UPDATE 1-BES bonds sell off on ownership structure concerns

Wed Jul 9, 2014 2:51pm EDT

* BES bank capital down 10 pts in two days

* Bond curve inverts, investors retreat

* Contagion sets in; Portuguese bonds widen (Adds comments from BPES)

By Aimee Donnellan

LONDON, July 9 (IFR) - Banco Espirito Santo (BES) bonds came under more 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 Espirito Santo Financial Group (ESFG), the holding company which owns 25.1% of BES, had received proposals to swap 85% of commercial paper into equity and 15% into long-term debt.

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

BES, Portugal's biggest bank, has also seen its senior unsecured bond curve invert - 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 after an audit found "material irregularities" at Espirito Santo International (ESI), a private company owned by the founding Espirito Santo family.

"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.

Banque Privee Espirito Santo (BPES) meanwhile told Reuters that some of its clients had not been reimbursed on debt issued by ESI on maturity.

BPES, a small Swiss bank owned by ESFG, said in an emailed reply that the delay was less than 30 days and not the bank's fault, but did not disclose any details.

Cross guarantees and loans across the entity are adding to the confusion and contributing to the dramatic moves in BES bonds.

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. The yields on Portugal's 10-year sovereign rose from just above 3.60% to 3.95% - the highest level since May - in only 24 hours.

Portugal Telecom's curve has also widened 15bp-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 by Adam Parry and Robert Smith; Editing by Natalie Harrison, Julian Baker and Marc Carnegie)

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