Portuguese Banking Group's Woes Deepen

When we wrote about the troubles at Banco Espirito Santo yesterday (our post was written before European markets opened) information was still fairly scant. However, on the very same day the situation continued to escalate. Here is an excerpt from the WSJ providing further details:

 

Shares in the troubled Portuguese lender have been under pressure since May, when the bank disclosed that an audit ordered by Bank of Portugal into Espírito Santo International SA, the conglomerate that indirectly holds a stake in the bank, had found Espírito Santo International was in a "serious financial condition" and had uncovered accounting irregularities. But the declines mounted drastically Thursday after investors learned Espírito Santo International had delayed coupon payments relating to some short-term debt securities.

Switzerland-based Banque Privee Espírito Santo SA, which is owned by Espírito Santo Financial Group, said in an emailed statement Wednesday that Espírito Santo International has delayed the repayment of short-term debt sold to some of its clients. It said the repayment is the sole responsibility of the conglomerate. The conglomerate declined to offer a separate comment.

The bank's stock dropped more than 17% before trading in its shares was suspended. Trading in Banco Espirito Santo's controlling shareholder, Espirito Santo Financial Group SA, listed in Luxembourg and Lisbon, was also suspended earlier Thursday. The Portuguese markets regulator banned short selling, or betting against, Banco Espirito Santo shares in Friday's session.

 

 

Apparently, short selling in European bank stocks is only allowed as long as they are going up. A short selling ban never helps a stock to recover or keeps it from falling. On the contrary, it is like a red flag – it's the regulator saying “we believe  only coercion can help at this point”. This is of course utter self-defeating nonsense.  Here is where Banco Espirito Santo landed before trading in the stock was halted:

 

BES_update

BES crashes another 17% before being halted – click to enlarge.

 

Here is more color from the WSJ – what's really amazing about all this is that the shady financing structure of the Espirito Santo group has apparently been criticized “for years”. How then can any of this have been a surprise to anyone?

It actually goes to show that the idiot population in financial markets continues to be quite large. Normally events like the 2008 crisis and the subsequent euro area debt crisis would have whittled it down significantly. Evidently that doesn't happen when all and sundry get bailed out and central banks print trillions in new money in no time at all. The fact that the stock of BES only started to fall such a short time ago (and rallied strongly previously) shows us how market participants have been lulled into a false sense of confidence by interventionist distortions.

 

It has been more than a year since fears about the health of a European bank rattled markets, and investors, bankers and regulators have been growing increasingly confident about the continent's financial system.

[…]

“Critics of Espírito Santo International's complex corporate structure have worried for years about the links among companies within the conglomerate. Among the concerns: whether the group's nonfinancial companies—including a hotel chain and a real-estate company—were using the bank and its customers to raise funds. Those concerns were heightened by the fact Ricardo Salgado, the chief executive of Banco Espírito Santo and a member of the influential Espírito Santo family, was also sitting on the board of Espírito Santo International. He quit the board earlier this year and is expected to resign as CEO of the bank later this month after the installation of a new management team led by outsiders, as requested by the Bank of Portugal.

Espírito Santo International had been relying heavily on selling debt to the funds marketed by its own banks, according to financial documents reviewed by the Journal last year. Over a 21-month period, it cumulatively sold more than €6 billion ($8.2 billion) in short-term debt to one of its own investment funds.

Espírito Santo International said in December it would replace the financing coming from the funds, mainly through the issuance of commercial debt. That debt was sold to private-banking customers and Portugal Telecom SGPS SA, among others. Portugal Telecom disclosed last month that it had €897 million of debt from a unit of Espírito Santo International. Banco Espírito Santo is a large Portugal Telecom shareholder.

The amount of Espírito Santo International's outstanding debt is unknown, because the company is privately owned. Banco Espírito Santo said late Thursday that exposure to Espírito Santo International entities, including Espírito Santo Financial Group, totaled €1.2 billion as of June 30, mostly in loans. Its retail clients held €853 million in debt from the entities, while institutional clients held €2 billion.

 

(emphasis added)

The amounts involved are of course quite small by international standards. Let us not forget that 10s of trillions in additional debt ($30 trillion in the form of debt securities alone) have been added atop the global debt pile since 2008. The problem is mainly that Espirito Santo serves as a reminder of the inherent instability of the modern monetary system. The fear is that this is tip of the iceberg stuff, which it actually is.

 

Related Chart Updates

Collateral damage victim Portugal Telecom also continued to get mauled on the Lisbon Stock Exchange. The stock has been in free-fall for the past two weeks:

 

Portugal Telecom-update

Portugal Tele-Splat's stock continued to get creamed – click to enlarge.

 

Yesterday we showed the (then still small) lateral support break the PSI 20 index in Lisbon had achieved on Wednesday. It seems it was the real McCoy:

 

PSI-20-update

That sure looks like a vigorous third wave down by now. – click to enlarge.

 

Portugal's 10 year yield shot back above the 4% level on Thursday, in its biggest one day rise since the recent short term uptrend began:

 

Portugal 10-Year Bond Yield(Daily)update

Portugal, 10 year government bond yield – back above 4% – click to enlarge.

 

However, CDS on the sovereign debt of the “PIGS” quartet haven't really budged much, which is an indication that the worries remain localized for the moment. It is possible that the move in Portuguese bond yields is simply due to profit taking, with recent events  providing the excuse.

 

CDS

5 yr. CDS spreads on the sovereign debt of Portugal (orange), Italy (yellow), Spain (cyan) and Greece (green) – note that the data series are differently scaled on this chart (color-coded) – Greek and Portuguese CDS spreads are not actually lower that those of Italy and Spain (the current levels are high-lighted) – click to enlarge.

 

Lastly, for the first time in a long time, euro basis swaps have moved a bit into negative territory again recently, after briefly hugging the zero line at the height of the recovery. It's not a big move and may not mean much, but it is definitely different from what went on before:

 

euro-basis swaps

Three month, one year, three year and five year euro basis swaps – click to enlarge.

 

Readers who have missed it and want some background information can download a primer on basis swaps here.

 

Conclusion:

As far as canaries in the coal mine go, this is a very small one. However, as noted  previously, problems in credit markets always begin with relatively small overextended players getting into trouble.

 

 

Charts by: 4-traders.com, investing.com, bigcharts, Bloomberg

 

 

 

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