The WSJ reports,"worries over the financial health of a major Portuguese lender spooked global markets Thursday, drubbing shares in southern Europe and sending U.S. stocks on an early swoon.
The broad, sharp market moves were reminiscent of the euro zone's debt crisis in 2011: A shock in a small country spread across the continent, pulling down every major stock index in Europe, trickling over into Wall Street and sending investors scurrying for the perceived safety of gold and U.S. and German government bonds. The 10-year German Bund traded at its strongest level since May 2013.
Portugal's benchmark index led the declines, falling 4.2%. Exchanges in Spain and Italy were each off close to 2%, and the broad Stoxx Europe 600 fell 1.1%. The Dow Jones Industrial Average closed down 70.54 points, or 0.4%, at 16915.07, after falling as much as 1.1% earlier. Amid the market turmoil, some southern European companies postponed planned stock and bond offerings, and investors were left wondering whether the problems were confined to Portugal or presaged a wider reassessment of Europe's recovering but still fragile banking system.
Friday morning in Asia, Japan shares fell 0.3%, Korea shares were down 0.6% and Australia shares gained 0.2%.
It has been more than a year since fears about the health of a European bank rattled markets, and investors, bankers and regulators have been growing increasingly confident about the continent's financial system. Regulators have hoped the banking industry's improving health would shine through on so-called stress tests they are conducting on more than 120 large banks.
Instead, the rapid descent of Portugal's Banco Espírito Santo SA, and the collateral damage in other European markets, suggests conditions remain precarious.
In a statement Thursday, the International Monetary Fund, which along with the European Union bailed out Portugal in 2011, said Portuguese banks had weathered the euro-zone crisis well but that "pockets of vulnerability remain."
At the epicenter is Banco Espírito Santo. Shares in the troubled Portuguese lender have been under pressure since May, when the bank disclosed that an audit ordered by Bank of Portugal into Espírito Santo International SA, the conglomerate that indirectly holds a stake in the bank, had found Espírito Santo International was in a "serious financial condition" and had uncovered accounting irregularities. But the declines mounted drastically Thursday after investors learned Espírito Santo International had delayed coupon payments relating to some short-term debt securities.
Switzerland-based Banque Privee Espírito Santo SA, which is owned by Espírito Santo Financial Group, said in an emailed statement Wednesday that Espírito Santo International has delayed the repayment of short-term debt sold to some of its clients. It said the repayment is the sole responsibility of the conglomerate. The conglomerate declined to offer a separate comment.
The bank's stock dropped more than 17% before trading in its shares was suspended. Trading in Banco Espirito Santo's controlling shareholder, Espirito Santo Financial Group SA, listed in Luxembourg and Lisbon, was also suspended earlier Thursday. The Portuguese markets regulator banned short selling, or betting against, Banco Espirito Santo shares in Friday's session.
U.S. stocks opened sharply lower but gradually pared losses as investors digested the news. Despite its declines, the Dow is just 0.9% off its record, reached July 3 after a stronger-than-expected reading on the U.S. job market. In late-afternoon trading, the 10-year Treasury note's yield fell to 2.531%, down slightly from Wednesday's 2.547%. When bond prices rise, yields fall.
Espírito Santo International had been relying heavily on selling debt to the funds marketed by its own banks, according to financial documents reviewed by the Journal last year. Over a 21-month period, it cumulatively sold more than €6 billion ($8.2 billion) in short-term debt to one of its own investment funds.
While the maneuver was legal, law and accounting professors said last year that the practice exposed investors to heightened risks and raised flags about the financial health of the conglomerate. Last November, Portugal's market regulator moved to limit the amount any Portuguese fund can invest in an affiliated company.
Espírito Santo International said in December it would replace the financing coming from the funds, mainly through the issuance of commercial debt. That debt was sold to private-banking customers and Portugal Telecom SGPS SA, among others. Portugal Telecom disclosed last month that it had €897 million of debt from a unit of Espírito Santo International. Banco Espírito Santo is a large Portugal Telecom shareholder.
The amount of Espírito Santo International's outstanding debt is unknown, because the company is privately owned.
Banco Espírito Santo said late Thursday that exposure to Espírito Santo International entities, including Espírito Santo Financial Group, totaled €1.2 billion as of June 30, mostly in loans. Its retail clients held €853 million in debt from the entities, while institutional clients held €2 billion.
The bank's "executive committee believes that the potential losses resulting from the exposure to [Espírito Santo entities] do not compromise the compliance with the regulatory capital requirements," it said in a statement.
Espírito Santo Financial Group earlier said it was forced to set aside €700 million in March to cover any losses retail clients of Banco Espírito Santo may face related to Espírito Santo International debt.
A Banco Espírito Santo spokesman declined to say Wednesday whether it has tapped that money to repay its customers. He said the bank's clients are being repaid in full and without delays.
Amid the bank's stock decline, lenders around Europe took a battering Thursday. Banks in the Iberian Peninsula suffered the most, but shares in financial institutions in Germany, France and the U.K. all dropped markedly, too.
Banco Popular Español stock closed the session down 2%, but earlier in the day had traded 5% weaker. The Spanish group also postponed a bond issue, citing the adverse market conditions. Riccardo Barbieri Hermitte, the chief European economist at Mizuho International PLC in London, said Thursday's selloff "shows that assumptions that the market was making were incorrect."
"If a banking system has been recapitalized, it doesn't necessarily mean that it doesn't face problems," he said".
