BES bondholders eye results for guidance on potential losses

Tue Jul 29, 2014 7:41am EDT

* Tier 2 bonds sink six points as bail-in fears surface

* Senior debt at risk if losses are greater than expected

By Aimee Donnellan

LONDON, July 29 (IFR) - European bondholders are lying in wait for Banco Espirito Santo's (BES) results Wednesday where an unknown loss could leave subordinated, and potentially senior debtholders, exposed to haircuts on their investments.

BES's outstanding 750m 7.125% Tier 2 bond came under heavy pressure today and sank six points to just below 80 as reports of a potential 3bn loss ramped up investors' fears. Meanwhile, the bank's senior cash curve was 20-25bp wider and the cost of insuring its five-year debt was 20bp wider at 400bp.

Portugal's central bank said late on Monday that if BES posted a loss larger than its existing capital cushion of 2.1bn, a capital increase would be needed to guarantee adequate solvency levels.

"The big question is how big is the hole and how are they going to fill it," said Robert Montague, a senior investment analyst at ECM Asset Management.

"Our base case scenario is BES may impose losses on the Tier 2 bonds. We now are in a world where state aid comes alongside the bail-in of junior debt."

By midday on Tuesday, BES's Tier 2 bond had recovered some of the losses and were back up to 81.6 but the price gyrations reflect the uncertainty surrounding any potential recapitalisation of the institution, after the Espirito Santo family effectively lost control of the bank they founded.

"It's really hard to know just how bad the losses will be," said John Raymond, an analyst at CreditSights.

"The 3bn figure that is rumoured seems to be plausible but it could equally be one, two or four billion. The Bank of Portugal is once again reiterating the possibility of a private sector solution and they believe there is demand for BES shares."

While market participants believe losses will likely be imposed on the bank's subordinated debt, questions remain over its senior debt.

BES's unsecured bonds are still quoted at a low 90s cash price indicating that investors are relatively confident their investment is safe from a potential bail-in.

"Bail-in of senior debt might be a step too far at this juncture," said Montague.

"But given that other Portuguese bank spreads are holding up so well as markets take the view that BES is a one-off, regulators might feel it is safe to haircut even senior debt."

Raymond agrees and says the unsecured bonds may be exposed.

"There's some chance they could find a way of partially bailing-in the senior unsecured debt. The Portuguese government has said that state support is available as a last resort but it's hard to know if that means all non-subordinated bondholders are fully protected in the process." (Reporting by Aimee Donnellan; Editing by Helene Durand and Sudip Roy)