Portuguese Guarantee Scheme

The Scheme formed part of the Portuguese government’s Initiative to Strengthen Financial Stability (IREF). IREF included a recapitalization scheme, notified to the EC on November 5, 2008 and approved by the EC on May 20, 2009, under State Aid N 556/2008. With the exception of one state-owned bank, Portuguese credit institutions did not participate in the Portuguese recapitalization scheme during the global financial crisis, though they did draw on this line during the sovereign debt crisis (APB 2015; see also GlobalCapital 2010).

IREF also included an increase in the Portuguese bank deposit guarantee; measures promoting bank transparency; and a “law aim[ing] to create conditions for credit institutions to strengthen ownership equity” (Torres 2009).

A new Portuguese legal regime was needed to launch the Scheme. On October 20, 2008, a new law - Lei n° 60-A/2008 - was passed creating a new legal regime for exceptional granting of guarantees. Implementing provisions were laid out in a decree order, Portaria n° 1219‑A/2008 of 10/23/2008; subsequent decree orders were issued in 2010, 2012, and 2014.

Portugal notified the EC of the Scheme on October 15, 2008. On October 29, 2008, the EC approved the Scheme until December 31, 2009. This meant that guarantees could be granted until the end of December 2009.

The Scheme was finalized in conjunction with the EC; there were “intensive exchanges” between the EC and Portuguese authorities before the EC approved the Scheme as “an appropriate tool for boosting investor confidence without creating undue market distortions” (EC 10/30/2008).^FThe EC approval process for Portugal was more drawn out than the process for Sweden (approved on October 30th), which took three days. On October 13, 2008, upon publication of the 2008 State Aid Communication, the EC announced that it would “aim to approve schemes that comply with this guidance very quickly (within 24 hours, if possible),” adding that “[s]upport schemes such as guarantees or recapitalisation schemes can be cleared by the Commission very quickly if they fulfil conditions which guarantee that they are well-targeted and proportionate to the objective of stabilising financial markets and contain certain safeguards against unnecessary negative effects on competition” (EC 10/13/2008). As discussed in more detail below, the need to structure the Guarantee Scheme in such a way as to ensure EC approval significantly influenced the design of certain program features.

The budget for the Scheme was initially set at €20 billion. The annual budget for the Scheme was “set so as to ensure that the overall issuance of guaranteed debt remains stable from year to year” (EC 12/19/2013).

In 2011, the budget for the scheme was increased to €35 billion as Portugal received a joint IMF-EU rescue package that totaled €78 billion over three years. The package was “designed to allow Portugal some breathing space from borrowing in the markets” (IMF 2011). In May 2011, as part of this support plan, the Portuguese authorities increased the total budget for the Scheme from €20 billion to €35 billion, noting that the government-guaranteed bonds could “be used by banks for ECB refinancing purposes subject to the approval of the Governing Council” (IMF 2011). The Memorandum of Understanding on Specific Economic Policy Conditionality between Portugal, the EC, the ECB, and the IMF, provided that, “[s]ubject to approval under EU competition rules, the authorities are committed to facilitate the issuance of government guaranteed bank bonds for an amount of up to €35 billion, including the existing package of support measures” (Portugal 5/17/2011).

Portugal financed the Scheme by issuing public debt securities (EC 12/17/2008). This is particularly significant in light of Portugal’s rising public debt. At the beginning of 2008, Portugal’s public debt stood at €115.6 billion (68.3% of GDP); by the end of the year, public debt had risen to €123.1 billion, or 71.6% of GDP (DBRS 2011). APB found that overall, the “impact of [Portuguese] State aid to the financial system was similar to that in the euro area and represented 18% of the increase in public debt between 2008 and 2014” (APB 2016).

In turn, according to the Portuguese Association of Banks, “the public debt crisis [led] to the increase in the usage of guarantees from the State” between 2011 and 2015 (ABP 2015).

In addition to the Scheme’s impact on public debt, DBRS cited guarantees provided under the Scheme (€4.9 billion, or 2.8% of GDP, at June 2011) among the factors having contributed to “a sharp increase in contingent liabilities” (DBRS 2011).

Portugal reported to the EC that “the net cash balance at the moment of the scheme’s wind-up, whether due to being unused or resulting from reimbursements of credit institutions as well as from the guarantee fees, will be used to repay the public debt that was issued” (EC 12/17/2008).

