- Portugal’s rescue of BES – involving losses for only junior bond holders – soothes markets…
- We remain positive on peripheral government bonds given fundamentals and ECB measures
- China’s authorities introduce a new tool to support infrastructure spending
Portugal’s BES rescued
Over the weekend, Portugal’s central bank presented a plan to rescue one of the country’s main banks, Banco Espirito Santo (BES). As part of the package, the deposit-taking operations of BES and all its healthy assets will be transferred into a ‘good’ bank, named Novo Banco. EUR 4.9 bn of fresh capital will be injected into Novo Banco, which will be financed by EU and IMF loans that are left over from the EU-IMF bailout that Portugal received in 2011. The loans will be repaid by the future sale of this ‘good bank’. All shareholders and subordinated creditors will remain in BES, which will be wound-down. According to a statement by the European Commission, in reaction to the rescue plan, “the full contribution of shareholders and of subordinated debt holders to the losses of BES will be ensured in accordance with the burden sharing rules set out in the commission’s 2013 Banking Communication”. Moreover, according to the EC, the plan is in line with EU state aid rules.
Rescue package soothes
Financial markets reacted positively to the rescue package. Portugal’s equity market index (The PSI index) rose by around 1% on Monday, while Portugal’s 10y government bond yields fell and its spread over Germany narrowed. This positive reaction is probably related to the fact that the rescue is rather benign in nature and did not force losses on unsecured deposit holders and other senior creditors, as had been required in the bank rescue package for Cyprus in March 2013. Earlier this summer, financial markets had been shaken by the news that the parent company of the BES Group could no longer meet its debt obligations. At that time, Portugal’s equity market index plummeted and its government bond yields jumped higher. There even was some modest contagion to Spain and Italy, as markets worried about the fragility of the banking sector in the eurozone periphery more generally. We think the rescue of BES should help soothe these concerns, since it was put together relatively smoothly and shows that a framework for bank rescues is in place and being put into action. We maintain our view that bond yield spreads of peripheral countries over Germany will continue to narrow this year and next on the back of improving economic fundamentals, ECB policy measures that will support banks in the periphery (TLTROs and ABS purchases) and investor risk appetite.
A new round of targeted support for China’s infrastructure projects
According to one of China’s newspapers, some days ago the People’s Bank of China (PBOC) granted a loan of around RMB 1 trillion through its pledged supplementary lending to China Development Bank. The aim is to support shantytown renovation and related infrastructure projects through low interest rate financing. Neither of the institutions involved has confirmed this measure publicly. Such a policy, however, would be in line with recent policies announced by China’s authorities to reduce borrowing costs for specific sectors. This remains a sign that authorities are hesitant to loosen monetary policy aggressively given the already high debt to GDP rates in certain areas, including local governments and the property sector. This type of policy is also consistent with the financing of sectors that tend to have low returns. In the past, broad-based financing was the norm, and there are currently risks that several of the loans extended to, for instance, certain property related projects will be difficult to recover. The cost, however, of this measure is that it can undermine efforts to liberalise interest rates, while letting the markets determine the allocation of resources. This remains one of the objectives of China’s authorities. Despite the more positive data reported in the past few months, we continue to expect further targeted easing in the coming time to reduce the impact of a more constrained shadow banking activity.