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Another Glitch: Espirito Santo Junior Debt Plummets As CDS Trigger May Be Avoided

Tyler Durden's picture




 

Fearful of any impact to the Portuguese/European dream, EU commission leaders folded and bailed out Banco Espirito Santo. Bond and CDS traders are scrambling this morning to come to grips with the consequences of BES bail-out/bail-in. The $6.6 billion bailout's burden-sharing has wiped out shareholders and crushed subordinated debt holders (traded down to 16c on the dollar this morning) where "the likelihood of recovery for junior bondholders is minimal,” according to one trader; but leaves senior bond holders (+10pts to 100) and depositors unaffected. However, it is those 'smart' investors who bought insurance in the CDS market that are struggling this morning as the plan to transfer BES assets to a new company, Novo Banco, may constitute a so-called 'succession event' whereby all the contracts associated with CDS move to the new company (and this do not trigger the CDS to pay). CDS spreads ripped 350bps tighter.

 

As Bloomberg reports,

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, 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.

 

“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.”

 

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.

 

“The likelihood of recovery for junior bondholders is minimal,” said Nuria Alvarez, an analyst at Renta 4 Banco SA, 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.”

But, traders and fixed income managers are scrambling to come to terms with what this means...

 

as CDS spreads collapse due to the possibility of "succession-event" that means the CDS-related contracts move to the new company and do not trigger payments

BES senior and subordinated CDS upgraded to overweight-70% from underweight-30%, Richard Thomas, analyst at BofAML, writes in client note, citing expectation that the swap contracts will succeed.

 

Prima facie, events announced yday constitute a “CDS succession event” meaning all the senior and sub CDS contracts move to the new bank

 

Caveats remarks on CDS saying a number of technical definitions are currently uncertain

 

All senior debt has been transferred to the new bank with only subordinated left behind in the bad bank

 

Estimates that subordinated debt outstanding is less than 10% of the bank’s total indebtedness, which is well inside the 25% threshold that would split the CDS

 

Possible triggers under bankruptcy event or a non-payment event (BESPL 7.125% T2s coupon due in Nov.) may not matter if CDS has already succeeded

ISDA asked to rule if Banco Espirito Santo in Succession Event

Primer on Succession Events (via Credit Suisse)

 

Summarizing Succession Events

 

Every CDS contract relates to a specified Reference Entity, be it a corporate or a sovereign issuer. Broadly speaking, a CDS Succession Event occurs if, when undertaking some form of corporate reorganization (like a merger or a spin-off), one entity becomes liable for the obligations of another, potentially requiring a change in the CDS contract’s Reference Entity and allocation of Relevant Obligations. For example, if a Reference Entity splits into two, the associated CDS contract may also split to reflect this if sufficient debt is inherited by the newly separated entity.

 

What constitutes a Succession Event?

 

A Succession Event for a non-sovereign is an event (e.g., merger, consolidation, amalgamation, transfer of assets or liabilities, demerger, spin-off or similar) in which an entity succeeds to the obligations of another entity. Succession Events exclude events in which holders of the obligations of the Reference Entity exchange the obligations for those of another entity, unless this occurs in connection with the events listed above.

 

What are the Successors?

 

The rules for determining the Successors in a non-sovereign Succession Event are included in Exhibit 1.

 

 

It would seem BES slots into the 1st or 2nd rows.

*  *  *
Put simply, you owned a home (sub-bond), bought insurance on it (CDS), the home burned down (bail-in), but due to some technicality in the language of your insuance document (succession), you do not get paid on your insurance...

 

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Mon, 08/04/2014 - 09:15 | 5043226 LawsofPhysics
LawsofPhysics's picture

This is the ultimate question, is it a CDS event or not and for whom?  I can see all the banksters in the West declaring a "CDS event" for all the banksters in the East.  Halarity will ensue, fuck them both, send all the moneychangers to the guillotine already, along with their political puppets.

