Two weeks ago, The Bank of Portugal shocked markets by bailing in [11] senior Novo Banco bondholders.
Novo Banco was the “good” bank forged from the ashes of Banco Espirito Santo which had to be bailed out by the state in August of 2014. The idea was to sell Novo Banco to pay for the cost of the bailout, but the auction process eventually floundered amid turmoil in Chinese markets (at least two of the potential bidders were Chinese) and uncertainty about whether this “good” bank would in fact need more capital given the elevated level of NPLs already on its books.
In November, the ECB told Novo it woudl indeed need to raise some €1.4 billion in fresh capital which the bank initially said would come from asset sales. A little over a month later, Portugal’s central bank essentially just gave up. On December 29, the bank announced it was transferring €2 billion in NB senior notes back to Banco Espirito Santo which, like a ghost skyscraper in China, is set for demolition.
In other words, Novo Banco plugged the €1.4 billion hole by essentially declaring €2 billion in bonds null and void.
There were five issues affected but you can get a pretty good idea about what happened next by having a look at how the 2017s traded that morning:
[12]
The reason this had to be done quickly was because if Portugal had waited until January, uninsured depositors would have been at risk under the EU's new bank resolution mechanism. Plus, Portugal is anxious to get the auction process started again to avoid the decidedly unappealing prospect of having to keep the cost of the bailout on Lisbon's books in perpetuity thus inflating the fiscal deficit by an extra 3% of GDP.
Now that the smoke has cleared, bondholders aren't happy and Lisbon is doing its best to distance itself from the central bank's decision even as it clearly paved the way for Novo's sale, which the government obviously benefits from. "The Portuguese government said it was against the central bank’s decision to impose losses on some Novo Banco SA bondholders, according to two people familiar with the situation," Bloomberg reports [13], noting that "Finance Secretary of State Ricardo Mourinho Felix told investors on Monday that the ministry had expressed concern to the central bank about the transfer of bonds to a bad bank, [but] didn’t interfere in the debt transfer because of central bank independence."
For their part, the ECB says it had nothing to do with the transfer either. "The decision by Banco de Portugal to bail in some senior bond holders in Novo Banco was taken exclusively by BdP under its national resolution powers," the central bank said, in a statement.
PIMCO, for one, isn't buying the idea that the government had no say in the matter and in an op-ed for FT, managing director and global head of financial research Philippe Bodereau likens Portugal to Venezuela and Argentina before calling the Novo Banco bail-in an "inconsistent, unfair and amateurish populist short-cut."
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From "Discrimination at Portuguese Bank Novo Banco Sets Dangerous Precedent" as originaly published in Financial Times [14]
Just over a year since the European Central Bank took over as the regulator for Europe’s systemically important banks, we face a situation in Portugal that calls into question the rule of law in that country and in the EU. This also raises very serious questions over how the ECB intends to act as Europe’s banking regulator [15].
Where banks are judged to be insolvent, then it is right and proper that senior bondholders should be bailed in and take losses. But this must be done in a fair manner and, indeed, in accordance with the law. What is clear is that in the case of Novo Banco, the ECB itself has concluded that the bank was solvent and in no need of another resolution, leaving no legal and economic rationale behind the radical course of action undertaken by the Portuguese authorities. It is important to stress that there is no new resolution, bail-in or insolvency proceeding here
In the case of Novo Banco, this shortfall could easily have been covered with private sector solutions, be they asset sales, equity raising and/or partial debt equitisation. This playbook has worked efficiently in the recent and much more challenging recapitalisation of the Greek banking sector [16], which led to an aggressive, but fair, bail-in of senior creditors.
The new Portuguese administration is not the first government to resort to asset confiscation and populist expediency. Venezuela and Argentina also belong to this club. The important distinction is that Portugal is a eurozone member state, and its systemically important banks are regulated by the ECB.
Indeed, it is no secret that the southern periphery of the eurozone has a large number of weak banks with significant non-performing loans on their balance sheets. The Novo Banco action sets a worrying precedent that an arbitrary and unfair confiscation of investor assets is an acceptable remedy to the financial challenges experienced by these weak banks.
It is a great shame that five years after the beginning of the eurozone sovereign and banking crisis, the eurozone is still dealing with banking crises in a manner that is inconsistent, unfair and amateurish. We collectively — investors, bankers, regulators and governments — should aspire to much higher standards and avoid populist short-cuts that will inevitably result in protracted litigation.
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For those wondering who's on the hook here, below find the list of bondholders who had a very bad day on December 29.
[17]
[18]
[19]
[20]