Subsidiaries of foreign banks with a registered office in Portugal were included.

Beginning in August 2013, beneficiaries of the Scheme could have “‘no capital shortfall’ according to the most recent Union-wide capital exercise^FAs noted by the EC, “the 2011 European Banking Authority (‘EBA’) capital exercise required at least a capitalisation of 9% as defined by EBA” (EC 8/1/2016). […] or other equivalent national exercises by the national supervisory authority” (EC 8/1/2013).

As a result of the solvency requirement, the Portuguese authorities did not provide the ailing Banco Privado Português (BPP) a state guarantee within the framework of the Scheme (EC 2009). The authorities were instead required to rely on earlier authority, Portuguese Law n.º112/97 (1997), in providing the state guarantee to BPP. The 1997 law established authority for the Portuguese government, or related legal entities, to make guarantees.

Similarly, the EC was ultimately unable to extend under the Scheme the guarantee on bonds that had been transferred to Novo Banco. Novo Banco was the bridge bank that was created in August 2014 as a result of the resolution of Banco Espírito Santo, S.A. (BES). In this context, the State guaranteed bonds issued by BES in 2011 and 2012 under the Scheme were transferred to Novo Banco. While Novo Banco extended the maturity and guarantee of these bonds under the Scheme in 2014, in November 2015 it was found to have a capital shortfall under a stress test adverse scenario (EC 2015). When a further extension of the maturity and guarantee of these bonds was sought in 2015, they were therefore extended (for one year, with revised coupons) outside the framework of the Scheme (EC 2015.).

The Bank of Portugal and the Institute of Management of Treasury and Public Credit^F"Instituto de Gestão da Tesouraria e do Crédito Público, I.P.” had to confirm a credit institution’s eligibility to participate in the Scheme.

For the aid to be granted, banks had to submit documentation proving the aid was “essential to ensure the applicant’s normal financing” (EC 12/17/2008). Applicants were also required to submit a draft financing agreement or documentation on the proposed debt issuance specifying the relevant terms and conditions (EC 12/17/2008).

The Portuguese Minister of Finance had to approve each bank’s application.

The first guaranteed bond issuance under the Scheme was made on November 24, 2008, by state-owned Caixa. According to Caixa’s head of funding, the bank “had long discussions internally about whether Caixa should come to the [government-guaranteed debt] market or not given that we are 100% government owned. But in the end, it was a political decision and it was decided that we would be the best credit [institution] to open this market” (GlobalCapital 2010). Portuguese authorities saw Caixa as being the institution best positioned to take this step (GlobalCapital 2010).

Subordinated debt could not be guaranteed under the Scheme (EC 12/17/2008).

The exclusion of subordinated debt was consistent with the guidance set forth in the EC’s October 2008 communication on The application of State aid rules to measures taken in relation to financial institutions in the context of the current global financial crisis (2008 State Aid Communication) (EC 10/13/2008).

The Scheme did not cover interbank money market deposits; did not cover liabilities already under another guarantee; and did not cover operations in non-transparent jurisdictions.

The exclusion of interbank money market deposits was consistent with the ECB’s October 2008 recommendation that “government guarantees on interbank deposits should not be provided” (ECB 2008).

The Scheme covered debt with a minimum maturity of three months. The maximum maturity of guaranteed debt was three years, or exceptionally five years. Coverage of debt with a five-year maturity had to be “duly justified by the Portuguese Central Bank” (EC 12/17/2008).

As amended in February 2010, the Scheme provided that debt with maturities between three and five years would be guaranteed “only in exceptional circumstances,” and that such debt would not exceed one third of the Scheme’s total volume (EC 2/22/2010).

On March 27, 2012, the Portuguese government issued a Decree Order, Portaria n.º 80/2012^FDiário da República, 1.ª série, n° 62., that materially expanded the types of debt covered under the Scheme consistent with guidelines from the European Commission. Per the 2012 decree, “[i]n case of guarantees on the issuance of covered bonds (on mortgages and on the public sector), the maturity can go up to seven years” (EC 2012). The Order provided that “[t]he part of the guaranteed liabilities with a maturity longer than three years will not exceed one-third of the total value of the liabilities covered by the State guarantee” (EC 2012).

