4th August 2014 by Shaun Richards
Late last night came the news which we had been fearing about the state of play at Banco Espirito Santo or BES. The Bank of Portugal announced that it was being bailed out.
The Board of Directors of Banco de Portugal has decided to apply a resolution measure to Banco Espírito Santo, S.A.. The general activity and assets of Banco Espírito Santo, S.A. are transferred, immediately and definitively, to Novo Banco, which is duly capitalised and clean of problem assets.
This meant that quite a long journey and in fact the longest possible one had taken place since the Bank of Portugal had told us this on July 11th.
Banco de Portugal clarifies, based on the information reported by BES and its external auditor (KPMG), that BES holds a sufficient capital buffer to accommodate possible negative impacts arising from its exposure to the non-financial arm of Espírito Santo Group (GES), without jeopardising its compliance with the required minimum capital ratios.
Even worse the Bank of Portugal took the opportunity back on July 11th to undertake some boasting about how an external audit commissioned by it had revealed all this. Now we know that it missed more than it uncovered!
What has happened since Thursday?
As regular readers will be aware the official view as recently as Thursday was that there was/were investors ready to put more money into BES to shore up its finances. However as the share price plummeted again on Friday there were increasing doubts as to whether private funds could fix the problem. Actually with the share price falling to 12 Euro cents before share trading was suspended on Friday (even though short-selling was banned) the economics of a private-sector bailout had pretty much collapsed. Of course that is assuming that there was some truth in the claims that money had been available for this purpose.
Accordingly the weekend saw the midnight oil being burnt at the Bank of Portugal and the Ministry of Finance.
How bad had the situation got?
Contrary to the official claims at the time, the state of play was dire as this from the Bank of Portugal reveals.
Access of Banco Espírito Santo, S.A. to monetary policy operations and therefore to the liquidity provided by the Eurosystem was suspended.
At that point the game was up as of course such news would spread like wildfire and the bank would find itself frozen out of all money markets. Indeed problems spread wider than just for it.
these problems endangered the stability of the national payment and financial systems.
How does the bailout work?
In essence BES has been split into a good bank and a bad bank. I described above the beginnings of Novo Bank and here below is the bad bit.
Problem assets, which in essence correspond to liabilities of other entities of the Grupo Espírito Santo and to shareholdings of Banco Espírito Santo Angola, S.A. whose losses are borne by the shareholders and subordinated creditors of Banco Espírito Santo, S.A.;
So far so conventional although the Portuguese authorities now award themselves five gold stars as you can see below.
The State will bear no costs related to this operation.
At this point the mind boggles somewhat as we know that private capital had run for the hills so we are bemused by the concept of public money not being needed either! Step forward the Resolution Fund.
The equity capital of Novo Banco, to the amount of €4.9 billion, is fully underwritten by the Resolution Fund.
This initially looks rather good until we realise that the Resolution Fund does not have 4.9 billion Euros or as it turns out anything like it!
the (Resolution) Fund took out a loan from the Portuguese State. The loan granted by the State to the Resolution Fund will be temporary and replaceable by loans granted by credit institutions.
This is starting to look as tangled a web as the finances of the Espirito Santo Group isn’t it? Which of course is exactly how the situation ended up in the mess that it is now in.
The Resolution Fund is financed by Portugal’s banks who overall have just got weaker as BES would have been assumed to be a supporter and financier of it. According to the Financial Times it has some 380 million Euros of resources so it will be geared nearly 13 times in this rescue. You could argue that is a little unfair as it could draw more funds from other Portuguese banks and Novo bank will have a value. But how much?
Is Portugal still in a bailout or not?
The 4.4 billion Euros of extra capital for Novo bank will be provided by the funds that were originally earmarked for Portuguese banks in the Troika (IMF,ECB and European Commission) bailout. There were around some 6 billion Euros left over so it is not mathematics which present a problem here, it is this from Portugal’s Prime Minister Pedro Passos Coelho on May 4th.
The government has decided to exit the assistance program without turning to any kind of precautionary program.
The Reuters news agency reviewed it in glowing terms.
The decision to exit the bailout without a security net is a major success for the government,
So it would appear that the Mad Hatters Tea Party carries on as “without a security net” morphs into “thank you Euro area taxpayers for the loan of 4.4 billion Euros “. Of course we are told that the situation is “temporary” in the way that UK taxpayers were told that financial interventions in Royal Bank of Scotland and Lloyds Banking Group were. We are of course still there.
In an economy the size of Portugal a loan of 4.4 billion Euros is no small matter as it represents around 2.5% of a year’s economic output. Also with a national debt already just short of 221 billion Euros (132.9% of GDP) Portugal does not need increases in it.
Let us hope that Novo bank thrives and does in time provide a mechanism for repaying the money borrowed on its behalf.
The bad bank
There are a lot of assumptions made by the Portuguese state in the creation of this. The situation is one created by a combination of fraud and deceit as the Bank of Portugal has itself made clear. So how can it possibly say that the shareholders funds and subordinated debt will be sufficient to cover the losses? The truth is that they may not. Indeed as such cans of worms have a habit of getting ever worse I suspect that the debts and losses will exceed the capital available. It is hard to avoid the thought that some can kicking is going on here as the situation will take quite some time to resolve with the hope that in true Sir Humphrey fashion minds will be focused on something else when the full truth is revealed.
The glass half-full side to the issue is that at least something has now been done about BES. That puts an end to the downwards spiral of the last few weeks. Also the good bank bad bank model is better than the debacle which was imposed in Cyprus. I understand that there were plenty of depositors in Spain attracted by the 2.5% interest-rate on offer for 12 month deposits who had invested more than the 100,000 Euro deposit insurance limit. So they amongst others will be grateful that there has been no depositor bail-in. But we are left we plenty of both questions and issues about what has taken place here.
Firstly there is the issue of corruption and fraud in the Espirito Santo Group and BES. This leads to obvious problems for the Bank of Portugal and the Portuguese authorities who offered us platitudes and false promises for a sustained period. Secondly there is the issue of how some 4.4 billion Euros of funding for the new clean Novo bank can be described as free? Euro area support lending may well be cheap but it is not free! Thirdly we have the issue of the bad bank where junior debt has been punished -I would not be surprised to see it pretty much wiped out- but senior debt has walked away one more time. I suspect that Portuguese taxpayers will not turn out to be so lucky.