BES was in focus in the FIG market this (Tuesday) morning on the back of concerns over the health of the bank’s parent, but market participants played down the implications for Portuguese covered bonds as the bank’s equity and other debt have taken the brunt of the worries.

Concerns have been mounting about the corporate governance of Banco Espírito Santo (BES) and the financial health of its parent, Espírito Santo International, the main shareholder in Espírito Santo Financial Group, BES’s holding company, with the Portuguese financial regulator yesterday (Monday) announcing a temporary ban on the naked short selling of BES shares.

Syndicate bankers this morning said that the market was focussed on the situation at BES, with the worries mainly affecting the bank’s share price, and senior unsecured and subordinated debt. Tier 2 instruments widened by around three points yesterday and another three this morning before recovering somewhat, while BES’s subordinated CDS is at 520, way off lows of 200, said one. Portuguese government bond yields are also said to have come under pressure. According to a trader there has not been any sell-off in Portuguese covered bonds, with only some offers in Santander Totta issues affected by widening of government bond yields yesterday.

Market participants said that the market movements in BES stem from idiosyncractic problems at the institution and that other Portuguese banks have not been heavily affected. According to one syndicate official, however, Banco Comercial Português subordinated CDS was at one point this morning 25bp wider versus yesterday, compared with 50bp wider in the case of BES.

BES has one benchmark covered bond outstanding, according to market participants, a February 2015 issue that they said is some 20bp wider. However, they added the caveat that the bonds are illiquid and are not actively traded, and said that covered bond spreads of other Portuguese banks have not been adversely affected.

“So far we are not aware of negative developments in entities apart from BES, at least in covered bonds,” said Agustín Martin, head of European credit research and covered bonds at BBVA. “All the movements are being played out through the senior and lower Tier 2 debt in BES.

“The problems are at the holding company and industrial conglomerate level and not at the bank, so unless something really dramatic happens at BES and it becomes a systemic issue I don’t see Portuguese covered bonds suffering.”

Investors have taken a more positive view on Portuguese banks following the resolution of the treatment of deferred tax assets, which has strengthened their capital ratios, he added.

Problems idiosyncratic

A syndicate official said that although the developments surrounding BES are specific to the institution and do not fundamentally undermine the validity of the peripheral compression trade, they nonetheless serve as a reminder about the risks involved in pursuing the latter.

“It flags to investors that the stuff they have been chasing for a while is high yielding for a reason, and that there’s an element of risk involved, so you have to be careful and do your homework on the individual names,” he said.

Although there has not been much or any mention of peripheral covered bond supply in the near term in any case, the syndicate official said that the BES situation is reason for a “pause for breath” and would have given any issuer considering tapping the market cause to be nervous.

BES covered bonds are on review for possible downgrade at Moody’s, which rates the obrigações hipotecarias Baa2, after the rating agency placed the issuer, rated Ba3, on review for downgrade because of corporate governance shortcomings.

Bank of America Merrill Lynch covered bond analysts said that BES is likely to remain under pressure – “our credit bank analysts don’t like what they are reading”- but said that the quality of the cover pool should help support the covered bond rating, which could nonetheless fall to below investment grade in the case of severe stress at the bank level.

“We thus believe that it is better to switch to names such as Catalunya Banc and Caja Rurales Unidas, which appear more attractive on recent news,” said the covered bond analysts.