Guarantees on debt with maturity of over three years were limited to “one-third of the total outstanding amount of guarantees granted to each individual bank” (EC 2017).

In the 2011 Communication from the Commission on the application, from 1 January 2012, of State aid rules to support measures in favour of banks in the context of the financial crisis (2011 Communication), the EC specified that “[s]ince pressure on the funding of banks is concentrated in the term funding markets, State guarantees should in general only cover debt with a maturity of between one and five years (seven years in the case of covered bonds)” (EC 2011).

Only euro-denominated debt could be guaranteed under the Scheme (EC 12/17/2008).

Program documents did not specify any limitation on the amount of an individual institution’s participation in the Scheme.

These fees were based on the October 20, 2008, Recommendations of the Governing Council of the European Central Bank on government guarantees for bank debt (ECB 2008). For debt with maturity of three months to one year, the Portuguese authorities charged an annualized fee of 50 basis points (bps). For debt with maturity of over one year, the fee was 50 bps plus the relevant CDS spread. The calculation formula for the CDS spreads was as follows:

For institutions with representative CDS data, The lower of either a) the median value of five-year CDS spreads during the period from January 1, 2007, to August 31, 2008; or b) the median value of five-year CDS spreads for a representative sample of credit institutions with the same credit rating for the period from January 1, 2007, to August 31, 2008.

For institutions with no CDS data, or no representative CDS data, but with a credit rating of “A” or higher, the fee was the median value of five-year CDS spreads, for a representative sample of institutions with the same credit rating during the period from January 1, 2007, to August 31, 2008.

For institutions with no CDS data, or no representative CDS data and a credit rating below “A,” the fee was the median value of five-year CDS spreads, for a representative sample of institutions with a credit rating of “A,” during the period from January 1, 2007, to August 31, 2008.

Per the initial terms of the Scheme, the Portuguese government was authorized to raise the fees during the period of the guarantee. Authorities made this decision “to allow the State to increase the price of the guarantee in the case of normalization of the markets, so as to limit the use of the scheme to cases where they are necessary” (EC 12/17/2008).

In 2010, fees were increased consistent with guidelines from the European Commission “to encourage banks to finance themselves without state support and to limit distortions of competition.” These increases to the ECB pricing formula recommendation of October 2008 were reflected by 20 basis points for banks with a rating of A+ or A, 30 basis points for banks rated A-, and 40 basis points for banks rated below A-. Banks without a rating would be considered to have a BBB rating (EC 7/23/2010).

Minimum fees were calculated based on Article 4 of Executive Order number 1219-A/2008, of October 23, 2008, as amended by Executive Order number 80/2012, of March 27, 2012 (EC 2017). Fees under the Scheme, which covered guarantees under Law 60-A, were significantly higher than fees for guarantees under other laws (Tribunal de Contas 2009).^FUnlike fees under the Scheme, fees for guarantees provided under Law 112/97 or Law 62-A/2008 were set between 0.2% (minimum) and 2% (maximum) in accordance with an October 19, 1995, order by the Portuguese Minister of Finance (Tribunal de Contas 2009).

In 2011, the EC issued a Communication from the Commission on the application, from 1 January 2012, of State aid rules to support measures in favour of banks in the context of the financial crisis (2011 Communication). The 2011 Communication laid out a new formula for calculating fees under the Scheme and under other guarantee schemes operated by member states.

In December 2011, Portugal modified the fees under the Scheme in accordance with the 2011 Communication (EC 12/21/2011). For banks with CDS data, the new formula was based on CDS spreads and the iTraxx Europe Senior Financials index.^FFormula: Fee = 40bp x (1 + [1/2 x A/B] + [1/2 x C/D]) where A is the beneficiary's median five-year senior CDS spread, B is the median iTraxx Europe Senior Financials five-year index, C is the median five-year senior CDS spread of all Member States, and D is the median five-year senior CDS spread of the Member State granting the guarantee. The medians would be calculated over the three years ending one month before the date of issue of the guaranteed bond. For guarantees for covered bonds, the guarantee fee could take into account only one half of the risk-based fee. For banks without CDS data but with a credit rating, a CDS spread would be taken from the median value of five-year CDS spreads of the same sample period for the rating category of the beneficiary bank. This would be done using a representative sample of large banks in the euro area and the supervisory authority would assess if the CDS data of the beneficiary bank was representative.

