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Situation Summary

Novo Banco was created as a "bridge bank" in August 2014 as part of the resolution of Portuguese bank Banco Espírito Santo (BES). BES's healthy operations and good assets were transferred to Novo Banco, while the toxic assets remained with BES. Novo Banco became the 'good' bank, and BES became the 'bad' bank.


On 29th December 2015, Banco de Portugal unlawfully retransferred €2.2bn of bonds (represented by 5 series of notes out of a total of 52 outstanding series of notes) from Novo Banco back to the ‘bad bank’ BES, using powers that were never designed for this purpose to fill a hole in Novo Banco’s balance sheet. For investors in those bonds, this imposed significant losses. These five series of bonds were all governed by Portuguese Law (save for one small series of notes, the other 46 were all governed by English law).

Banco de Portugal’s decision broke pari passu (both between the holders of notes and between the notes and other senior creditors of equal ranking with the notes), the key legal principle of equal treatment of senior creditors, and discriminated against international investors.

This has damaged Portugal’s credibility as an investment destination going forwards.

‘Legal action’

The Novo Note Group, the ad-hoc bondholder group of over 20 financial institutions co-ordinated by Attestor Capital, BlackRock, CQS and PIMCO, is pursuing legal action against Banco de Portugal and is attempting to reach a resolution that will allow the funds to continue their long history of investing in Portugal.

In total, five series of Novo Banco bonds were retransferred back to BES out of a total series of  52. It appears that this select series of notes were chosen for retransfer rather than others because they were governed by Portuguese Law rather than English Law, which allowed Banco de Portugal to avoid litigation outside of Portugal. Despite the challenges this presents, the Novo Note Group has filed an appeal in the Administrative Court of Lisbon to challenge Banco de Portugal’s actions in the proper forum.

Banco de Portugal’s use of the retransfer powers was unlawful because it failed to exercise those powers for the original purpose they were designed for. Rather than use the retransfer powers to correct the perimeter of the ‘good bank’ and the ‘bad bank’, Banco de Portugal exercised the retransfer powers to fundamentally improve Novo Banco's financial condition. This is not what the retransfer powers were created for.

Moreover, Banco de Portugal was not permitted to use the retransfer powers it exercised in December 2015 because it failed to specify the assets that were subject to potential retransfer in the original resolution measure, as was required by the Bank Recovery and Resolution Directive (BRRD). In doing so, Banco de Portugal failed to comply with both EU law and the fundamental principles of Portuguese law.

‘Impact on Portugal’

The actions taken by Banco de Portugal have fundamentally damaged Portugal’s financial standing, with support from long-term institutional investors now in doubt. This has put the country’s affordable access to capital markets and its wider economic recovery at risk, at the cost of the Portuguese population:

  • Portugal’s cost of borrowing has increased significantly as a result of the retransfer decision, with sovereign debt spreads widening by 100 basis points in the week after the retransfer. This translates to ca. €200m every year in additional interest expenses based on Portugal’s capital needs
  • The higher cost of borrowing comes at a time when Portugal faces:
    • The need to repay the ca. €10bn bail-out loan still outstanding to the ECB
    • The need to replace the ECB as a buyer, as the central bank phases out its QE programme in 2018 (the ECB has purchased ca. 23% of Portugal’s outstanding tradable debt as of September 2017)
  • Portugal’s troubled banking system has also faced higher borrowing costs to comparable banks (e.g. in Spain and Italy) since the retransfer, at a time when the country’s banks face:
    • The need to issue ca. €9bn of additional “bail-inable” debt to comply with new capital requirements set by the European Commission
    • The need to reduce Non Performing Loans (NPLs), following ECB guidance that NPLs should be 100% provisioned. Novo Banco alone would potentially require an additional ca. €5bn

Banco de Portugal must take action to address the unlawful Novo Banco retransfer and rehabilitate Portugal’s reputation with the investment community.  Only then will some of the world’s largest investors be able to continue their long history of supporting Portugal.