Portugal: bail-in guinea pig or back-door bail-out?

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Could Lisbon make its two biggest problems one by nationalizing Novo Banco and merging it with CGD?

After the national euphoria of Portugal’s win in the Euro 2016 football tournament, the country is now having to face up to the prospect of a fresh banking crisis. While Italy may be a bigger problem for Europe, the shock of the UK’s decision to exit the EU has also brought to a head the numerous uncertainties in Portugal’s banking sector.

Portugal, which is facing a comparable NPL problem to Italy, may be hoping that the European authorities will blink on bail-in rules for Italy, so it can get round the rules too. Could Portugal’s biggest bank, Caixa Geral de Depósitos (CGD) – despite state ownership and its own array of troubles – offer a way out?

As in Italy, Portugal’s bad debt stock continues to rise, and getting more of it off banks’ balance sheet needs widespread recapitalization. But after a controversial bail-in of bondholders in Novo Banco (the remains of the collapsed Banco Espírito Santo) and the more gradual erosion of valuations after previous post-crisis recapitalizations, it will be hard, or perhaps impossible, to persuade private investors to put in more money. 

Replicating Italy’s Atlante, or Portugal’s own 2014 resolution of Novo Banco, is also tough; healthier banks can only support weaker ones if the problem is not systemic. Almost no one thinks the central bank will find a private-sector buyer for Novo Banco, or at least one paying enough to recoup the resolution fund’s €4.9 billion 2014 injection, to relieve the banks of their contributions. (It hardly helps that Novo Banco’s CEO, Eduardo Stock da Cunha, is leaving in August to go back to Lloyds.)

Portugal’s government says it is renegotiating terms of the treasury’s support to the resolution fund, so the fund would remain solvent even if a sale happened on the cheap. But there are also rumours in Lisbon that the government, supported by allies on the far left, is contemplating a solution involving a merger between Novo Banco and CGD, which is the biggest contributor to the fund.

Given CGD’s state ownership, the EU would likely class a takeover of Novo Banco as state aid. Even without taking over Novo Banco, CGD needs recapitalizing. Some even think the country’s finance minister, Mario Centano, is exaggerating the capital needs at CGD so it can swallow up Novo Banco.

CGD continued to lose money last year, with questionable loans accounting for more than 10% of its loan book. The government launched an investigation into its loan practices in June. At this most critical of times, it is also going through a series of internally divisive management changes with the arrival of a new CEO, Antonio Domingues, along with several former colleagues from BPI.

A marriage of two troubled banks is hardly an enticing option for investors. Yet the alternative of more bail-ins could be more than the system would support. The worry in Lisbon is that Portugal – posing less of a systemic danger than Italy – could be used as a bail-in testing ground, like Cyprus.

Portugal’s government looks likely to avoid sanctions for breaching its deficit targets – which, if imposed, could have further strained relations. If the EU does allow another bail-out – involving Novo-Banco, or otherwise – the conditions will be stringent, likely leading to more job losses, which in turn would not bode well for political stability. It is beginning to look like a familiar story.