The Canadian Press - ONLINE EDITION

Fears over fate of major Portuguese financial group reignite euro market tensions

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LISBON, Portugal - The spectre of Europe's financial crisis is back to haunt investors.

Worries over the health of Portugal's biggest bank on Thursday raised fears that the country might run into financial trouble again — just weeks after emerging from a bailout — and trigger a flare-up in the market crisis Europe thought it had quelled.

Stocks and bonds fell in Europe and the U.S. while the price of gold rallied as traders sought it out as a safe investment.

The tensions centre on Espirito Santo International, a holding company that is the largest shareholder in a group of Espirito Santo family companies, including the parent of Portugal's largest bank, Banco Espirito Santo. Espirito Santo International reportedly missed a debt payment this week and was cited for accounting irregularities — the sort of shenanigans that helped cause Europe's debt crisis four years ago.

Portugal is one of the smaller eurozone economies and, like Greece and Ireland, needed an international rescue in 2011 during the continent's debt crisis. A three-year economic recovery program was supposed to straighten out its finances. Difficulties at Banco Espirito Santo have triggered fears there may still be some unexploded bombs.

The International Monetary Fund, which provided funds for the Portuguese bailout, acknowledged in a statement that "pockets of vulnerability remain" in Portugal but declined to comment specifically on the case.

Trading in Banco Espirito Santo stock was suspended after a fall of more than 17 per cent, which dragged the Lisbon stock market down by 4.2 per cent. The yield on Portugal's benchmark 10-year bonds rose by 0.21 percentage points to 3.97 per cent. The Dow Jones Industrial average slid 0.4 per cent while Germany's DAX fell 1.5 per cent. Italy and Spain saw sharper drops of 2 per cent.

Part of what is spooking investors is that the size of the problem remains unclear and there is potential for the trouble to spread to other companies.

An audit in May found "serious" accounting irregularities at Espirito Santo International, which this week reportedly delayed a short-term debt payment to clients. Because Espirito Santo International has important stakes in a network of the group's companies, its financial trouble could weigh on the others.

One of the subsidiaries, Espirito Santo Financial Group S.A., is the major shareholder in Banco Espirito Santo and was downgraded Wednesday by Moody's by three notches. The ratings agency expressed concern about "the lack of transparency" and the extent of links between the group's companies.

The Portuguese government insists Banco Espirito Santo is solid and the drop in its stock prices merely reflects trouble at the parent company.

But investors have heard such reassurances in Europe before, only for banks to go bust and require the sort of huge rescue loans that can bankrupt small countries like Portugal.

Analysts say that without more information about the size of the financial problem in the Espirito Santo group, investors became cautious.

That was reflected in early trading in the U.S., where the Dow dropped as much as 180 points 20 minutes after the opening bell. The blue-chip index went on the recover most of that loss and ended the day down 70.54 points, or 0.4 per cent, at 16,915.07. But buyers focused on stocks that are considered safer, such as utilities and telecoms.

The Standard & Poor's 500 index finished lower by 8.15 points, or 0.4 per cent, at 1,964.88 and the Nasdaq composite fell 22.83 points, or 0.5 per cent, to 4,396.20.

The sharp reaction in markets is also partly due to the fact that many stock indexes have hit records recently, leaving investors fearful of a big retreat. The prospect of a flare-up in Europe's financial troubles seemed enough to set off those fears.

"With Portugal looking to be in trouble once again, prudent analysis has been thrown out of the window in preference to a knee-jerk reaction," said Chris Beauchamp, market analyst at IG.

Portugal became the third eurozone country after Greece and Ireland to require a financial rescue when it got a 78 billion-euro ($106 billion) bailout in 2011. In return, the government has enacted tough austerity measures, such as cutting spending and reforming the economy.

Europe's debt crisis contributed to the U.S. stock market's last correction — a decline of 10 per cent or more — in 2011. Concerns that the crisis was spreading helped push the S&P 500 index down 19.4 per cent between April 29 and Oct. 3 of that year. Stocks also fell after the U.S. credit rating was cut.

Portugal's efforts in recent years to get its public finances in shape have helped it regain the trust of investors. That was apparent in the fall in interest rates the country pays on its borrowings. As a result, Portugal concluded its three-year international bailout program in May, and the government has since been able to raise money in the markets.

Thursday's rise in the country's bond yields is still small compared with the increases it saw during the crisis. In fact, its borrowing rates are near record lows, having dropped for months as Europe's financial crisis eased.

How markets react in coming days as more information about the Portuguese firm's problems is unveiled will be watched closely.

Shareholders in Banco Espirito Santo include France's Credit Agricole, Brazil's Banco Bradesco and Portugal Telecom. The Espirito Santo family owns 25 per cent through Espirito Santo Financial Group.

The group of companies grew out of a banking dynasty dating back to the 19th century. It also owns Portuguese and international interests in industries such as tourism and private health care.

Portuguese banks recorded heavy losses during Portugal's bailout but passed the so-called European "stress tests" meant to assess whether they were sound.

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