Mon, 08/04/2014 - 09:18 | 5043242 Ghordius
Ghordius's picture

the ultimate question regarding CDSs is only... when are we going to ban them. or at least forbid banks and insurances to even touch them. they are pure casino-financialist poison with negative market value

Mon, 08/04/2014 - 09:25 | 5043267 fonzannoon
fonzannoon's picture

Agreed. But I say we don't ban them. Anyone stupid enough to buy CDS and ever expect to be paid out are the ultimate muppets. Fuck em if they never get the joke is on them.

Mon, 08/04/2014 - 09:32 | 5043294 NoDebt
NoDebt's picture

"Well fuck 'em if they can't take a joke."   - Whoever wrote the CDS contracts

Mon, 08/04/2014 - 09:35 | 5043310 GetZeeGold
GetZeeGold's picture

 

 

CDS Trigger May Be Avoided

 

Surprise!

Surprise!

Surprise!

Mon, 08/04/2014 - 09:57 | 5043400 Richard Chesler
Richard Chesler's picture

CDS is just another term banksters use for money laundering.

 

Mon, 08/04/2014 - 10:35 | 5043565 SumTing Wong
SumTing Wong's picture

If you hold a junior bond CDS, you have to get paid here. There is no fucking way that you can have junios bondholders holding the bag and not at least be insured. 

Fucking corrupt regulators. I could say that about government entities since the beginning of time.

Mon, 08/04/2014 - 10:42 | 5043601 Vampyroteuthis ...
Vampyroteuthis infernalis's picture

Someone will get screwed in the end. Those with the best lawyers, connections to the elite will come out on the winning side. Bet on that.

Mon, 08/04/2014 - 10:48 | 5043630 NotApplicable
NotApplicable's picture

CDS = Created for Dumb Shits.

<= (My shocked face)

Mon, 08/04/2014 - 11:26 | 5043899 PT
PT's picture

Only buy CDSs ( or any other security for that matter ) that are backed by the full faith and credit  and protection of a nail gun.

Mon, 08/04/2014 - 11:29 | 5043900 PT
PT's picture

dup.

NBS

Nailgun Backed Securities

Mon, 08/04/2014 - 11:32 | 5043938 PT
PT's picture

CNO - Collateralized Nailgun Obligations

Mon, 08/04/2014 - 09:29 | 5043268 IANAE
IANAE's picture

"...they are pure casino-financialist poison ponzi with negative market value"

Mon, 08/04/2014 - 09:33 | 5043302 Ghordius
Ghordius's picture

even better. though I'd perhaps allow them as gambling... with a high sin tax attached

Mon, 08/04/2014 - 09:30 | 5043291 Tasty Sandwich
Tasty Sandwich's picture

At least in an actual casino, the house doesn't change the rules in the middle of the game or simply make them up as they go along.

Mon, 08/04/2014 - 09:32 | 5043300 LawsofPhysics
LawsofPhysics's picture

Ultimately, this is the end game for the Fed...

 

"full faith and credit..."

Mon, 08/04/2014 - 09:42 | 5043339 Tasty Sandwich
Tasty Sandwich's picture

It's the end game for industrial civilization.  Nothing to lose.

Peak oil.

Mon, 08/04/2014 - 10:03 | 5043418 LawsofPhysics
LawsofPhysics's picture

"Peak energy available for immediate consumption" - fixed.  yes, patience is a virtue.

Mon, 08/04/2014 - 10:11 | 5043457 Tasty Sandwich
Tasty Sandwich's picture

That's all that matters for the just-in-time inventory system though.

Mon, 08/04/2014 - 10:54 | 5043640 PT
PT's picture

Ghordius re: when are we going to ban CDSs?

Maybe we can produce a CDS on a CDS - perhaps call it CDS2 or CDSCDS.  The CDSCDS pays out when a CDS would normally pay out but doesn't due to some technicality.

