Banking Risks Lurk Behind Beleaguered Portugal Hit by Bond Rout

Updated on
  • Lenders may need more capital as loans continue to sour
  • Banking woes reflect Portugal's wait-and-see approach

As the bond market frets about Portuguese politics, another costly drama may be unfolding in the country’s banking industry.

The country’s bonds have tumbled on concern that the Socialist minority government won’t do enough to curb the budget deficit. Yet last week, Prime Minister Antonio Costa drew attention to a whole different issue, telling weekly newspaper Expresso that state-owned Caixa Geral de Depositos SA will have to raise money to bolster its finances. 

This year has been marked by some of the worst turmoil for European banks since 2008. As well as lenders in indebted nations like Spain and Italy, shares in Deutsche Bank AG in Germany and Credit Suisse Group AG in Switzerland plunged. In Portugal, it’s a legacy of how the country dealt with the roughly 40 billion euros ($45 billion) of impairments recognized by its banks between 2008 and 2014, mainly for bad loans.

“There is a significant increase in capital requirements for banks and with growth lagging you can’t create capital organically,” said Owen Callan, a fixed-income strategist at Cantor Fitzgerald LP in Dublin. “You need to fix the bad loans at banks eventually.”

Under Pressure

Ireland took a big-bang approach to recapitalizing its financial industry as part of an international rescue in 2010. Portugal took a more gradual approach, concerned that losses would sink the government’s finances further and in turn harm the financial industry even more, what’s known as the diabolic loop.

The country, though, is vulnerable again as debt remains high. Portugal is in a group of six European countries with a non-performing loan ratio above 10 percent, alongside Italy, Ireland and Cyprus, the Bank of Portugal said last month.

In December, almost two years after exiting its bailout program, Portugal was forced to set aside 1.8 billion euros for Banif SGPS SA. Banco Comercial Portugues SA still has to repay 750 million euros in contingent convertible bonds to the government and Caixa Geral has to repay 900 million euros.

That’s after Portugal’s eight biggest banks raised more than 26 billion euros in capital from 2008 through 2014, including state aid during the bailout and the rescue of Banco Espirito Santo SA, according to the Bank of Portugal.

Asking Questions

If you have a debt load like Portugal “that is high, and with no control over your currency, there is always the risk that the market will start questioning and running against you,” said David Schnautz, a director of rates strategy at Commerzbank AG. “Even if for good reason, you just can’t afford putting more weight on the sovereign.”

Portuguese 10-year bonds have tumbled since Costa took power in November, promising to ease spending cuts.

The yield difference with Germany rose above 300 basis points last week for the first time since 2014, and now stands at 3.05 percentage points.

The bonds deepened their slump in January after the Bank of Portugal’s decision to impose losses on some senior bondholders of Novo Banco SA, the new bank created out of the ashes of Espirito Santo, following European Central Bank tests that showed a potential capital shortfall.

“There is a risk that you need more capital in Portuguese banks and this may be difficult to raise in the market, given the uncertainty regarding the restructuring of Novo Banco and the general sentiment about banks in Europe,” said Jens Peter Soerensen, chief analyst at Danske Bank A/S in Copenhagen. “Everyone has higher funding costs.”

— With assistance by Joao Lima

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