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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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.

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

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.

NoDebt's picture

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

GetZeeGold's picture



CDS Trigger May Be Avoided





Richard Chesler's picture

CDS is just another term banksters use for money laundering.


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.

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.

NotApplicable's picture

CDS = Created for Dumb Shits.

<= (My shocked face)

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.

PT's picture



Nailgun Backed Securities

PT's picture

CNO - Collateralized Nailgun Obligations

IANAE's picture

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

Ghordius's picture

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

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.

LawsofPhysics's picture

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


"full faith and credit..."

Tasty Sandwich's picture

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

Peak oil.

LawsofPhysics's picture

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

Tasty Sandwich's picture

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

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.


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?


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

LawsofPhysics's picture

yes, bail-in bitchez...


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

hedge accordingly.

Spastica Rex's picture

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

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. 

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"

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


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.


SumTing Wong's picture

You overstate it. BIS tells us there is *only* $21 trillion in OTC CDS outstanding as of last December... and never more than 

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

gatorboat's picture

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


SumTing Wong's picture

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

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"


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

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??

Winston Churchill's picture

The small print is always worth reading.

NYPoke's picture

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

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.

kowalli's picture

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

gatorboat's picture

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

kowalli's picture

ahahah i hope some guys suddenly will jump from window

ShrNfr's picture

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

buzzsaw99's picture

why does anyone buy CDS? they NEVER fucking PAY!

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.

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!"

Renfield's picture

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


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

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

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?

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.

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.

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.

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"???

PT's picture

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

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

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.