Espirito Santo Bonds Tumble to Records Amid Missed Note Payments

Banco Espirito Santo SA bonds plunged to record lows after a parent company delayed payments on short-term notes, reawakening concern that banks remain vulnerable as the euro region emerges from the sovereign debt crisis.

Portugal government bonds also fell, sending the 10-year yield up the most in two months, leading declines among securities from Europe’s most indebted nations. A gauge of Portuguese stocks fell to a seven-month low.

The selloff was prompted by Espirito Santo International SA saying it delayed payments on some securities and follows a warning from the bank in May that its parent company faced a “serious financial situation” that could be damaging. Moody’s Investors Service placed Banco Espirito Santo under review for a potential downgrade citing “corporate governance shortcomings” last month.

“The bigger question is whether the government will have to get involved,” said Steve Hussey, a London-based financial institutions analyst at AllianceBernstein Ltd., which manages about $445 billion, including bonds of Banco Espirito Santo. “Will it cost the government money? Will it have to step in to prevent systemic repercussions?”

The Lisbon-based bank’s 7.125 percent subordinated notes due November 2023 slid 3.25 cents on the euro to 90.10 cents, to yield 8.51 percent, according to data compiled by Bloomberg. Portugal’s 10-year government bond yield jumped as much as 26 basis points to 3.91 percent today, the highest since May 21. It was up 13 basis points at 3.78 percent as of 3:20 p.m. in Lisbon.

Debt Losses

The Portugal PSI 20 Index dropped for a sixth consecutive day, falling 2 percent.

Subordinated bonds of banks that get into trouble are at risk of write-downs, known as bail-ins, after the financial crisis prompted European authorities to inflict losses on investors rather than on taxpayers.

Investors holding subordinated debt from failed Austrian lender Hypo Alpe-Adria-Bank International AG could face losses after lawmakers voided guarantees on the securities yesterday.

The Austrian move follows the Dutch government’s seizure of SNS Reaal NV subordinated bonds last year after distressed real estate loans brought the lender to the brink of collapse. In both cases holders of senior debt were spared.

“If anyone is going to be left in the lurch it’s probably going to be holders of their subordinated bonds,” said John Raymond, an analyst at CreditSights Inc. in London. “You don’t have senior bail-in at the moment but national laws can be change very quickly.”

‘Solid’ Solvency

The cost of insuring European bank debt against losses on climbed to the highest in more than a month today, with the Markit iTraxx Europe Senior Financial Index of credit-default swaps climbing 1.5 basis points to 68.5 basis points.

The Bank of Portugal said in an e-mail it reaffirmed a July 3 comment that Banco Espirito Santo’s solvency situation is “solid,” having been significantly reinforced with a recent capital increase.

The lender, which has about 83 billion euros of assets, raised 1.04 billion euros with a stock offering last month to strengthen capital ratios before European Central Bank’s stress tests. The bank was the only one of the three biggest publicly traded Portuguese lenders that didn’t request state aid after the country received a European Union-led bailout in May 2011.

‘Huge Uncertainty’

Banque Privee Espirito Santo SA said yesterday the delay in payments of some debt securities issued by parent company Espirito Santo International affects “only a few clients.” Some investors have been asked to swap the commercial paper for stock and new long-term securities, according to Portuguese newspaper Expresso.

“The news flow in the last few days is confirming investors’ suspicions over how extensive problems are at the top of the group,” said Roger Francis, an analyst at Mizuho International Plc in London. “The market has huge uncertainty with reports of payments being missed and debt for equity swaps circulating widely.”

Shares of Espirito Santo Financial Group SA, which owns 25 percent of Banco Espirito Santo, dropped as much as 14 percent to 1.25 euros and were at 1.34 euros at 3:30 p.m. in Lisbon. Banco Espirito Santo, Portugal’s second-biggest bank by market value, dropped 3.7 percent to 62.1 euro cents.

The group’s subordinated bonds also declined. The company’s 351 million euros ($477 million) of 6.875 percent bonds fell more than 11.25 cents on the euro to 18 cents. The securities closed at 100.2 cents on June 18.

Moody’s cut Espirito Santo Financial three levels today to Caa2, its third-lowest rating, citing lack of transparency about the its financial position and its links to other companies within the group.

Credit-Default Swaps

Credit-default swaps on the senior debt of Banco Espirito Santo were the worst performing among 120 financial companies around the world today, according to data compiled by Bloomberg. The lender’s debt is the most expensive to insure among 325 financial companies tracked by Bloomberg.

The cost of insuring the bank’s debt jumped 50 basis points to 377 basis points, the highest level since Oct. 31. The contracts, which peaked above 1,200 basis points during Europe’s sovereign debt crisis in 2011, are up from a more than four-year low of 156 basis points last month.

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