Markets Steady on Portugal Bank Rescue

Markets Steady on Portugal Bank Rescue.

The Portuguese central bank has confirmed plans to rescue ailing Portuguese bank and mortgage lender Banco Espirito Santo (BES).

As with many banks across Europe, BES had exposed itself heavily to toxic debt lending as was suffering significant losses or repossessions and resale, with the banks overall capital adequacy coming under immense strain, resulting Portugal’s Central Bank taking action.

What is toxic debt?

• High low to value mortgage lending on property when their prices were high.
• Property prices then tumble in the recession.
• Value of property is now lower than the mortgage outstanding. This is negative equity.
• Borrowers are then face with paying mortgages on property that is lower than the value of the mortgage.
• Some people loses their jobs.
• Some people simply try to walk away and ‘give back the keys’.
• The lender is left with a capital loss and negative impact on their balance sheet.
• In other cases it can be poor lending to businesses where the business loan goes to bad debt as the business ceases trading etc i.e. there are no assets (this is the case with BES)
• This makes it difficult for the lender to raise further finance for lending/investment opportunities as they are not deemed stable or credit worthy as they have little or no assets.

What has Portugal’s central bank done?
It has segmented BES into two, separately identifiable banks

• Bank A – the good side of the bank – has been loaned €6.6bn and will continue to trade – now called Novo Bank (New Bank)
• Bank B – the toxic side of the bank – in the this case, not residential lending but business lending gone bad, BES, with details remaining on how it will deal, but technically it is now state owned.

Comment – Why take this action?

The EU regulatory framework for banks means that much greater capital adequacy is required and governments must take supervisory action when they are failing. The move by the Portuguese Central Bank is a string move to protect savers deposits and confidence in their banking system. As a result, market around Europe have stabilised today with minor jumps.

What it tells us though is that the finance industry as a whole and EU wide recovery is far from being on a stable footing.