* Markets more optimistic about BES financial stability
* Portuguese yields fall tough uncertainty persists
* Portuguese T-bill sale goes smoothly
* Investors see limited fallout from Espirito Santo problems (Updates prices, adds fresh analyst comment)
By Marius Zaharia
LONDON, July 16 (Reuters) - Portuguese bond yields fell on Wednesday, with investors more optimistic that the country’s largest listed bank can deal with the financial troubles faced by its founding family, although uncertainty remained high.
Rioforte, which indirectly owns a stake in Banco Espirito Santo, was preparing to file for creditor protection in Luxembourg, where it is based. The news hurt Portuguese government debt in early trade, but the bonds recovered later as the stock market opened and BES shares rose.
The bank’s shares have been recovering since late on Tuesday, when its chief executive said it was well capitalised and investor appetite for riskier assets picked up on the back of strong earnings from U.S. banks and dovish comments from Federal Reserve chief Janet Yellen.
The government and the central bank have repeatedly said BES is able to deal with any exposure to the troubled companies of its founding family since it has 2.1 billion euros ($2.84 billion) in capital above the minimum regulatory requirements.
“The market is starting to come to terms with the situation regarding BES,” said Gianluca Ziglio, an analyst at Sunrise Brokers. “Authorities in Portugal have been pretty clear that the bank is well capitalised.”
He added, however, that uncertainty about the extent of the problems the Espirito Santo family was facing kept many investors nervous.
Portuguese 10-year government bond yields fell 11 basis points to 3.73 percent. They have regularly seen daily swings of more than 10 bps over the past week, having briefly broken above 4 percent in the process.
Debt market were calmer after last week’s sell-off in peripheral bonds.
The Portuguese government has a residual 6 billion euros from its rescue programme available for its banking sector if needed and the Treasury has built a financial buffer, having raised some of the funds it will need for next year.
“The market probably read too much across onto the sovereign impact,” said Michael Michaelides, a strategist at RBS.
The market for insurance against default suggests many investors see BES risks as localised.
Five-year Portuguese credit default swaps hit two-month highs of over 200 basis points last week, having risen from June lows of 126 bps. In comparison, CDS on BES hit nine-month highs of 500 bps, having traded as low as 148 bps in June.
Portuguese CDS last traded 183 bps, while BES’s were 416 bps, both lower on the day, according to data from Markit.
Portugal sold the targeted 1.25 billion euros in Treasury bills, with the yield on the 12-month maturity rising slightly.
“The modest uptick in 12-month yields here should arguably be seen, at worst, as indicative of an element of caution,” Rabobank strategist Richard McGuire said. “Meanwhile, the higher cover ratio ... potentially highlights the ready willingness of investors to buy on dips.”
After a bout of contagion across euro zone peripheral bond markets last week, the other indebted countries traded independently of Portugal’s woes this week.
Analysts said the fears around BES have been “overplayed” and opened up a buying opportunity in peripheral debt markets.
A key reason for that is the European Central Bank’s promise to offer banks up to 1 trillion euros in long-term loans from September at a rate of only 0.25 percent. The measure aims to encourage banks to lend to businesses and consumers, but if they do not they can pay back the loans for no penalty in 2016.
“Peripherals can rally further. Our call is for 100 basis points in 10-year Spain and Italy spreads to Bunds,” Michaelides said. Spain’s 10-year yield gap over German Bunds stood at 147 bps while the equivalent Italian spread was at 163 bps. ($1 = 0.7393 Euros) (Additional reporting by Emelia Sithole-Matarise; Editing by Mark Heinrich)