Separating The Sheep From The Goats: How The Central Bank Of Portugal Let Goldman Sachs Foot The Bill

The Good, the Bad, and the Defunct  – Early last July, Goldman Sachs set up a financing vehicle called Oak Finance Luxembourg SA, so that the US-based investment bank could coordinate a four-year loan to the Portuguese Banco Espirito Santo. On Christmas Eve, Goldman executives found out via Portuguese media that the loan is not likely to be paid. The shock of the news lies mostly in the size of the loan: $835 million.

This was part of a move to restructure the failing bank and share the burden of bailing it out between the public and the private investors. In the legislative environment after the unpopular bailouts of the Great Recession, Portugal decided to divide Banco Espirito Santo (BES) into two banks: the good bank, Novo Banco, and the bad bank or, simply put, everything Portugal refuses to pay for. Novo Banco will be receiving €4.9 billion from Portugal’s bank-resolution fund to manage the untroubled assets formerly owned by BES, whereas the troublesome assets are planned to remain with BES, which is slated to be liquidated entirely.

New Bank, New Problems – The resolution fund money is not a free ride for Novo Banco. The new bank has been set up to eventually be sold, at which time the initial capital from Portugal’s treasury loan must be repaid. Senior bondholders and depositors are going to face few, if any, consequences, but subordinated bondholders have seen serious losses as regulators throughout Europe have tried to ensure that taxpayers are not on the hook for the losses. The issue remains that Novo Banco will be retaining the sounder, less risky assets while BES will be scrapped along with its so-called “toxic” assets and liabilities.

Goldman Sachs’ problems exist within a small technicality: a Portuguese law passed in August declared that anyone owning more than 2% of a bail-out bank’s shares has last priority for any debt repayments. Goldman acquired 2.27% of ESB in July, which means that Oak Finance Luxembourg SA’s loan will now be tossed into the bad bank scrap heap.

He said, she said – Goldman Sachs is taking legal action against the Bank of Portugal for supposedly breaking its promise to include the Oak Finance loan in with the Novo Banco liabilities. Goldman’s spokesman claims that on August 11th, a senior representative of the Bank of Portugal “explicitly confirmed to [Goldman Sachs] in writing the transfer of these obligations. In addition, Novo Banco also confirmed in writing that Oak Finance had been transferred as one of its liabilities.” And so a court battle is on the cards. Goldman Sachs claims to have written permission that Oak Finance would be included in the bail-out section as a Novo Banco liability that will be paid in full. The Bank of Portugal claims that Goldman’s temporary ownership of more than 2% stake in BES is legal grounds for excludOak Finance from Novo Banco’s liabilities, almost entirely ensuring that the remaining $785 million loan amount will never be paid in full.

Looking Forward – The wake of Banco Espirito Santo’s demise is vast and deep. As regulators throughout Europe investigate subsidiaries of the collapsing megabank, fines will continue to pour in and eat up any claims on cash from the sale of the bank. Toxic loans from London to Angola will only continue to reveal that inordinate amount of capital lent compared to payments received. It is crucial for Goldman Sachs and their investors that Oak Finance’s BES loan be transferred to Novo Banco. Goldman has begun to fight, but a sense of fatalism has been reflected in the reduction of some employee’s bonuses being shrunk, a sign that executives anticipate absorbing the cost of BES’s failure internally. No matter the outcome, the ruling will be important in the future as banks consider which laws protect them and which laws prey on them.