As every amateur haggler knows, there are two rules to getting a good deal on the market: inspect what you are seeking to buy closely for defects, and drive a hard bargain, as you never know what you might get away with.
GlobalCapital was not privy to the negotiations US private equity firm Lone Star held when it was looking to buy Novo Banco, the lender set up in 2014 to take on the good assets of Banco Espírito Santo.
But it appears to have followed both the aforementioned rules to a tee before eventually signing to take on 75% of the bank last year.
Its due diligence of Novo Banco’s top 44 assets and some other loans found “significant uncertainties as regards adequacy in provisioning”, according to a European Commission document.
As a result, it managed to get Portugal to set up a contingent capital agreement, whereby Lone Star is able to insulate itself from the risks of a portfolio of the existing loan stock. The assets in that portfolio are regarded as being of significantly worse quality than those not in it.
Each year, Lone Star can reclaim funding costs, realised losses and provisions related to that portfolio of loans if Novo Banco’s common equity tier one (CET1) ratio has fallen below a certain level.
As an added freebie, that level is calculated to exclude the impact of a €250m contribution from Lone Star.
This agreement expires after around eight years, has a cap of €3.89bn, and payments are limited to the amount needed to bring the CET1 ratio back up to the trigger level. The Commission also warns that the losses on the protected assets could exceed this amount.
Some of the money from that total figure has already been drawn: based on the bank’s 2017 results the resolution fund paid out €791.7m, from a total net loss of €1.4bn.
But it still gives the bank — and Lone Star — a substantial safety net.
And Lone Star managed to secure even more in its negotiations.
Under the so-called capital backstop, if the bank’s Supervisory Review and Evaluation Process (SREP) total capital ratio falls below the requirement, Portugal may provide additional capital.
More precisely, if “routine capital measures” in the nine months following the breach, a request to Lone Star to inject capital, and a market call all fail to close the breach, Portugal will inject capital.
That additional capital will come either as additional tier one (AT1) debt sold to the market with Portugal paying the coupon, AT1 underwritten directly by Portugal, or through public capital.
And if Lone Star does inject capital in that scenario, Portugal is entitled to match it.
Portugal: got bondholders’ backs?
It is quite clear that plenty more money from Portugal and its resolution fund is ready to flow into Novo Banco to address its losses before Lone Star would find itself on the hook. And before bondholders would, too.
In that light, the 10 year non-call five tier two bond Novo Banco issued last week at a coupon of 8.5% seems, well, sort of attractive, despite what Moody’s called earlier this year “the very large stock of non-performing assets and ongoing uncertainties regarding the bank’s de-risking strategy”.
Coincidentally, the resolution fund would actually have had to underwrite the tier two had the deal not attracted private investors.
Of course, many bond investors will point to the Portuguese authorities’ decision to retransfer a handful of senior bonds from Novo Banco to BES while leaving others untouched in 2015 as a reason to pour scepticism on any notion of bondholders being protected in the country.
And this is not, of course, investment research.
But if you think that the Spanish banking sector’s recovery is already well-flagged and priced in, that the new Italian government’s determination to inflate the country’s debt pile and fight with the EU is worrying, and that Greek banks are still a bit too hairy, then Portuguese lenders may offer an interesting prospect on Europe’s periphery.
Caixa Geral de Depósitos also recently issued tier two, under a plan agreed with the Commission after the Portuguese state put in €3.9bn of capital. Banco Comercial Português is the only other Portuguese bank to issue recently with its own tier two.
Caixa Geral is still state-owned; BCP has private owners. But neither benefit from the type of agreement Novo Banco enjoys.
Those two issues from Caixa Geral and BCP were trading in the high 5% at the time of Novo Banco pricing its deal: a substantial difference.
As noted by a spokesperson for the Novo Note Group — the investors protesting that retransfer of bonds from Novo Banco to BES — the Novo Banco bond was priced at more than 5% above the most recent comparable offerings from non-Portuguese peripheral banks.
A CaixaBank tier two bond issued in April with first call in 2025 was trading at a yield to call of 3.26% this week.
The agreement reached with Lone Star has served the Portuguese state and its resolution fund badly given that they are taking on substantial risk. It makes a mockery of the aims of the bank recovery and resolution directive (BRRD).
But for a bond investor, an 8.5% coupon appears to offer a generous risk premium for credit mollycoddled by these other poor stakeholders.