Espirito Santo Sells Notes to to Bank Clients as Investors Shun Portugal

Banco Espirito Santo SA, Portugal’s largest bank by market value, sold 176 million euros ($234 million) of notes to customers as Europe’s debt contagion leaves the nation’s banks shut out of international markets.

Espirito Santo offered an interest rate of 8.5 percent on the subordinated notes, its first sale to Portuguese consumer- banking clients, said Paulo Ferreira, head of funding at the Lisbon-based lender. It plans to sell an additional 75 million euros of the notes, and use the funds to augment capital.

Portugal’s banks, locked out of the bond market since March, are looking for ways to raise funds as concern escalates that the nation will follow Greece and Ireland in requesting a bailout from the European Union. The three biggest publicly traded lenders -- Espirito Santo, Banco BPI SA and Banco Comercial Portugues SA -- have a combined 9.2 billion euros of debt due next year.

“It’s very hard for the Portuguese banks, not just because of the price they have to pay to issue,” said Filipe Silva, who manages about $80 million, including Portuguese bonds, at Banco Carregosa SA in Porto, Portugal. “The other problem is that there are no buyers.”

While selling debt to consumer-banking customers is unusual in Portugal, it’s more common in Spain and Italy. Ferreira said Espirito Santo is offering clients an attractive yield for the so-called perpetual notes, which the bank can choose to redeem starting in March 2016. Payment of interest isn’t guaranteed and the debt, which the company describes as “deeply” subordinated, can be used to absorb losses.

Alternatives to Wholesale

“Getting financing is not the main goal of our issue to clients, but it is a consequence,” Ferreira said. Even so, “conditions are difficult, and we need to find alternatives to funding wholesale.”

John Raymond, an analyst at CreditSights Inc. in London, said Espirito Santo’s offer looks less generous than sales of similar debt to institutional investors. Milan-based Intesa Sanpaolo SpA, Italy’s second-biggest bank, sold subordinated perpetual notes in September with a 9.5 percent coupon.

Portuguese banks, though profitable, may face rising loan defaults as the government implements austerity measures. Portugal plans to reduce state workers’ salaries and raise taxes to convince global investors it can shrink its budget gap, the fourth-largest in the euro region as a percentage of gross domestic product. Greece’s debt crisis led to a surge in borrowing costs for debt-laden EU nations, forcing Ireland to become the second euro country to seek a bailout on Nov. 21.

‘Captive’ to Sovereign

S&P said on Dec. 3 that Espirito Santo, Banco BPI SA, Banco Comercial Portugues SA, Banco Santander Totta SA and state-owned Caixa Geral de Depositos SA may have their credit ratings lowered. New York-based S&P made the announcement three days after saying Portugal’s A- debt rating was at risk of a cut.

Bank of Portugal Governor Carlos Costa, a member of the European Central Bank’s governing council, said Oct. 4 that Portuguese banks are “captive” to the country’s sovereign risk.

Espirito Santo fell as much as 1.6 percent in Lisbon trading, and was 0.5 percent lower at the close, bringing the decline this year to 37 percent, the seventh-worst performance on the 53-company Bloomberg Europe Banks and Financial Services Index. Banco Comercial Portugues dropped 0.5 percent, extending this year’s slump to 26 percent. Banco BPI gained 2 percent, paring its 2010 decline to 32 percent.

Portugal’s planned spending cuts for next year are set to be the biggest since at least 1978, according to the EU. The measures may hurt economic growth, which averaged less than 1 percent a year in the past decade. The International Monetary Fund forecasts that Portugal’s economy may shrink 1.4 percent next year.

ECB Assistance

The cost of insuring the debt of Portugal rose to 552 basis points on Nov. 30, the highest among European Union member states aside from Ireland and Greece. The credit default swaps have since declined, after ECB President Jean-Claude Trichet said on Dec. 2 the central bank would delay the withdrawal of emergency liquidity measures and buy more government bonds to fight “acute” financial market tensions.

Trichet said the ECB will keep offering banks as much cash as they want through the first quarter, for periods up to three months, at a fixed interest rate. The ECB also embarked on a new wave of bond purchases, triggering a rebound in Irish and Portuguese debt.

‘Creative’ Methods

The inability of Portuguese lenders to tap wholesale markets has forced the industry to rely on the ECB to meet funding needs. Portugal’s banks have about 40 billion euros in borrowings from the ECB, equivalent to about 7.2 percent of banking assets, according to central bank data. That compares with 7.8 percent for Ireland and about 2 percent for Spain.

The lenders, which probably have their funding needs covered until March or April, are competing for client funds and using “more creative” methods, said Silva at Banco Carregosa.

“The Portuguese banks just have to keep looking for alternative sources of funding and trying to use any contingency plans they have,” said Peter Chatwell, a fixed-income strategist at Credit Agricole CIB in London. That may mean paying higher rates on deposits, he said.

Lenders have started to do so. Portuguese banks raised the average rate on 12-month savings deposits for individuals to 2.29 percent in October from 1.91 percent in September and 1.49 percent a year ago, ECB figures show.

Competing for Deposits

“Banks can use the ECB to address their short-term liquidity needs and in the medium term they will likely have to deleverage,” said Carlos Peixoto, an analyst at Banco BPI in Porto. “Deposits are another alternative for funding, but I don’t expect this segment to experience a significant increase next year as disposable income will be pressured by wage cuts and higher taxes.”

Portuguese household deposits stood at 116.9 billion euros in September, compared with 118.3 billion euros in August and 115.2 billion euros a year ago, according to Bank of Portugal data.

Espirito Santo’s total deposits jumped 15 percent to 29.9 billion euros in the third quarter from the previous three months, and the lender cut its net borrowings at the ECB to 4.3 billion euros from 6.9 billion euros. The bank said in its third-quarter report that ECB lending has been fundamental in Portugal, Spain and Ireland “to overcome the lack of liquidity.”

Eligible Assets

While Banco Comercial’s deposits in Portugal rose 2.5 percent to 30.4 billion euros in the third quarter, they fell from a year before. Total deposits at the bank, Portugal’s largest by assets, rose 2.8 percent to 45.3 billion euros in September from June, and increased 1.7 percent from a year earlier.

Banco Comercial, based in Porto, doesn’t plan to sell subordinated notes to its consumer-banking customers, though it issued 1 billion euros of the debt in 2009 through its branch network and to institutional investors, said spokesman Erik Burns.

The bank plans to cover its 2011 refinancing needs by going back to the markets “when possible,” Burns said. “At present we are focusing on increasing our assets eligible for discounting at the ECB -- we aim to have more than 20 billion euros in eligible assets by the end of 2010 -- and on continuing to reduce our commercial gap.”

The bank’s annual financing needs have been decreasing and are expected to drop to 1 billion euros by 2013, he said. Banco Comercial increased its use of central bank funding to 14.1 billion euros in the third quarter, from 11.6 billion euros in the second, company reports show.

All the banks are looking at alternatives to ECB funding, said Ferreira at Espirito Santo, who added that “necessity is the mother of invention.”

To contact the reporters on this story: Niklas Magnusson in Stockholm at nmagnusson1@bloomberg.net Charles Penty in Madrid at cpenty@bloomberg.net

To contact the editor responsible for this story: Frank Connelly at fconnelly@bloomberg.net

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