latest post at Pieria
, I took a hard look at the half-year results of Portugal's
distressed Banco Espirito Santo (
). They are pretty grim reading. No, they are worse than that. They
read like an instruction manual for how to rip off a bank. It's no
surprise that the losses are appalling.
But now it seems that Banco Espirito Santo is to be bailed out
by the Portuguese government. The rescue plan was announced by the
Bank of Portugal late in the evening of 3rd August, and the
European Commission confirmed that it complied with existing state
Bank of Portugal's statement
describes the dramatic events that led to the decision to rescue
BES (my emphasis):
On July 30, Banco Espírito Santo, SA announced losses which
greatly exceeded those anticipated from the information
previously provided by Banco Espírito Santo, SA and its
Results released on July 30 reflect management acts
seriously prejudicial to the interests of Banco Espírito Santo,
SA and infringement of Bank of Portugal decisions forbidding
increased exposure to other entities of the Espírito Santo
These events took place during the tenure of the previous
administration of Banco Espírito Santo, SA.
Management acts at a time when the replacement of the
previous administration had already been announced translated
into an additional loss of the order of €1.5 billion
compared to that expected from the statement of Banco Espírito
Santo, SA to the market on July 10 . This had several
i) placed Banco Espírito Santo, SA in a position of
non-compliance with minimum solvency ratios in force (Common
Equity Tier 1 ratio of 5 percent, three percentage points below
the regulatory minimum);
ii) determined a decision to suspend access by Banco
Espírito Santo, SA to monetary policy operations and therefore,
the liquidity of the Eurosystem;
iii) generated a growing pressure on the Treasury of Banco
Espírito Santo, SA;
iv) worsened the public perception of Banco Espírito Santo,
SA, as evidenced by the strongly negative performance of the
respective titles, injurious situation for the confidence of
depositors. This negative public perception led to the
suspension of transactions on the afternoon of Friday, August
1, at the risk of infecting the perception relation to other
institutions of the Portuguese banking system;
v) worsened the uncertainty about the balance of Banco
Espírito Santo, SA, invalidating a privately funded solution in
a short time.
This framework created continuity problems for Banco
Espírito Santo, SA activities. Given the importance of the
institution in the whole banking system and the financing of
the economy, these problems jeopardized the stability of the
payment system and the national financial system.
So when BES's eyewatering losses were declared, which forced it
into regulatory insolvency, it was denied access to Eurosystem
liquidity and trading in its shares and bonds was suspended. The
Bank of Portugal's strong language in this statement echoes that
from the new Board of BES: neither seems in any doubt that the
activities that directly caused BES's collapse were illegal. As I
noted in my Pieria post, the Board's statement amounted to an
allegation of fraud. The Bank of Portugal's statement in effect
alleges embezzlement, non-compliance with regulatory decisions and
failure of fiduciary duty to shareholders. Wow.
BES is to be wound up. The "good" assets of BES are to be placed
into a new credit institution, along with ordinary deposits and
senior bonds: the remaining assets, along with shareholders' funds
and subordinated debt, will remain in BES and be run down over
time. No haircut is to be applied to senior unsecured debt.
Bondholders and large depositors are no doubt breathing a huge sigh
of relief: eighteen months later and they would have been facing
losses. The Cyprus solution - haircuts on large deposits and senior
bonds to protect the sovereign balance sheet - will become law
across the whole EU from January 2016.
But there is something of a puzzle here. The Bank of Portugal
calls the new "good bank" Banco Novo, or "New Bank", and seems to
expect it to remain intact for the foreseeable future. But the
calls it the Bridge Bank, and describes it as a "temporary credit
institution". The reason appears to be the different objectives of
the two institutions: the Bank of Portugal is primarily concerned
with preserving financial stability and ensuring that BES customers
suffer as little disruption as possible, whereas the European
Commission is primarily concerned with minimizing the impact of
this bailout on the fragile finances of the Portuguese state.
The problem is the approach to funding the "good bank". Banco
Novo (or Bridge Bank) is to be provided with capital to the tune of
E4.9bn from the Bank Resolution Fund. But the Resolution Fund
actually doesn't have this money or anything like it. So the
Portuguese state will lend it E4.4bn from funds already earmarked
for bank recapitalization - that's around 2/3 of the earmarked
funds. Earmarked it may be, but it is still public debt: unless it
can be refinanced with private sector money VERY fast, the Bank of
Portugal's statement that capitalizing the new bank "does not
entail cost to the public purse" is not remotely realistic.
The Bank of Portugal describes this loan as "temporary and
replaceable with bank loans". I would like to know how long is
"temporary" and which banks would replace the loans. But the
European Commission has a different view of the means by which the
loan will be repaid:
Portugal's Resolution Fund will provide EUR 4,9 billion as
capital to the Bridge Bank. To this end, the Resolution Fund
will receive a EUR 4.4 billion loan from the Portuguese State.
This loan will be primarily reimbursed by the proceeds
of the sale of assets of the Bridge Bank
It seems that the Commission expects the "good bank" to be
broken up and sold piecemeal. Oh dear. Clearly there will have to
be some negotiation about this.
But the funding of the "good bank", confused though it is, at
least should be adequate to allow the new bank to operate. And if a
buyer could be found for the whole thing, or a successful flotation
achieved, then the loan could be paid off without breaking up the
bank. This has to be the best solution for BES's customers. So the
fact that the Commission has not recommended this just shows how
narrow its focus is. Never mind the people affected, worry about
state finances. Hmm.
To my mind the bigger problem is the inadequate funding of the
"bad bank". Both the Bank of Portugal and the European Commission
assume that once the good assets and senior debt have been removed
to the new bank, the remaining shareholders' funds and subordinated
debt will be sufficient to enable BES to be wound up without
further funding. I'm afraid this is a very dangerous assumption.
The Board of BES made it clear in the half year results that the
extent of BES's exposure to ES Group liabilities is unknown and
considerable risks remain: it seems likely that there will be more
losses, possibly very large ones. The final bill could be far
higher than the combined shareholders' funds and subordinated debt.
But neither the Bank of Portugal nor the European Commission has
considered the effect on Portuguese state finances of the "bad
bank" BES incurring losses in excess of the value of shareholders'
funds and subordinated debt. Protecting senior creditors could turn
out to be a very bad decision.
And the decision to rescue BES fails to address the problem I
raised in my previous posts about BES (see reading list below),
namely the moral hazard that setting such a precedent creates for
non-bank conglomerates with embedded banks. Yes, those responsible
for the failure of BES may face litigation at some point. But from
the record of the last few years, I am not hopeful that it will
succeed. And even if it does, I doubt if the amounts recovered will
in any way offset the losses suffered - ultimately, I suspect, by
Portuguese taxpayers. I stand by what I said in my most recent
Pieria post. Those who brought down BES will walk away with the
proceeds, and ordinary people will pay.
Banco Espirito Santo: a Portuguese disaster, not
a European crisis
Espirito Santo: complexity, opacity and moral
United Insurance Holdings. Insider Buying Alert -
Why Earnings Will Double.