No point moaning after you’ve lost your shirt

7 min read

Of the many events going on in the dying days of December and into the hesitant first days of January one that caught my eye was the impact of the impending arrival of the EU’s Bank Resolution and Recovery Directive and the severe ructions it caused in Portugal in the days leading up to Christmas.

Let me start with my conclusion, which is this: why oh why don’t investors get themselves out of the line of the fire when they can – and when the writing is on the wall – rather than acting hurt or surprised when harm befalls them and acting tough when they’ve already lost their shirts?

What am I talking about? Let’s back up a little.

First, the Portuguese resolution authority hurriedly bailed out and sold the good assets of Banif – Banco Internacional do Funchal to Santander Totta, the local subsidiary of Santander – for €150m in December. Shareholders and subordinated creditors will be bailed in to cover losses.

Second, certain institutional bondholders of Novo Banco were effectively wiped out because five lines of euro-denominated senior debt with nominal value of €1.941bn were transferred to bad bank Banco Espirito Santo ahead of BES’s winding up.

The Bank of Portugal had little choice really, faced with a projected capital deficit of €1.398bn at Novo Banco coming out of the ECB’s Comprehensive Assessment/Stress Test. As a result of the transfer, Novo Banco’s CET1 rose to around 13% from 9.4% at the mid-year stage.

The fact that the December transfer of liabilities was supposedly the final re-cut will offer little solace to bondholders affected, although why any of them thought it was an unexpected act is a mystery to me. If anything it suggests something approaching negligence on the part of affected investors, as the bonds collapsed from the mid-90s to a price of around 10. I say they’ve only got themselves to blame.

And if, by the way, you threaten legal action on the back of supposed pari passu breaches in the BES/Novo Banco case, you’d better read carefully the legal small print of the resolution documentation and understand the latitude that resolution authorities have in such cases.

In a story as far back as mid-September about a spike in Novo Banco’s CDS levels owing to (ultimately well founded) doubts over the bank’s sale, my colleague David Wigan wrote: “[Novo Banco] CDS prices were boosted by rumours that senior bonds might be bailed in as part of a plan to restructure the bank …” In other words, it was an open secret that this might happen. In the circumstances, you’d have thought real-money investors would have got out of the line of fire months ago and left the fight to the distressed or vulture community.

No matter that the original plan had been to sell non-core assets to plug the capital deficit, the authorities had made it pretty clear at the time of the original resolution plan that switching assets and liabilities from Novo Banco to BES was a distinct possibility in a bid to ensure that Novo Banco remained a going concern and losses were borne by shareholders and creditors rather than the country’s banking sector, depositors or taxpayers.

Sale fiasco

As for the Novo Banco sale, what a fiasco the process has been. Portuguese authorities have applied to the EC to have the deadline extended after they halted the process in December, declaring the bids from Anbang Insurance Group, Fosun International and private equity firm Apollo unsatisfactory. The Chinese bidders, in particular, were said to have attached so many conditions as to make their bids untenable. If that was the case they should have been disqualified months ago.

So what happens now? I read that Spain’s Caixabank and Santander might be bidding at the second auction, although I wonder about the latter in the light of the Banif developments. That said, its Banif takeover boosted its share of the Portuguese market to number two (among private sector lenders) behind BCP so the shot at the number one spot may be too tempting to pass up.

Caixabank dropped a bid last year to acquire the remainder of Banco BPI (in which it has a 44% stake) as negotiations ran into trouble following pushback from Angolan investor Isabel dos Santos, BPI’s second largest shareholder. But the Spanish bank presumably remains interested in adding assets in Portugal.

One potential home-grown outcome is a merger between Novo Banco and Banco BPI. Incidentally, a merger between Banco BPI and BCP, the country’s largest private sector lender, has previously been mooted and is, I gather, an outcome preferred by dos Santos, so watch out for that.

Beyond the strict confines of the banking story, the most pressing issue for the Portuguese government is that the costs of the bank bailouts sit on the state’s books, which is severely straining budget deficit reduction efforts. The Banif bailout resulted in an injection of €2.26bn of state aid plus an additional €422m in guarantees to cover potential losses on assets transferred to Santander. The government had previously injected €1.1bn into Banif in 2013, €700m for a 60% equity stake and the rest in CoCos.

In summary, bail-in is part of the investing landscape. There’s no getting away from that. Investing in small, storied, second-tier banks in the EU periphery can be risky. Investors need to keep their ears to the ground, be crystal clear about resolution modalities and methodologies, and price their risk appropriately.

Yield pick-up is a wonderful thing in a world of super low euro rates. But it can come with strings attached. If they’re not prepared to do the leg work, investors should exit and buy something else. Long drawn out legal battles after the event don’t strike me as a good way to proceed. And the hope-and-a-prayer method of protecting capital in a world that’s likely to be volatile in this coming year is best left out of the playbook.

Keith Mullin