* Portugal's worries about BES group have regional
* Greek three-year debt sale sees lacklustre demand
* Irish, Spanish sales go smoothly as markets differentiate
(Adds more detail on Portugal, fresh comments, updates prices)
By Marius Zaharia and Emelia Sithole-Matarise
LONDON, July 10 Concern about the health of a
parent company of Portugal's largest bank hurt bonds from the
euro zone's periphery on Thursday, curbing demand at Greece's
second debt sale following its 2012 default.
It was the first significant episode of contagion for
peripheral markets in 2014. Debt yields in those markets reached
record lows in the first half of the year, helped by ultra-easy
European Central Bank policies that let countries sell debt
easily regardless of their ratings or economic situation.
Espirito Santo Financial Group, the largest shareholder in
Portugal's Banco Espirito Santo, said on Thursday it
had decided to suspend its shares and bonds, citing "material
difficulties" at its parent company, ESI.
Separately, Portugal's securities market watchdog, CMVM,
said it was analysing a major investment by Portugal Telecom
in the debt of Rioforte, a holding company of the
Espiroto Santo group.
Sources told Reuters on Wednesday that Espirito Santo was
considering debt-for-equity swaps and may ask for more time to
repay debts, as it grapples with the financial problems.
The government in Lisbon has repeatedly said that BES is
isolated from the holding company's problems and there is no
risk to public finances. However, the turmoil has led to a sharp
sell-off in Portuguese government bonds and had repercussions
for other markets as well.
Greece's sale of three-year bonds drew mediocre demand
compared with recent offerings from euro zone peripheral
issuers. Athens raised 1.5 billion euros, well below the 2.5
billion to 3 billion euros it was widely expected to achieve.
Total bids were only 3 billion euros. That looked lacklustre
to many market players who are used to seeing order books
several times that size at a peripheral euro zone debt sale.
Spain's Banco Popular Espanol, meanwhile, was forced to
postpone the sale of contingent convertible debt citing poor
market conditions, according to a lead manager on the planned
Guido Barthels, chief investment officer at Luxembourg-based
Ethenea, was initially interested in the Greek bond sale but was
put off by what was happening in Portugal.
"It is not a good day to come to the market for Greece,"
Barthels said. "Given what's happening in Portugal, it does not
make a whole lot of sense to touch that."
Yields on Portuguese 10-year bonds rose 21
basis points to 4.01 percent, dragging their peripheral peers
with them. Greek yields were 20 bps higher at 6.32
percent. Spanish and Italian yields
rose 6 bps to 2.82 and 2.94 percent, respectively.
Some market participants said contagion from Portugal
"We do not think the problems emanating from the BES
debacle should be seen as a systemic issue for the sovereign,
and feel that the contagion effects are overdone and likely
exacerbated by positioning and poor liquidity," said Martin
Harvey, European bond manager at Threadneedle Investments.
"Having said that, it is a reminder that peripheral nations
will continue to face sporadic mini-crises due to the deep
structural problems their economies and financial systems face."
The Greek bond was sold at a yield of 3.50 percent, the
lower end of a 3.50-3.625 percent price guidance. That is higher
than those offered by all 10-year euro zone bonds apart from
Investors in Italian debt, for example, would have to buy a
15-year bond to get a higher yield than Greece's three-year
paper. German 30-year paper offered 2.16 percent.
Market action suggested that investors were still
differentiating between peripheral markets, though.
Aid-receiving Greece and Portugal, which emerged from its
bailout less than two months ago, were seen as the most
vulnerable. Irish 10-year yields were 2 bps up at
2.34 percent; the country saw record low borrowing costs at an
auction of 500 million euros in 10-year bonds.
Spain also held a smooth sale of 1 billion euros of 10-year
inflation-linked bond at an average yield of 1.46 percent.
"We've seen a very strong sale in Ireland," said Michael
Michaelides, rates analyst at RBS. "The broader correlation
still stands in the periphery but now you see increasingly
that when there is a particular story in one country, that
market moves a lot more than the others."
That differentiation will last as long as the euro zone
stays clear of any systemic risks, such as those in 2012, when
Greece was on the brink of crashing out of the currency union
following its default.
Greece's bond sale is a hallmark of its recovery. The
country is slowly emerging from a six-year recession and is
running a budget surplus before interest rate payments.
But the new bond comes with a caveat. One of the most
attractive features of Greek debt before this sale was that the
country had no debt to pay back for the next five years, hence
no near-term financing risk.
In comparison, half of the combined debts of Italy and Spain
expire in the next five years.
In the next three years, Greece will have to decide which
path to take after the end of its second bailout deal with the
International Monetary Fund and the European Union. It will also
have to hold elections in 2016, or earlier if the fragile ruling
coalition loses even more strength.
Anti-bailout leftist party Syriza did well in the May
European Parliament elections and is expected to retain its
support from a population deeply hurt by austerity. Bondholders
prefer the predictability of a pro-bailout government.
(Editing by Larry King and Anna Willard)