BES bonds sell off on ownership structure concerns

Wed Jul 9, 2014 10:46am EDT

* BES bank capital drops 10 points in two days

* Senior unsecured bond curve inverts as investors retreat

* Contagion sets in as Portuguese sovereign and corporate bonds widen

By Aimee Donnellan

LONDON, July 9 (IFR) - Banco Espirito Santo's bonds came under further pressure Wednesday as reports of a potential debt restructuring at a group holding company raised fears of losses at the bank level.

Portuguese newspaper Expresso said creditors of Luxembourg-registered holding company Espirito Santo Financial Group (ESFG), which owns 25.1% of BES, had received proposals to swap 85% of commercial paper into equity and 15% into long-term debt.

BES' only outstanding Tier 2 bond - a 750m 10-year issued last November - has sunk to a cash price of just 89, after losing 10 points over the past two days on escalating fears that the bank's capital base could be eroded.

BES, Portugal's biggest bank, has also seen its senior unsecured bond curve invert in what is a typical sign of distress, with short dated bonds more than 100bp wider since Monday and longer dated maturities 70bp wider.

Investors were already unnerved by troubles revealed at Espirito Santo International (ESI), a private company owned by the founding Espirito Santo family, after an audit found "material irregularities".

"I'd like to know what's going to happen with the commercial paper that is set to mature next week," said one London-based portfolio manager.

Cross guarantees and loans across the entity are adding to the confusion and contributing to the dramatic moves in the group's debt.

ESFG, for example, has provided a 700m guarantee to BES, which covers potential liabilities arising from the exposure of BES to ESI. But the market fears that will not be enough to insulate BES bondholders.

However, some debt capital markets bankers believe the moves are overdone, and one even said it was a good time to buy.

"What's going on doesn't make sense. ESFG only has around a 25% stake in BES so there really isn't any reason why the Lower Tier 2 bonds would be wiped out," said the banker.

BIGGER UNKNOWNS?

Investors also fear more unknowns could surface, especially as BES recently revealed it was owed 980m by firms controlled by the founding family - 700m more than it disclosed at the time of its 1.045bn share capital raising on June 11.

Moody's has added fuel to the fire by slashing the long-term issuer and debt ratings of ESFG three notches to Caa2 from B2.

Meanwhile, the risk of contagion is rising with Portugal's 10-year sovereign yields rising from just above 3.60% to 3.95% - the highest level since May - in just 24 hours.

Portugal Telecom's curve has also widened 15-20bp over the course of the last two days. Portugal Telecom has 897m invested in commercial paper of RioForte - a holding company of ESI - that is due to mature on July 15 and 17. (Reporting by Aimee Donnellan; additional reporting Adam Parry and Robert Smith; Editing by Natalie Harrison, Julian Baker)

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