. Banco Espirito Santo is going to become the bad bank in comparison with the new good bank. It will be left with all the toxic assets.”

Portugal’s benchmark PSI-20 stock index rose 0.8 percent after declining in the last four trading days. The yield on the government’s 10-year bond fell eight basis points, or 0.08 percentage point, to 3.62 percent. Two-year yields fell to the lowest level since 1999.

Banco Espirito Santo has been forced to take public money after regulators uncovered potential losses on loans to other companies tied to the Espirito Santo group and ordered the lender to raise capital. Bank of Portugal Governor Carlos Costa had sought to find private investors to inject the cash, and said government funds would only be availably as a last resort.

‘Much Worse’

That plan faltered as Banco Espirito Santo plunged 73 percent in Lisbon trading last week before trading was suspended on Aug. 1. The bank had a market value of just 675 million euros.

“I was very surprised that they went down the route of a state bailout so quickly,” said Lutz Roehmeyer, who helps manage 10 billion euros including senior bonds of Banco Espirito Santo at Landesbank Berlin Investment. “That suggests that the bank’s situation was much worse than described.”

The Portuguese government has about 6.4 billion euros remaining from its European Union-led bailout in 2011 to fund the recapitalization of Banco Espirito Santo. Banco Novo’s managers will seek to find private investors to buy “significant” stakes in “an adequate time horizon,” according to the central bank.

2011 Bailout

“Shareholders, subordinated debt holders, as well as board members or former board members directly involved in the more recent events, and not the taxpayers, will be called to shoulder the losses incurred by a banking business they failed to adequately oversee,” the Finance Ministry said yesterday. “Deposits and all non-subordinated bonds are fully preserved.”

Subordinated bonds have been hit by European regulators seeking to share the cost of resolving distressed banks with bondholders, with losses inflicted on holders of junior debt of lenders including Britain’s Co-Operative Bank Plc and Spain’s Bankia SA. (BKIA)

Portugal accepted a bailout by the EU and International Monetary Fund in 2011 as it lost access to market funding, and the country’s financial institutions faced a similar squeeze, though Banco Espirito Santo had returned to the bond market in November 2012.

The financial crisis took a toll on the lender as well as its competitors. It posted losses in 2011 and 2013, with a 517.6 million-euro loss last year. Shareholders hadn’t received dividends in three years.

‘Convoluted’ Structure

Banco Espirito Santo is 20 percent owned by Espirito Santo Financial Group, part of a chain of companies linked to the bank’s founding family. The lender’s largest outside shareholders include France’s Credit Agricole SA (ACA), owner of a 14.6 percent stake, as well as Brazil’s Banco Bradesco SA (BBDC4), which has a 3.9 percent holding.

“The convoluted corporate structure and corporate governance make it very difficult to hazard a guess as to where recoveries will be,’’ said Jon Mawby, a London-based fund manager at GLG Partners LP, which manages $37.2 billion. He said he sold his subordinated holdings last week because “we started to see more opaqueness.”

‘Quick Intervention’

Banco Espirito Santo shares slumped 67 percent in July as three parent companies linked to the Espirito Santo family requested protection from creditors and concern grew that the bank may have to inject additional capital into its Angola unit.

“The government has been prompt in acting and that’s certainly a positive, that there’s quick intervention without much disruption,” David Costa, dean of faculty at Robert Kennedy College in Zurich, said in an interview with Bloomberg Television’s Mark Barton. Still, “the evolution of the banking sector isn’t over yet, there may be some other surprises.”

To contact the reporters on this story: Joao Lima in Lisbon at jlima1@bloomberg.net; Alastair Marsh in London at amarsh25@bloomberg.net

To contact the editors responsible for this story: Edward Evans at eevans3@bloomberg.net; Shelley Smith at ssmith118@bloomberg.net

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