Case study Novo Banco

Banco Esperito Santo SA, one of the systemic banks in Portugal, was placed under resolution by the central bank of Portugal. A bridge bank, Novo Banco S.A., was formed with an equity capital injection by the resolution fund. Banco Esperito Santo experienced consolidated losses, a downgrade of the banks’ rating by a credit rating agency, cash flow challenges and liquidity shortfall. The worsened situation was a threat to the economy and the bank requested Emergency Liquidity Assistance.

That fact that central banks need to learn to adapt to changes in resolution becomes apparent following analysis of the transfer of bond liabilities from NOVO Banco back to Banco Espirito Santo to protect local investors at the expense of foreign bond holders. The bonds were asset linked liabilities of Novo Banco and diminished in value after the retransfer to Banco Espirito Santo due to the lack of collateral. The central bank of Portugal handpicked five out of forty similar Novo Bonds based on their value and retransferred these to Banco Espirito Santo. The high valued bonds were owned by two Hedge Funds, one of which took the central bank of Portugal to court based on the lack of equal treatment- the pari passu principle. A preliminary suspension to transfer the bonds to Banco Esperito Santo was ordered by the Portugese court whilst deliberations continued a final definitive decision. The argument put forward by the central bank of Portugal was these were measures justifying the retransfer of bonds to Banco Espirito Santo and that most significant bonds were issued under foreign law and therefore excluded from the bail-in. The ultimate solution for all stakeholders lies in the protection of small investors while ensuring equal treatment to other bondholders with an equal credit rank. The Portugese court is yet to decide if this is a feasible and appropriate policy.