The day that Banco Espirito Santo finally crashed and was liquidated nationalized under the weight of its countless criminal "inside the family" fund transfers, money losing loans, and off balance sheet activities, we pointed out to something amusing: the Goldman trail. Because not only was it revealed that in mid-July, two weeks before the Portuguese bank conglomerate failed, Goldman had invested several hundred million into the broken business, but that all through 2014, Goldman had done its best to drag the muppets down with it.
Recall from January 14, 2014 where Goldman said:
Buy BES: Winner at home, recovering abroad
In our view, BES is (1) optimally positioned to gain from Portugal’s banking market evolution and (2) likely to benefit from improving margins in Angola. With the stock trading at a 29% discount to peers’ 2015E P/TBV and with 28% upside to our 12m target price of €1.55, we upgrade BES to Buy.
* * *
Positioning: Looking beyond the crisis – BES best placed
Resilience to asset quality deterioration determined banks’ ability to withstand the effects of the economic and financial crisis. Those effects, however, have their cause in macroeconomic imbalances that led Portugal to ask for financial assistance from the EU/IMF. Addressing those causes will determine the future shape of the Portuguese banking market and the relative positioning of the banks. In this context, we develop a theoretical (and severe) scenario to assess relative positioning in a deleveraging economy: under this scenario, we estimate that Portuguese banks would need to delever by a further €35 bn domestic loans (or 15%) by 2020 to partially reverse the imbalances that contributed to the crisis. This is a top-end assumption and depends heavily on the country’s future macroeconomic performance. In this negative scenario, we show that BES would be best positioned to gain from a “race to the bottom”. Our estimate is harsh, but we still believe that it is a good proxy for the underlying trends in the lending market. In this context, even under more benign scenarios, BES is best placed.
Goldman had BES at a Buy until, well, just before the default.
The crashing stock price rose briefly on July 23 after it was revealed that such "deep value investors" as Baupost and quant algos as D.E.Shaw, but most importantly, Goldman, had become substantial holders of the BES common, with Goldman controlling just under 3% of the equity. Surely if anyone would have done their due diligence it would be Seth Clarman, David Shaw and the Squid. Well, ten days later it became abundantly clear that not only had nobody done any homework, but that the investors were merely piggybacking on each other, hoping that the "other guy" had actually analyzed the situation.
But while Baupost and DE Shaw, hedge funds which have deep-distrssed investing pockets, are logical buyers of a pre-bankruptcy stock and can assess the risks of a full wipe-out, why did Goldman feel compelled to chase a falling knife?
As Bloomberg reported on July 23, Goldman Sachs said today that it “entered into positions in Banco Espirito Santo by virtue of its facilitation of client transactions,” according to an e-mail sent to Bloomberg News. "This purchase passes on some security to the market and can open the door for other institutional investors," said Juan Dieste, a trader at Orey iTrade in Lisbon.
Turns out as usual there was much more to the story, and - not unexpectedly - the squid had its tentacles all over Europe's latest bank failure.
As the WSJ reported this morning, in addition to all the previously documented tentacles, Goldman had one more money-sucking contingency when it comes to the heretofore Portuguese cookie jar: it turns out that "through a Luxembourg financing vehicle created by Goldman, Banco Espírito Santo received $835 million in July, according to a prospectus reviewed by The Wall Street Journal, a time when it was nearly impossible for the troubled lender to borrow directly in the capital markets... The transaction with Goldman is the latest instance of a Wall Street firm helping finance the Espírito Santo empire via off-balance-sheet vehicles before its demise. Portuguese regulators, for example, are investigating special-purpose vehicles, administered by Credit Suisse Group AG, that bought debt from Espírito Santo companies, the Journal reported last month."
So what: just another insolvent Europen bank funding itself entirely off the books with the help of the world's most opportunistic banks (one wonders how many trillions in such SPVs are currently floating around Europe funding the banking sector's €1+ trillion non-performing loan deficiencies, but that is a topic for another day). But unlike the "plain vanilla" Spivs of the first credit bubble, the complexity of this one was truly impressive:
At least some of that money was earmarked for an unusual destination: helping finance a refinery-construction project that a troubled Chinese company was running for Venezuela's state oil company. That oil company was a major creditor of companies in the Espírito Santo group. The previously unreported Goldman deal offered a fleeting respite for Portugal's second-largest bank, which was struggling with a cash crunch and a month later was bailed out and broken up by the Portuguese central bank.
The latest twist in the Espírito Santo saga started last September, when Venezuela's state oil company, PDVSA Petroleo SA, known as PDVSA, awarded an $834 million contract to a Chinese company named Wison Engineering Services Co.
