Pedestrians pass a Novo Banco SA bank branch in Lisbon, Portugal

Investors have reacted with anger and threatened legal action after Portugal announced plans to impose heavy losses on almost €2bn of senior bonds at Novo Banco, the bank created from the ruins of Banco Espírito Santo.

The bonds are to be transferred from Novo Banco to the so-called “bad bank” created as part of last year’s €4.9bn bailout of BES, which will then be liquidated, the Bank of Portugal said in a statement late on Tuesday night.

Investors are angry that Portugal has changed the rules of a bank resolution 18 months after first announcing it and that it has chosen to inflict losses on some of Novo Banco’s €12bn of senior bonds but left others unscathed, in their view breaking the pari-passu principle of equality among senior bondholders.

“It is absolutely extraordinary,” said Mark Holman, head of 24 Asset Management, a holder of some of the senior bonds affected by the move. “I think there is enough money involved here and it is so unusual that there is going to be some legal wrangling.”

Some of the affected bonds are owned by some of the world’s biggest fixed-income investors, such as BlackRock and Pimco, which each hold more than €100m of the notes. “This is going to open a can of worms of litigation,” said one large investor. “Being put in the bad bank means a single-digit percentage recovery.”

The move comes only hours before tougher EU bail-in rules are due to take effect with the implementation of the Bank Resolution and Recovery Directive (BRRD) from January 1.

This means that from next year some depositors could also be hit in any further rescue of banks such as Novo Banco. It has already triggered the rushed recapitalisation of struggling banks in Greece and Italy before the new rules start.

Portugal’s central bank said it chose five of Novo Banco’s 52 senior bond issues to transfer to the bad bank “in accordance with Portuguese law and the principles underlying BRRD”.

The Bank of Portugal said that “where creditors within the same class are treated differently in the context of resolution action” BRRD requires that “distinctions must be equitable, justified in the public interest and proportionate and must not discriminate on the grounds of nationality”.

It said many of the bank’s outstanding senior bonds had been sold to retail investors or issued by an offshore vehicle, making the central bank unwilling or unable to include them in the switch to the bad bank.

“Retransferring retail bonds would have been highly prejudicial to Novo Banco’s franchise, potentially causing a loss of customers and deposits and a loss of confidence in Novo Banco,” it said.

“There were also a number of technical and legal reasons why bonds of the offshore finance vehicle could not be retransferred,” it added.

The decision follows a ruling by the European Central Bank in November ordering Novo Banco to fill a €1.4bn capital shortfall found as a result of stress tests.

The bond move would have a positive impact of €1.98bn on Novo Banco’s capital and pave the way for relaunching the sale of the bank in January, the central bank said.

Novo Banco said on Wednesday that its common equity tier one ratio, a measure of capital strength, would rise to about 13 per cent as a result of the central bank’s decision, up from 9.4 per cent at the end of June.

The senior bonds affected were all sold to institutional investors in minimum lots of €100,000 with maturities ranging from 2016 to 2024.

Initial efforts to sell Novo Banco and recoup as much as possible of its €4.9bn bailout funding collapsed in September after Portuguese authorities received only “unsatisfactory” offers.

In the original rescue of BES last year, shareholders and subordinated debt holders were “bailed in”, their assets being left in the “bad bank”, which kept the name BES.

Senior bondholders were protected, along with depositors, their holdings being transferred to Novo Banco together with BES’s branch network and other healthy assets.

However, the Bank of Portugal said it was now exercising its powers as the bank resolution authority to “alter the perimeter of the assets and liabilities” of BES and Novo Banco.

The new measure protected depositors in Novo Banco and no further changes in the perimeters of the two banks would be made, the central bank added. It would ask the ECB to revoke BES’s banking authorisation so that its judicial liquidation could begin.

Additional reporting by Thomas Hale in London

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