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Portugal’s largest listed bank is in trouble again. But markets are still flying high on cheap money
Usually markets have the memory of a well-trained gerbil, but last week something refreshed it. Banco Espírito Santo (BES), Portugal’s largest listed bank ran into some trouble. Since it is a bank and since it is in one of Europe’s peripheral countries, there were fears that the problems associated with previous bailouts were not over. There were some immediate repercussions. European markets dropped about 1.5%. A Spanish bank pulled its bond auction and the Greek government’s bond did not sell as well as hoped. But it was all over soon. Markets bounced back and forgot all about it. Perhaps they should have thought about it a bit more. The solvency of just one small bank in a small country is not important to the international financial system. But it represents something much larger.
The first issue is the bubble in some European bonds. For example, recently the yield on Irish bonds, a country that just exited a bailout and has a credit rating two levels above junk, is lower than the yield on US treasuries. Investors are basically ignoring any risks and putting money into anything that pays some yield. Portugal's bonds do not even have investment grade ratings, but pay only 3.46%, down from 6.04%. Portugal also just exited its international bailout two months ago without the protection of the EU line of credit. Its government debt to GDP ratio is one of the highest in the world at 130%. So a weak Portuguese bank set off some bad memories.
Fortunately Portugal itself was not exposed to the bank’s problems. BES was the only one of Portugal’s top banks that did not receive an injection of capital during the three-year bailout program. Portugal still has €6 billion of the €12 billion left from the program, but the Portuguese prime minister refused to put taxpayers on the hook for the bank’s problems. Portugal itself is actually doing much better. Its forecast growth of 1.2% is above the Euro-zone average and unemployment has dropped from a peak of 17.5% down to 14.3%.
The bank, BES, itself wasn't the problem either. It had €2.1 billion in reserves, above the regulatory minimum. The problem was what BES represents. BES is a part of a much larger family held firm. The bank is controlled by the firm, using a pyramid system of smaller and smaller companies toward the top of the pyramid that control larger companies near the bottom.
BES is controlled by Espírito Santo Financial Group, which holds a 25% stake in the bank. The bank was run by the head of the family Ricardo Espírito Santo Salgado. Mr. Salgado also ran the Espírito Santo Financial Group that had interests in a small bank in Panama, ES Bank (Panama) SA. Espírito Santo Financial Group was in turn controlled by a Luxemburg holding company, Espírito Santo International, through its main unit Rioforte Investments. Espírito Santo International holds other assets ranging from real estate and hotels in Portugal and Brazil in addition to its 49% stake in Espírito Santo Financial Group. There are other banks. Including Private Bank Espírito Santo, a Swiss bank and a smaller bank, BES Angola.
The Espírito Santo Empire has been around since 1869 when it opened as a currency exchange business. Mr. Salgado is the grandson of Ricardo Espírito Santo, who ran the bank and on the side served as financial advisor to António de Oliveira Salazar, Portugal’s dictator from 1932 to 1968.
For investors, the problem with the Espírito Santo family business is two fold. First, the various units are intertwined. They all lend to each other. There are not only loans, but many are guaranteed by other parts of the business. So a weakness in one part of the business quickly infects other parts. The second issue has to do with disclosure. Family businesses by their very nature tend to be private affairs. Outside investors are given the minimal amount of information required and no more. Nor are outside investors given any control.
So the troubles with BES started when disclosures of “serious accounting irregularities” and “an extremely negative” financial situation in Espírito Santo International surfaced earlier this year. Eventually Espírito Santo Financial Group, suspended trading in its shares and listed bonds. Finally on Saturday Espírito Santo International declared bankruptcy. In theory BES’s exposure to the rest of the family group is only € 1.1 billion, but it will take a long time to sort it out.
If EspíritoSanto businesses were unique it would end there, but it is not. Even in Spain one of the largest banks, the Santander group is family owned. Big family owned businesses with their own banks are common throughout Latin America and Asia. The regulators in developing countries are usually not as well funded or capable as their colleagues in Europe and the US. These conglomerates are also politically connected, with the power to rein in over zealous regulator attempting to examine aspects of the family business.
Worse, the tsunami of money unleashed by central banks has found its way into these banks. The banks have no doubt made some very interesting perhaps dubious loans to riskier family businesses.
Perhaps these issues could be covered up by rapid growth. But growth in Europe appears to have stalled. Italy with its enormous public debt, 133% of GDP, is forecast not to grow at all. Industrial production in the Eurozone slumped in May. The situation will not be made any better by the mess in Ukraine and the increased sanctions that are almost sure to follow.
Since last week markets have moved on. Neither lack of growth, questionable banks nor failed states and civil wars have dented the no fear attitude of markets still flying high on cheap money. But just because these problems can be ignored, does not mean that they are going away. They will just get worse waiting for that first rise in interest rates to get the attention they so richly deserve.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and speaks four languages.)
During the June quarter, the Mukesh Ambani-led company's net profit rose 13.7% to Rs5,957 crore while its turnover grew 7.2% to Rs1.08 lakh crore
Reliance Industries Ltd (RIL), India's largest private sector company, reported a 13.7% increase in its first quarter net profit on improved refining margins and higher prices.
For the quarter to end-June, RIL's net profit rose to Rs5,957 crore from Rs5,237 crore while its total turnover increased 7.2% to Rs1.08 lakh crore from Rs1.0 lakh crore same period a year ago.
Commenting on the results, Mukesh Ambani, chairman and managing director (CMD) of RIL said, “Despite weak regional refining margins and a planned turnaround in our refinery, RIL has delivered a record level of consolidated net profit this quarter. We have a great pipeline of new projects which will give Reliance an enduring competitive advantage. We are further expanding our retail business in existing markets, while exploring newer markets and channels.”
During the first quarter, RIL said its exports grew 16.8% to Rs66,600 crore, while gross refining margin (GRM) came at $8.7 per bbl, RIL said in a release.
As on 30 June 2014, RIL had a cash and cash equivalent of Rs81,559 crore in bank deposits, mutual funds, corporate deposits and government securities and bonds.
RIL shares closed Friday marginally down at Rs976.7 on the BSE, while the benchmark Sensex ended the week marginally higher at 25,641.