The contract, awarded just days after Chinese police detained Wison's controlling shareholder in an oil-industry corruption crackdown, was to help build an oil refinery in Puerto la Cruz on Venezuela's coast. It marked the biggest such contract in Latin America for a Chinese company and a rare international foray for Wison.
Banco Espírito Santo at the time had a substantial presence in Venezuela. It had opened a Caracas branch in January 2012, part of an ambitious global growth strategy, and served as banker to the Venezuelan government and PdVSA on multiple projects. A Banco Espírito Santo marketing presentation this year touted Venezuela as "an important market," noting the large community of Portuguese expatriates there.
PDVSA, meanwhile, held significant sums of Espírito Santo debt, making it one of the family-owned conglomerate's largest creditors, according to a person familiar with the relationship.
So a Chinese criminal entity investing in Venezuela, using money from a soon to be insolvent Portuguese bank that wouldn't be around in one year's time. And who ties it all together? Why the bank that was telling its clients to invest in the insolvent Portuguese bank all along.
Then things accelerated: in May, Banco Espírito Santo approached Goldman to set up a special-purpose vehicle named Oak Finance Luxembourg SA. Banco Espírito Santo wanted to use the vehicle to raise dollar-denominated funding, which was growing scarce due to the bank's financial troubles, according to the person familiar with the relationship.
On July 3, locked out of bond markets and bleeding cash, Banco Espírito Santo borrowed $835 million from Oak Finance, according to the prospectus. The borrowed funds were for purposes including trade financing for Wison Engineering on PDVSA's Deep Conversion Project, according to the loan agreement included in the Oak Finance prospectus.
The problem is that at just about that time, a Chinese crackdown on Wison's controlling shareholder Hua Bangsong, about to be arrested on bribery charges, meant that the key player was about to drop out of the picture. Somewhat symmetrically, Wison announced on July 21 that the investigation casts doubt on its ability to stay in business, noting last week that it is in default on some of its bank obligations.
By this time, however, Goldman was furiously spinning the damage control machine, seeking to offload as much risk as possible knowing that the end is insight.
The same day that Banco Espírito Santo tapped the Oak Finance loan, Oak Finance issued $785 million of debt with annual interest rates of up to 3.5%. Goldman, which served as arranger and dealer for the transaction, bought the debt and hoped to sell it at a profit to outside investors.
What Goldman did not anticipate is how quickly the situation would spin out of control: "At first, the arrangement appeared lucrative for Goldman. It stood to collect fees from Oak Finance that "will be materially higher than the fees and/or commissions typically charged in vanilla bond transactions," according to the prospectus. But Banco Espírito Santo's financial difficulties made it hard for Goldman to attract buyers. During July, customers and creditors of the Portuguese lender yanked €3.35 billion ($4.4 billion) of funds, leaving the bank with "a severe liquidity shortfall," according to Portugal's central bank. The bank's shares plunged 80% before its Aug. 3 bailout.
So what did Goldman do to make it seem it was in control? It invested a token amount in the BES equity for one simple reason: to offload as much of its SPV exposure to clueless invesotrs, as fast as possible. Because after all, why would Goldman be buying a chunk of the bank if it didn't expect it to survive.
Well, it didn't, but the whole point was to give just this impression, and in the fog of confusion, to dump as much of the 3.5% yielding paper to yield starved managers experiencing career risk and "Fear Of Missing Out", and glutted with other people's money.
Sadly it failed, and this time around Goldman's double down bluff blew up in its face, with the 200 West bank suffering losses on both its SPV exposure and its equity investment. To be sure, not total losses:
Goldman eventually sold a slug of the Oak Finance debt, at a loss, to hedge funds that specialize in distressed debt, according to a person familiar with the market activity. Goldman is still holding some of the debt, which has lost value, this person said.
The fate of the Oak Finance debt is unclear. The sole collateral on the bonds is Oak Finance's $835 million loan to Banco Espírito Santo. Despite the bank's collapse, that loan is supposed to be repaid. It was among the liabilities transferred to Novo Banco, the "good bank" that Portugal carved out of Banco Espírito Santo when it was bailed out in August, according to Moody's Investors Service.
Perhaps the take home message here is that in the New Normal, a truly distressed security yields a tiny 3.5%.
Or maybe, the lessons is that if Goldman is involved, someone will always end up suffering massive losses.
No matter what the lesson may be, if there even is one, here is what years of "macroprudential policies" have yielded:
- Off balance sheet vehicles? Check
- Conflicted bank "research" recommending muppets buy stock while soliciting banking fees from same stock? Check
- Hoping to sell debt on to muppets? Check
- Chinese corruption? Check
- State bailout of failed bank? Check
And that ladies and gentlemen, is precisely how the New differs from the Old Normal. Oh wait...