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