Or perhaps investors should wake-the-fuck up and realize that the casino doesn't pay out when it loses.  The casino pays out red vs black but never when you put big money on one number and win.  Do you still play there?  The CDS should right now be dying from self-inflicted knife wounds.  Or perhaps the only people now buying CDSs are those using OPM.  ( Do you know where your pension fund puts your money?  Don't wait 30 years to find out! )

I feel sorry for the guys that looked at the fundamentals, placed their bets with a CDS, only to get shafted when they should have won - but that's just me.  You don't have to agree.  Some of them may have been slime buckets but you have to admit that buying CDSs is a lot more honest than BTFD!  Some of those guys rolled over their losses for a few years, thinking "any day now".  Well, they live, they learn.

DON'T PLAY IF YOU CAN'T MAKE THEM PAY!!!

There's an old scam where you pretend to buy everyone's lotto tickets but just keep the money, since people usually lose lotto anyway.  Then if the tickets (that you never intended on buying) win, you just tell the suckers, "Sorry, I didn't get to the shop on time, but here's your money back."  Let's get real here.  CDSs are now the same trick except you don't get your money back.

So we can only hope that the CDS buyer's now understand the real risk behind them - they may not get paid out even if they "win".  Let's hope they decide to pick up their ball and go home.  This will be interesting because without CDSs, they can not make synthetic CDOs.

The only strategy left that works is to back the bigger bully - if he wins then you pick up a few scraps from his table.  Is anyone really comfortable with that idea?

 

Mon, 08/04/2014 - 09:28 | 5043289 Ghordius
Ghordius's picture

btw, what is this talk about "EU commission", "fearful" and "folded"? Espirito Santo was broke, and the famous "template" was used. the key ingredient of the template was always who is going to bleed and who not. Taxpayers and depositors were to be left unscathed

someone has to bear the bill, and - lo and behold - in this case even senior creditors were left whole, while shareholders... not

with all this talk in other threads about sovereignty, please do remember that Portugal is a sovereign nation, and bankruptcy is a matter of national law... in this case in tandem with various EU schemes and the famous "template"

no, I do understand that taxpayers will bear some of "it", though the "fig leave" for the Portuguese gov is that they had those funds already "on stand-by", and "had to be used anyway" (yeah, sure)

fact is... depositors were left whole, shareholders... not. not completely satisfactory, imho, yet there it is

Mon, 08/04/2014 - 09:31 | 5043297 LawsofPhysics
LawsofPhysics's picture

yes, bail-in bitchez...

 

...and you can't steal from those who have nothing...

hedge accordingly.

Mon, 08/04/2014 - 09:46 | 5043350 Spastica Rex
Spastica Rex's picture

"Freedom" is just another word for "nothing left to lose."

Mon, 08/04/2014 - 10:24 | 5043522 falak pema
falak pema's picture

except a few loose screws.

Then the wheels come off!

Which makes you cry : I can't find my screw driver.

By that time the luscious wheel you want to screw "on" has run away like a lost wheel of fortune. 

Now you're poorer for traveling as for resting on your laurels of screw driving hero. 

Mon, 08/04/2014 - 10:50 | 5043643 Ghordius
Ghordius's picture

I think depositors would not agree... and don't worry, in the next case this template is used... if there is too much to pay, depositors will be bled... as per "template"

Mon, 08/04/2014 - 09:47 | 5043361 The Fifth Empire
The Fifth Empire's picture

When you are poor, only your Life to be taken

Bear in mind, will you redeem violence when the time comes

 

Mon, 08/04/2014 - 10:35 | 5043380 gatorboat
gatorboat's picture

"is it a CDS event or not"

With $1,500 TRILLION CDS out there, no CDS trigger event will be allowed to happen.  

So anything with CDS tied to it will be protected, like senior bonds in this case.

Everybody else will take losses, share holders, junior bond holders, depositors, and taxpayers of course, who fund the bailout.

