Back From the Brink, Portugal Still Has a Long Way to Go / The New York Times.

Back From the Brink, Portugal Still Has a Long Way to Go

By RAPHAEL MINDER / JULY 14, 2014 / http://www.nytimes.com/2014/07/15/business/international/back-from-the-brink-portugal-still-has-far-to-go.html?smid=fb-share&_r=0

LISBON — Only two months after Portugal proudly exited its international bailout program, the financial problems of the country’s most powerful family have given investors an unwelcome reminder of the potential fragility of the Portuguese recovery.

Portugal’s stock market plunged last Thursday, helping drag equities lower around the world, after one of the companies controlled by the powerful Espírito Santo family missed a payment on its short-term debt. The Portuguese market has since recouped some of these losses, and regulators have offered assurances that the cost of any Espírito Santo rescue would not be sufficient to damage Portugal’s public finances.

But the problems of the Espírito Santo empire have exposed a convoluted corporate structure in which industrial assets were propped up by the group’s own bank, Banco Espírito Santo, Portugal’s second-largest bank.

On Monday, Vítor Bento, a banking industry executive, was appointed chief executive of Banco Espírito Santo under a deal brokered by the Portuguese central bank. Mr. Bento replaces Ricardo Espírito Santo Silva Salgado, who was at the bank’s helm for more than two decades and whose influence made him known in Portugal as “Dono disto tudo,” or “Owner of everything.”

The management move is part of an effort by Portuguese authorities to show that the difficulties of the Espírito Santo group will not threaten the country’s banking system.

The Espírito Santo family has been exerting influence over Portugal’s economy for more than a century, also managing to rebuild its business empire after the 1974 revolution that led to the nationalization of the family’s assets. It controls financial companies but also property, energy and health care assets — through a cascade of holding companies, in part registered in Luxembourg.

“They are our Rothschilds or our Rockefellers,” said Maria João Gago, a journalist and co-author of “The Last Banker,” a new book about Mr. Salgado and his family. “They have great influence, not only economically but also politically.”

One concern is that, as the financial crisis fueled infighting between different branches of the Espírito Santo family, its members managed to use their influence to take out loans even after regulators in Portugal and Luxembourg started investigating possible financial irregularities at some of their holding companies.

After trading of its stock was suspended last Thursday, Banco Espírito Santo said in a filing that its lending exposure to other companies in the group was 1.18 billion euros, or $1.61 billion, covered by a “solid” level of solvency, €2.1 billion above the regulatory minimum. Whether that will stand up to scrutiny remains to be seen, but it satisfied regulators enough that the bank’s shares were allowed to resume trading on Friday.

The ripple effect, though, is already being felt in the country’s corporate world — including at Portugal Telecom. That company is in the process of merging with Oi, operator of one of Brazil’s biggest wireless networks.

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Portugal Telecom was due this week to get back a €900 million loan of three-month commercial paper issued by a company called Rioforte. But Rioforte is owned by Espírito Santo International, the holding company whose missed debt payment triggered last week’s market sell-off.

In a further sign of how interconnected the businesses are: Banco Espírito Santo owns a 10 percent stake in Portugal Telecom, while Portugal Telecom holds 2 percent of the bank.

The family’s problems, and its entangling investments, make it uncertain that Portugal Telecom will receive its debt payment, which could put the merger in jeopardy.

Portugal Telecom’s Brazilian partner said the Rioforte loan was inconsistent with “minimum standards of good corporate governance,” raising expectations that it will instead seek improved merger terms. Some Portugal Telecom directors have resigned.

Banco Espírito Santo did not respond to a request for comment. Rioforte said its management was not available for an interview.

What the Espírito Santos did is “take advantage of a bank to support weak industrial holdings,” said André Júdice Glória, a partner at Gama Glória, a law firm in Lisbon.

“This is a story of poor supervision in the Portuguese system,” Mr. Júdice Glória added. But given the lending and shareholding connections that the Espírito Santo group built up, “it’s possible that the collapse of one company forces the biggest corporate shake-up since the 1974 revolution.”

He was referring to the uprising that ended a military dictatorship and led to the nationalization of much of the economy, including companies owned by the Espírito Santos.

The turmoil raised Portugal’s borrowing costs last week, though there is also some optimism about a Portuguese economy that has returned to growth — even if the country is still struggling with high public debt and unemployment.

As a result, while Moody’s downgraded Banco Espírito Santo, it maintained its growth forecast and credit ratings for Portuguese sovereign debt, arguing that the bank’s problems were “unlikely to jeopardize Portugal’s improving fundamentals.”

The Portuguese government has cash buffers of at least €15 billion at its disposal, according to Moody’s, including €6.4 billion of unused international banking bailout money.

In May 2011, when Portugal negotiated its €78 billion bailout, its government and international creditors allocated as much as €12 billion to keep banks afloat. Banco Espírito Santo was the only significant bank not to tap into the bailout money.

In retrospect, “we’re talking about people who had a huge skeleton in their closet and did not ask for capital because they were probably doing everything possible not to open their accounts,” said Antonio Roldán, an analyst at the Eurasia Group in London.

Other analysts were taking the news in stride. Marino Marin, a managing director at MLV & Company, a boutique investment bank in New York, said, “When any financial sector modernizes, you have these kinds of situations.” He added, “At best or at worst, this is an isolated case and a Portuguese affair.”

Family control could decline further as creditors force them to divest themselves of assets, including equity used as collateral for loans. On Monday, one of the family companies said it cut its stake in Banco Espírito Santo to 20 percent from 25 percent, equivalent to the collateral negotiated for a loan from Nomura, the Japanese bank.

“Funding cost volatility is likely to remain for Portuguese banks until the Espírito Santo group situation is clarified and resolved,” Fitch, the credit rating agency, warned on Monday. “The impact on banks in the wider periphery should only be temporary, but it highlights the fragility of investor sentiment for the region and could raise funding costs.”