Banco Espírito Santo, the Portuguese bank, has become the top concern for international investors in recent days. The Portuguese stock exchange has taken a big hit and other European equity markets have also suffered, reviving worries about the health of the European banking sector.

The bank’s name translates as “bank of the holy spirit,” of all things. And as the uncertainty spreads, the question is what we are up against here. Is this just a slip of the halo that can be readjusted by some prompt correcting action from the authorities? Or is this the ghost of old concerns about the European banking sector returning to haunt us?

Espírito Santo is the largest Portuguese banks by assets. Its problems are partly attributable to the damaged reputation of its main shareholder, Espírito Santo Financial Group (ESFG), which owns 25% of the bank and is controlled by the Espírito Santo banking dynasty. Other shareholders of the bank include Crédit Agricole (14.6%), Silchester (4.7%), BalckRock (4.65%), CRM (4.2%) and Bradport (3.9%).

On Wednesday, ESFG bonds were cut to junk status by ratings agency Moody’s after failing to meet certain debt payments. Having long enjoyed a good reputation, it turns the group into something of a fallen angel.

The family who fell to Earth

After being nationalised in 1974 as part of the Portuguese social revolution, the Espírito Santo family regained control of the bank in 2000. They extended its activity to other countries including Spain, Brazil, Mozambique and Angola. Importantly, the bank survived the difficult last few years in the Portuguese economy and banking sector without requiring state aid. Its financial situation looked relatively safe as it increased capital by €3.3bn (£2.6bn) over the last three years.

The main problems at ESFG have apparently come from the private investments of the family group in countries like Angola, where latent losses of around €5.7bn have recently been uncovered. Related to these accounting holes, an audit of Espírito Santo International, a Luxembourg-based non-listed holding company that owns 49% of EFSG, detected other non-disclosed losses amounting €1.3bn.

The growing mess of ESFG’s investments culminated last month in the announcement that the Espírito Santo family would step back from managing the bank. This was triggered by internal fights within the family group, which will see Ricardo Espírito Santo Salgado step down as executive chairman of the bank at the end of this month once a new board is elected.

Yet this change in leadership has not prevented the bank from the turmoil of the last couple of weeks. The paradox is that bank coped with the severe macroeconomic environment in Portugal during the European sovereign debt crisis, but has lost momentum more recently. Profits fell from €96m in 2012 to a loss of €518m in 2013. This would suggest that Espírito Santo has not been a victim of the crisis but a victim of some more recent bad managerial decisions.

A jittery Europe

Then there is the wider context: the remaining doubts surrounding the health of the European banking sector ahead of the next comprehensive assessment of the European Central Bank (ECB) in November. Banco Espírito Santo is one of four Portuguese banks that will be subject to such scrutiny, and the Portuguese central bank has tried to calm investors by stating that Espírito Santo is solvent.

But it would not be the first time that a situation apparently under control rapidly ends up in a forensic analysis and, ultimately, a bank bail-out. What investors seem to assume is that some form of bailout is likely to happen soon. The early estimates are that €2bn-€3bn more in aid for Portugal will be required to cover the equity shortfall of the bank – only weeks after Portugal became the second country after Ireland to exit its €78bn European bailout.

Overall, this situation has uncovered the fragility of the European markets after the impressive rally maintained over the first half of 2014. One of the main concerns before that rally took place was the uncertainty surrounding the true solvency of many European banks.

Some supervisors in Europe have made an effort to undertake augmented transparency exercises on the banks and make forward-looking estimates of the resilience of financial institutions to adverse shocks. But the renewed lack of confidence will stay at least until the comprehensive analysis and stress tests of the banks' balance sheets are completed and the necessary actions are announced by any banks showing capital shortfalls.

In the end, uncertainty is bad no matter the source. Whether it is a falling angel, a family mess or a potentially deeper equity hole, market concerns about some European banks may be back. Assuming that the ECB makes the right moves in relation to the bank in the coming days, the best scenario would be that the travails of the Espírito Santo turn out to be the last episode of negative bank surprises before November.

Author

1. 

   Santiago Carbo-Valverde

   Professor of Economics and Finance at Bangor University