Shocks to the European banking sector can have unexpected origins. Banco Espírito Santo (BES) had seemed a relatively unremarkable mid-sized bank with total assets of about €90bn. But in early July, concern over the health of the Portuguese lender triggered a sudden sell-off across European stock markets, sparking fears that peripheral Europe’s banking crisis was about to re-erupt.
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Angela Merkel, the German chancellor, was moved to comment that the market turmoil caused by a single Portuguese bank shows how quickly uncertainty can return and how fragile the eurozone remains.
In the event, the market turbulence proved short-lived and within a week the risk of contagion appeared to be safely contained within Portugal. Now the country’s financial regulators are working to protect the Portuguese banking system and BES itself by ensuring that the strife is confined to the non-financial businesses of the troubled Espírito Santo family group, the biggest shareholders in BES with 20%.
After the crisis
BES, run by a celebrated banking dynasty that goes back almost 150 years, had seemed the most resilient of Portugal’s banks. Under executive chairman Ricardo Espírito Santo Salgado, it rode out the global financial and eurozone crises without serious difficulty and was the only one of Portugal’s top three listed lenders not to receive an injection of state capital during the country’s three-year international bail-out, which ended in May.
But pressures had been building for months in the complex ladder of Espírito Santo holding companies above the bank. These erupted in June when, in the context of a €1.045bn rights issue, BES disclosed 'accounting irregularities' and an 'extremely negative' financial situation at Espírito Santo International (ESI), the Luxembourg-based parent company for the group’s holdings.
Amid growing uncertainty over the extent of BES’s exposure to the Espírito Santo group’s liabilities, ESI’s failure to meet a number of commercial paper repayments proved the trigger for a brief spell of Europe-wide market turbulence. ESI has since applied for protection from its creditors in an effort to prevent a disorderly fire sale of the group’s assets.
Ringfence action
The first concern of the Bank of Portugal has been to ringfence BES, Portugal’s largest listed bank by assets, from the problems afflicting its largest shareholder. Mr Salgado and all other members of the Espírito Santo family have had to relinquish any direct management role in the bank, making way for a new independent board led by Vítor Bento, a respected economist and company manager.
Regulators and government ministers insist that BES has enough capital to withstand the strain. BES says it has a capital buffer of €2.1bn above the minimum regulatory requirement. This is based on its March 31 capitalisation plus the €1.045bn raised in a capital increase in June. According to BES, the rights issue increased its common equity tier one capital ratio under Basel III rules from 8% to 9.6%.
BES says its exposure to Espírito Santo holding companies and subsidiaries totals €1.15bn, including €1.08bn in loans. Non-performing loans accounted for 6% of the bank’s total loan portfolio at the end of March, when liquidity support from the European Central Bank was given as €8.35bn.
According to Citigroup Research, if, in a worst-case scenario, BES had to absorb all of its own and its clients’ exposures to Espírito Santo group companies as well as half of the non-guaranteed exposures of its Angolan banking unit, it could face a maximum loss of €4.3bn, meaning “the bank would have to raise an additional €4bn” to regain a capital ratio above 10%.
If BES’s own defences prove inadequate, Antonio Roldán, an analyst with the Eurasia Group, says EU funds are available to the government to help shore up the bank’s capital strength, but only on the condition of private sector burden sharing.
A total of €12bn for banks was set aside from the €78bn in rescue loans that Portugal received during its bailout. More than €6bn of this is still available, but would now be subject to EU state aid rules. “In principle, this means that the government’s ability to access the remaining €6.4bn will be dependent on some degree of private sector burden sharing, certainly involving shareholders and junior creditors,” says Mr Roldán.
However, Carlos Costa, Portugal’s central bank governor, has floated the possibility of international banks and investment funds buying into BES as a means of strengthening its capital, telling a parliamentary hearing that there have been “credible expressions of interest”.