CDS is the new "insurance" for securities.  Hang trillions of dollars of CDS on a security and you can rest assured its value will be protected.

CDS only appear in a fake financial bubble where worthless junk has to be shown on bank books at full value to keep banks looking solvent. It's a way to prevent regulators marking down the value of those securities, and it operates on the "M.A.D." principle, you destroy us and we'll destroy the whole financial system.

This is why the financial system won't collapse.  CDS will allow banks to keep their fake financial bubble going forever.  It's why CDS were created.

But something has to collapse eventually, and it will be the US dollar, because Fed has to keep printing more dollars to buy up the flood of new (worthless) securities being issued by governments, gse's, banks, corporations, etc, because everybody has to keep borrowing money to stay afloat.

 

Mon, 08/04/2014 - 10:43 | 5043608 SumTing Wong
SumTing Wong's picture

You overstate it. BIS tells us there is *only* $21 trillion in OTC CDS outstanding as of last December...http://www.bis.org/statistics/dt1920a.pdf and never more than 

If BIS is right, this is only 4 months of Global World Product. What could possibly go wrong there???

Mon, 08/04/2014 - 10:53 | 5043659 gatorboat
gatorboat's picture

BIS should be BS, because $21 trillion is bullshit.

 

Mon, 08/04/2014 - 16:00 | 5045332 SumTing Wong
SumTing Wong's picture

I'd tend to agree with you...and the BIS sure does issue forth a lot of BS.

Mon, 08/04/2014 - 11:24 | 5043863 JRobby
JRobby's picture

Is a bailout a default? Depends on the structure and wording of "the contract" defining said default or bailout subject to local statute (laughter). Sure, sounds good.

"If it rains during the next 24 hours after an announced bailout, the underlying debt will be considered in default"

"If a monkey parachutes from an aircraft registered in the nation who's laws would define the insolvency of the institution who's debt is the underlying instrument as defined in subject CDS, lands within the borders of that nation then shakes hands with the first maile person he encounters, and If the scrotum of that first person rests on the left side of of his pants seam at the moment of said handshake. The underlying debt instrument is considered to be in default"

ETC.....

The "bailout" is 90% taxpayer funded. Same old.

Mon, 08/04/2014 - 12:00 | 5044080 garypaul
garypaul's picture

That reminds of the Bugs Bunny episode where Daffy Duck sells Bugs an insurance contract on his house. When something then happens to it, Daffy pulls out all this fine print about 'has to happen on such and such a date, must involve rogue elephants and this and that, and of course, one baby rhino'. The joke was that all those events then actually happen (I think Daffy even got trampled by the rhino or something), but that's just a cartoon.

How can grown adults get screwed on something even a toddler understands??

Mon, 08/04/2014 - 09:15 | 5043229 Winston Churchill
Winston Churchill's picture

The small print is always worth reading.

Mon, 08/04/2014 - 09:45 | 5043348 NYPoke
NYPoke's picture

This is why financial & legal scumbags are usually nearsighted.  CDS market is a scam.

Mon, 08/04/2014 - 09:16 | 5043233 Tjeff1
Tjeff1's picture

Now the race to get bailed out before all the funds are gone?  We may start to see lots and lots more of these.

Mon, 08/04/2014 - 09:19 | 5043244 kowalli
kowalli's picture

You can't bailed out all -> someone still need to spend money for them... west is completely broken world...

Mon, 08/04/2014 - 10:25 | 5043527 gatorboat
gatorboat's picture

No, the west isn't broke.  Fed can create trillions of dollars with a few computer keystrokes.

Mon, 08/04/2014 - 09:17 | 5043237 kowalli
kowalli's picture

ahahah i hope some guys suddenly will jump from window

Mon, 08/04/2014 - 09:19 | 5043243 ShrNfr
ShrNfr's picture

Covenant lite will be the death of a lot of bonds yet.

