Bad bank for distressed debt? “Portugal doesn’t have the funds”, says Mint

21 July 2017

There is a 120-billion-euro problem in southern European banks. Mint Partners, a wholesale brokerage, says shifting distressed debts to bad banks and hedge funds could be a solution, but Portugal does not currently have the funds to finance a bad bank.

The Portuguese government has “little budgetary room to finance a ‘bad bank'” that could absorb non-performing loans on the banks’ balance sheets. This vehicle may be the solution to the toxic assets weighing on the profitability of financial institutions in southern Europe: the bad debt on the banks’ books amounts to 120 billion euros, according to Mint Partners. The Novo Banco has the highest proportion of distressed debts in Portugal, but the most worrying cases are in Cyprus and Greece.

“With a debt-to-GDP ratio of 130%, the [Portuguese] government’s ability to recapitalize and rescue banks, as it did with Caixa Geral de Depósitos (CGD) at the end of last year, is limited,” according to one Mint report obtained by ECO. The Portuguese government has, therefore, “little budgetary margin” for the creation of a “bad bank.” That option had already been dismissed by the Portuguese Prime Minister, António Costa, and a solution has been presented to the banks, but little about it is known.

Bill Blain, head of equity at Mint, and Ben Stheeman, his associate, warn that distressed debt is a burden that leaves the European banking sector “in a precarious position.” The solution to the problems is the transfer, financed with public money, of these toxic assets from the banks’ balance sheets to hedge funds and “bad banks.” Recently, CGD sold a portfolio of almost €500 million in distressed debt to Bain Capital.

“With a debt-to-GDP ratio of 130%, the [Portuguese] Government’s ability to recapitalize and rescue banks, as it did with Caixa Geral de Depósitos (CGD) at the end of last year, is limited.” Mint Partners

But experts warn: it’s not enough. “Measures have to be taken to reduce the weight of Non-Performing Loans (NPLs), but even once these measures have been carried out the problem of distressed debt in southern Europe will not have been solved,” they state. “The NPLs will not be eliminated, only moved. The strategy may fail, as the non-performing loans will continue to exist within the financial system,” they note.

The two representatives of Mint Partners believe that solving this problem “will require a change in policy,” and warn that in addition to the bad debt there are other weaknesses in Euro Area banks. They argue that there are still significant differences between the European resolution rules and the measures adopted by each country. “In such a scenario, the European Central Bank’s banking regulations will not adequately address a European banking crisis.”

A spotlight on Portuguese banks

Novo Banco “should survive”

The transitional bank, which was set up after the liquidation of Banco Espírito Santo, “has been singled out as an example of a ‘bad bank’ in Europe.” Bill Blain and Ben Stheeman say that if everything goes as expected, “[Novo Banco’s] transition period will end in November after its sale to the U.S.-based Lone Star fund.”

But they still have some doubts. “The successful conclusion of the sale is not completely certain,” they state. This operation is dependent on a debt swap that will strengthen its capital ratio by 500 million euros. The details of the swap should soon be made known to investors. Therefore, the sale is more a matter of “when” and not “if”, they point out. Once the Novo Banco is in the hands of Lone Star, “losses from the NPLs will no longer be borne by Novo Banco and its new owner [Lone Star]. So, the bank should survive.”

Montepio? “A bank to keep an eye on”

The profitability of the financial institution led by Félix Morgado “is extremely volatile,” Mint said. Why? “Partly because of the high NPL ratio.” The bank recently completed a capital increase of 250 million euros, fully subscribed by the sole shareholder, Associação Mutualista, which launched a takeover bid for Montepio.

But, according to Moody’s, this capital increase, despite positively impacting the bank, is not enough to offset the challenges that the institution continues to face, such its distressed debt. Montepio appears to be making improvements, but “has made no progress in reducing the stock of NPLs. Thus, it is a bank to keep an eye on,” Mint warns.

BCP: Well capitalized, but distressed debt still needs to be reduced

The largest Portuguese private bank had to receive aid in 2012 through CoCos that have already been fully paid. This occurred after the financial crisis led the bank’s CET1 capital ratio to fall below the requirements imposed by European regulations. The bank now has a ratio of 13% and an NPL ratio of almost 16%. But there is more work to do, says Mint.

“BCP seems to be well capitalized, but it has to continue to reduce its exposure to distressed debt. BCP plans to reduce total NPLs by 1 billion euros over the next few years, which should be manageable considering the progress it has made. For this reason, and despite still having a capital deficit of 1.1 billion, BCP should recover,” Mint officials conclude.

CGD: A “well-protected” bank

CGD’s financial situation has not been the most favourable in recent years. It is also, therefore, a bank that needs to be scrutinized, Bill Blain and Ben Stheeman believe. But with the recapitalization plan, which has led to an injection of five billion euros, and restructuring, with the closure of branches and redundancies, “CGD is relatively well protected.” This is also considering that CGD “has already begun to sell portfolios of distressed debt.”

The state-owned bank recently sold 476 million euros in distressed debt to the private equity fund Bain Capital Credit. The loan portfolio purchased by Bain Capital consists “mainly of bilateral real estate loans guaranteed by small and medium-sized companies and some large companies,” the fund explained.

Original Story: Economia Online – Rita Atalaia

Translation: Richard Turner