For banks with no CDS data and no credit rating, a CDS spread would be taken from the median value of five-year CDS spreads of the same sample period for the lowest rating category, based on a representative sample of large banks in the euro area. The CDS spread for that category would be adapted based on supervisory assessment.

Because CDS were not considered to provide an adequate measure of credit risk for short-term debt, the fees for guarantees of debt with a maturity of less than one year would be a minimum of the sum of:

a) a basic fee of 50 bp; and

b) a risk-based fee equal to 20 bp for banks with a rating of A+ or A, 30 bp for banks with a rating of A-, or 40 bp for banks rated below A- or without a rating.

In 2012, Portugal exceptionally calculated the fee for three large Portuguese banks based on the CDS of a sample of the lowest-rated banks in the EU, rather than using each of the three banks’ CDS spreads. According to the Portuguese authorities, the banks’ CDS spreads were inappropriate measures because - notwithstanding the application of a “new pricing formula [that] isolates the intrinsic risk of individual banks from changes in CDS spreads of sovereigns” - the CDS spreads had “widened along the spreads of the sovereign. As a result, the individual CDS spreads of those credit institutions do not reflect fairly the intrinsic risk of the credit institutions in question and may lead to the remuneration of State guarantees being excessively high” (EC 12/17/2012).

In 2017, in providing the EC with an estimate of guarantee fees, the Portuguese authorities “applied the formula for banks without CDS prices, as according to the Bank of Portugal’s opinion Portuguese bank’s [sic] CDS prices are still tainted by sovereign risk and therefore not representative since the calculations are related to a period of three years” (EC 2017).

Until mid-December 2012, the aggregate balance-sheet growth of beneficiaries of the Scheme was capped at whatever value was highest: “the annual rate of growth of Portuguese nominal GDP in the preceding year,” “the average historical growth of the balance sheets in the Portuguese banking sector during the period 1987-2007,” or “the average growth rate of the balance sheet volume in the banking sector in the EU in the preceding six months” (EC 12/17/2008).

If this threshold was exceeded, Portugal would make whatever adjustments to the Scheme were necessary to bring aggregate balance-sheet growth back under the threshold.

According to the EC, this feature of the Scheme “help[ed] to ensure that support [was] limited to what [was] necessary for restoring the normal functioning of the markets” (EC 10/30/2008).

Beginning in 2013, Portugal committed “to impose a ban on advertising referring to State support by the beneficiaries of the scheme and to prevent them from employing any aggressive commercial strategies which would not take place without the support of the Portuguese government” (12/17/2012).

The advertising ban and the ban on aggressive commercial strategies were in line with the 2008 State Aid Communication suggestion of “restrictions on commercial conduct, such as advertising invoking the guaranteed status of the beneficiary bank, pricing or on business expansion” (EC 10/13/2008).

The 2013 proscriptions were specifically based on section 4(59)(f) of the Communication from the Commission on the application, from 1 August 2013, of State aid rules to support measures in favour of banks in the context of the financial crisis (2013 Banking Communication), which states that for a guarantee scheme to be approved, “the recipients of guarantees and liquidity support must refrain from advertising referring to State support and from employing any aggressive commercial strategies which would not take place without the support of the Member State” (EC 2013).

As required by European Commission guidelines for guarantee programs remaining open beyond June 30, 2010, any beneficiary of the Scheme whose “total outstanding guaranteed liabilities […] exceed[ed] both a ratio of 5% of total liabilities and the total amount of €500 million” was “required to present a restructuring plan within two months of the granting of the guarantees” (EC 7/30/2014). These guidelines sought to encourage healthy banks to shift to non-guaranteed issuances while requiring remaining banks to take steps to address their weaknesses.

If a bank defaulted and called on a guarantee, the bank would be required to either pay back the Portuguese state or exchange the loan for preference shares. The EC described this feature as one of “various safeguards aimed at minimising distortions of competition” (10/30/2008). Starting in mid-December 2012, the State could no longer “convert its rights as a creditor into preferential shares” (EC 12/17/2012).

For a list of extensions, see Appendix A.