Mon, 08/04/2014 - 09:20 | 5043246 buzzsaw99
buzzsaw99's picture

why does anyone buy CDS? they NEVER fucking PAY!

Mon, 08/04/2014 - 09:22 | 5043254 kowalli
kowalli's picture

who cares...

Mon, 08/04/2014 - 11:05 | 5043742 bbq on whitehou...
bbq on whitehouse lawn's picture

You will, when you find out that you are the one paying for them. Call it a CDS TAX on everything you buy, trade or sell.

Mon, 08/04/2014 - 09:24 | 5043264 Bernoulli
Bernoulli's picture

They are a great tool to make your manager and the board of directors happy.

A: "And you are sure, there is zero risk?"

B: "Yes, absolutely! And we are even insured against the unlikely events with CDS!"

A: "Ok, brilliant. Carry on!"

Mon, 08/04/2014 - 09:34 | 5043307 Renfield
Renfield's picture

<<B: "Yes, absolutely! And we are even insured against the unlikely events with CDS!">>

hehehe

How to make question time at the conference table suddenly interesting:

"Swaps you say? Awesome, who's the counterparty?"

Mon, 08/04/2014 - 09:55 | 5043369 babkjl
babkjl's picture

Something doesn't make sense here. If the CDS follow the subordinate bonds into the bad bank and the bad bank doesn't make the interest payments (very likely), then doesn't that eventually trigger the CDS to pay out?

If they still don't pay out, then buzzsaw99 is entirely correct: never buy CDS. What if we ZeroHedgers pooled together with our own real form of CDS? We pick something many of us are invested in and a different group of us pools together and issues real insurance that does pay in a form similar to put options. Is there any interest, or is it a dumb idea?

Mon, 08/04/2014 - 11:16 | 5043822 bbq on whitehou...
bbq on whitehouse lawn's picture

Unfortunetly banks don't allow competion in this area. Its a hidden tax on pooled money. Its a check box on the cover your ass list for the managers. Banks under law can't sell insureance but they can sell CDS insureance like product. Its like selling oil pumped with hydrogen and calling it butter.
It is and will always be unlawfull but we no longer have laws, only children playing stupid gotcha games.

Mon, 08/04/2014 - 10:02 | 5043413 gatorboat
gatorboat's picture

They're not meant to pay off. 

CDS is a way to "legitimize" worthless securities so they can be carried on the books at full value.  It's just an accounting gimmick allowing worthless junk to be shown on the books at full value.

It works on the "M.A.D." principle.  Mark these worthless securites down to true market value, trillions of dollars of CDS will trigger, and the whole financial system will collapse.  So no, don't mark them down, don't even think about it.

Mon, 08/04/2014 - 11:40 | 5043983 Amish Hacker
Amish Hacker's picture

And not just CDS. All markets are now geared to prevent price discovery. I doubt that a single large western bank could survive having its assets marked to true market prices. And you gotta love the Orwellian use of language: this is a "succession event," not a "trigger event," and under no circumstances should you be picturing a can getting kicked by a very expensive shoe.

Mon, 08/04/2014 - 15:12 | 5045049 Bernoulli
Bernoulli's picture

Fully agree.

Actually, this whole fuck up of the financial system is all because of accounting rules in the first place. If CDS would have no effect on how the risks LOOK on the books, then there would probably be no CDS market...

And if there would be no "mark to unicorn" but principle of lower of cost or market (Niederstwertprinzip, however this may translate) like it used to be in Germany until some years ago under HGB accounting rules then the global economy could be going quite well all.

Now the big question is: Who makes the accounting "standards"???

Mon, 08/04/2014 - 11:11 | 5043780 PT
PT's picture

buzzsaw99 re "Why does anyone buy CDS?  They never fucking pay!" :

Didn't the Argentine ones pay out the other day?

http://www.zerohedge.com/news/2014-08-01/cds-triggered-isda-confirms-argentina-credit-event-took-place

Otherwise, yes.  The casino is only honest if you're losing.  Time to go home.  Maybe set fire to the curtains on your way out.  A real casino might give you your money back just to try and keep the peace.

