Fisher Investments Editorial Staff

The PIIGS Who Cried Wolf?

By, 07/11/2014
Ratings593.652542

Peripheral eurozone markets sold off Thursday after Portugal’s second-largest bank experienced a tumultuous few days. After falling around 32% for the week and dragging Portuguese stocks down around 10% with it, Banco Espírito Santo’s stock was suspended. As markets fell, a Spanish bank delayed a bond auction, Greek sovereign debt sold poorly, and an Italian pharma firm cancelled its IPO. Cue the inevitable media alarm: The eurozone crisis’s next phase was here! In our view, though, that interpretation is a tad hasty and quite overwrought—there is no evidence Banco Espírito Santo’s troubles are in any way a result of or catalyst for Spanish, Greek, Italian or eurozone-wide market issues. There is even little reason to believe the bank’s solvency is truly in question. Seems to us markets temporarily overreacted to a corporate governance issue, demonstrating how skepticism remains in the eurozone.

Banco Espírito Santo’s current troubles aren’t exactly its own—this isn’t a case of an overextended eurozone bank teetering on the brink. The problems lie with its parent company, Espírito Santo International SA—a privately held conglomerate regulators have been eyeing for its lack of transparency and questionable management decisions, including fundraising by selling debt through its own investment funds. Not an illegal move, but widely considered iffy and not so wonderful for its investors. So when Espírito Santo International missed a payment on some commercial paper on Wednesday, investors started fleeing. Banco Espírito Santo especially came under fire as Espírito Santo International is a major shareholder of Espírito Santo Financial Group, which owns about a quarter of Banco Espírito Santo. It’s all in the família—literally. This is a family-run conglomerate, with cross-shareholdings typical of the Korean chaebol. Corporate governance issues are fairly common under this structure.

This structure seems to be the primary source of investors’ angst with Banco Espírito Santo. Investors tend to like clear insight into the finances of a bank’s major shareholders, and the parent company’s ongoing accounting issues make it clear there is a lack of transparency. That also drove fears over the bank’s funding—investors didn’t know how much exposure the bank had to its parent company’s commercial paper and whether it would still meet regulatory capital requirements after taking losses (if need be). There was also the broader, scarier question of whether the bank could stay well-funded if the parent company went under (a big if, but one investors will logically consider). Questions on funding and solvency have a way of triggering bank runs, though in this case, with a buyer on the other side of every sale of the bank’s shares, we wouldn’t technically call this a run, per se. Fundamentally, though, the bank seems well-equipped to contain the damage. Espríto Santo Financial Group set aside €700 million in case of emergencies like this. And Friday, Banco Espírito Santo released information about its exposure to Espírito Santo International: about €1.6 billion in assets, which could easily be covered by the €2.1 billion in capital it keeps in excess of regulatory requirements.

In short, this isn’t a bank solvency issue. Nor does it signal deep problems in Portugal’s wider banking system. It’s just sort of what happens when a privately held holding company without disclosure requirements tries to get creative. Sometimes you get misfires, and in this case, Banco Espírito Santo was collateral damage.

Yet markets reacted as if it was the start of the next phase in the eurozone debt crisis, sparking renewed eurozone crisis media frenzy. But that seems a bridge (or three) too far, in our view. Sometimes markets just overreact. Investors get fearful, assume the worst and don’t take time to weigh the facts before they act. That’s volatility: markets’ occasional, short-term irrationality.

In our view, nothing about Banco Espírito Santo’s troubles contravenes Portugal’s—or the peripheral eurozone’s—long-term progress. One conglomerate’s shady corporate governance just isn’t a bellwether for an entire country or region. Some claim the market’s broader reaction is a wake-up call, evidence Portugal’s stock and bond markets have overlooked risk in recent months or the country left its bailout too soon—alleging its long downward trajectory in yields is a farce. But to us, that overlooks all of Portugal’s progress: Its economy is growing (albeit shakily), and public finances are in far better shape than three years ago. It has a host of other positives going for it, too, as structural reforms start taking effect—all more important than a single stock’s suspension.

Other market-related events in the eurozone Thursday seem part of the same emotion-driven overreaction. True, a Spanish bank delayed a bond offering, citing “difficult market conditions.” Greece saw soft demand for its bond offering, and an Italian drug maker failed to get sufficient funding for an IPO. But none of those are especially surprising or suggestive of regional insolvency—it seems more like companies and sovereigns trying to get the most bang for their buck. Why sell bonds or new stock to the public if you know you’ll get a lower price—and less funding—for reasons unrelated to you? Spain’s Banco Popular apparently understood this when it pulled its offering. And Greece—though its April return to the bond market beat expectations—is still in rocky territory and has every incentive to issue bonds under only the most favorable market conditions. Cancelling the auction outright might have sparked a wider panic, so simply issuing fewer bonds makes sense. The Italian IPO is equally unrelated—this was the second time Rottapharm Madaus failed to get its desired funding (suggesting the real problem is how the stock is priced).

Markets are markets. Sometimes they overreact. We wouldn’t read much into any of this. That said, investors’ being so quick to look for signs of the next crisis suggests skepticism is alive and well in the eurozone. Overall, the region appears poised to keep inching toward improvement, likely surprising those determined to spot PIIGS crisis 2.0 to the upside. It might not be the best-performing or fastest-growing place in the world, but in our view, now is not the time for a crisis mentality.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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