Heavy trading of BES sub debt highlights bail-in fears

Wed Jul 16, 2014 10:34am EDT

LONDON, July 15 (IFR) - European investors are actively trading Banco Espirito Santo's 750m Tier 2 bond as uncertainty over the bank's ability to withstand losses raises the prospect of a potential bail-in.

The Portuguese bank's subordinated bond dropped to a cash price of 69.50 on Tuesday from a high of 110 at the beginning of June. And although there has been a 10-point recovery in the past day, market participants are continuing to question whether the extent of the problem has been fully exposed.

"It's definitely possible that the Tier 2 bonds would be wiped out," said a DCM syndicate banker.

"Investors are really struggling to believe the numbers, as it's very hard to speculate just how much will be enough to sort out the problem in Portugal."

The problem for holders of BES's Tier 2 bond is the bank's exposure to the wider Espirito Santo group of companies. According to CreditSights, this is made up of 1.2bn of direct exposure to the ES group, guarantees written on 641m of ES group securities and potential exposure to another 212m of securities sold by Espirito Santo Financial Group to BES clients.

BES also has a 2bn of ES group debt securities held by institutional clients, which are not guaranteed but could give rise to claims by the clients, CreditSights says.

It is also exposed to a loan portfolio in Angola totalling 6.1bn, of which 4.2bn is covered by a guarantee from the country's government. According to CreditSights, this guarantee has determined loan loss provisioning policy, but its exact status - including the permanence of the guarantee beyond 2015 - is not clear. It also owns equity in Angolan subsidiary Banco Espirito Santo Angola of 663m.

If BES were to lose 100% of the exposure at group level, take a 100% write-down on the equity in the Angolan unit and lose 50% on the unguaranteed portion of its lending in Angola, it would need 1.5bn of capital to restore its Common Equity Tier 1 ratio to an acceptable 10%, according to Breakingviews analysis.

BES, Portugal's largest listed bank, said last week that it had 2.1bn in capital above regulatory minimums.

This could place the bank's subordinated capital in the fulcrum of any restructuring.

Bankers are reporting that some 150m of BES's Tier 2 debt has been traded in the past week, which makes up 20% of the deal size.

One insider said there are more sellers than buyers, with investors unwilling to ride the uncertainty. Hedge funds and family offices are taking the other side, believing the lender's assurances about its capital position, which have been vigorously supported by the government and central bank.

"People can speculate but it's hard to believe that a prime minister and or governor of a central bank can say three times that a bank is adequately capitalised and be wrong," said an advisor.

"But it is very complex group and the holding structures make people nervous. The prime minister wants a private solution to a private problem - if this gets solved privately this is a huge victory for the system."

At the weekend, Pedro Passos Coelho, Portugal's prime minister, appeared to rule out a moral-hazard-inducing bailout.

"Private businesses have to suffer the consequences of the bad deals they make. Taxpayers will not be asked to bear the losses of private companies," Passos Coelho said.

And while the Tier 2 debt looks to be at risk, bankers believe that BES's senior unsecured bonds are safe for now - something reflected in the fact that the senior debt is still trading in the 90s. (Reporting by Aimee Donnellan; Editing by Matthew Davies and Philip Wright)

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