Mon, 08/04/2014 - 15:59 | 5045335 JRobby
JRobby's picture

Depends on the definition of "pay". They have been known to trigger bailouts of large insurance concerns that apparently no longer need to adhere to regulatory risk guidelines.

Mon, 08/04/2014 - 09:22 | 5043253 Its Only Rock N Roll
Its Only Rock N Roll's picture

This new normal thingy is quite confusing....just keep away from it all.

Mon, 08/04/2014 - 09:23 | 5043256 junction
junction's picture

The AIG CDS derivatives paid out about 180 billion dollars in 2008 and 2009.  Of course, that money initially came from generous U.S. taxpayers through TARP.

Mon, 08/04/2014 - 09:26 | 5043274 flyonmywall
flyonmywall's picture

Yeah, it's just a small country at the left toe of Europe. Nobody gives a rat's ass, until the left foot kicks the right foot and then it swings up to the face.

Screw it all, it's 5 o'clock somewhere.

 

Mon, 08/04/2014 - 10:34 | 5043558 astoriajoe
astoriajoe's picture

4:20 even.

i want to sleep through what's next.

Mon, 08/04/2014 - 09:26 | 5043276 Seasmoke
Seasmoke's picture

When is a default, a default ?  NEVER !!!!!

Mon, 08/04/2014 - 09:32 | 5043301 Kina
Kina's picture

Like buying insurance from the Mafia. Ever going to collect?

Mon, 08/04/2014 - 09:40 | 5043330 Ghordius
Ghordius's picture

the funniest thing about CDSs is that they are often penned by the banks themselves. so the problem of collection is more: how do you get money for betting on the bankruptcy of Banco Ghordius... if Banco Ghordius goes bankrupt and it's the one entity that is supposed to pay you?

which leads of course to the question: why did you buy insurance on something that does not belong to you? which all leads again to the "freedom to bet" or...

... the freedom of having this kind of poisonos stuff made more for hiding idiocies in off balance sheet "vehicles". Enron, the gift that keeps giving

Mon, 08/04/2014 - 09:58 | 5043402 falak pema
falak pema's picture

OTC hanky panky to cover your ass when you perpetrate a scam in the first place.

When the financial arsonists play at being firemen, when poachers become game keepers  and call for "fair treatment" of their previous shenanigans.

Bring this whole intra banking and shadow bank casino down please. Pronto! 

Mon, 08/04/2014 - 09:37 | 5043320 spanish inquisition
spanish inquisition's picture

Seniors were not touched, it would seem they did not cross the Russian ownership threshold like they did in Cyprus?

Mon, 08/04/2014 - 09:56 | 5043397 1stepcloser
1stepcloser's picture

the NWO want all their ducks in a row before they allow the derivatives dominos to start falling.   They want maximum pain inflicted, so you come to them for their solution

Mon, 08/04/2014 - 11:21 | 5043856 PT
PT's picture

By avoiding the payout of CDSs, they should kill the market for CDSs.  When there are no CDSs, there are no synthetic CDOs.  Shouldn't this be the end?

Of course, the above scenario assumes that the buyers of CDSs care.  If someone uses OPM to buy something that the OP won't see for 30 years, eg pension fund, do they still care?

Mon, 08/04/2014 - 10:10 | 5043448 roadhazard
roadhazard's picture

Six $billion and a bad bank can cure whatever the problem is, next.

Mon, 08/04/2014 - 10:42 | 5043604 q99x2
q99x2's picture

Gotta save those banksters M'Fers.

Mon, 08/04/2014 - 10:48 | 5043639 Seize Mars
Seize Mars's picture

ISDA is a bunch of intellectual slobs.
Why even bother trading credit if the shit is never allowed to pay off?

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