Worst Case In the Price - We estimate that BES shares are trading on 0.6x P/'14 BV for 7.3% sustainable ROE pro-forma for: the bank's full exposure to the Espirito Santo (ES) companies before any guarantees; 50% of the non-guaranteed exposure to BES Angola; and the full amount of BES' retail clients' exposure to debt issued by the ES companies. This scenario does not include €1.7bn of guarantees and potential collateral but includes €4.2bn of guarantees by the Angolan state on BES Angola's loan book. At current share levels we thus believe that the worst is more than priced in and reiterate our Buy/High Risk rating on BES shares.
What BES Disclosed - The bank's direct exposure to the ES companies is €980m, of which €200m guaranteed exposure to Rio Forte and €780m to ESFG (potentially covered by ESFG assets including the 25% stake in BES). Retail clients have €651m of exposure to debt of ES companies (down from €2.1bn at end-2013) and institutional clients have €1.9bn (up from €1.5bn at end-2013). The former are guaranteed by ESFG but the latter are not. In Angola, where BES owns 55% of BES Angola, 70% of the €6bn loan book is guaranteed by the state (specific guarantee, not portfolio). The Angolan portfolio will be part of the AQR exercise and the guarantee has been accepted by the ECB.
Maximum Losses of €4.3bn - Assuming that BES needs to absorb all of its own and its clients' exposures to the ES companies as well as half of the non-guaranteed Angolan exposures, the maximum loss would amount to €4.3bn. This would push the 2014E B3 CET1 ratio down from 10.7% (pro-forma for the recent €1.1bn capital raise) to 3.1%. To regain a 10% CET1 ratio, the bank would need to raise an additional €4bn. Pro-forma for such a capital raise and losses, BES would be trading on 0.6x P/'14E BV for 7.3% sustainable ROE.
ES Company Structure & Restructuring Plans - ESI is the main holding company of the Espirito Santo family, housing its financial and non-financial company assets. ESI owns 100% of Rio Forte, which in turn owns 49% of ESFG, which owns 25% of BES. The ES companies are expected to announce a restructuring plan in the coming days, which could include reinforcement of the capital base and/or asset sales. The Bank of Portugal is also in the process of reviewing a new governance structure for the family's shareholding in BES as well as the family's recent proposal for a new management team and new board members (a BES shareholders' meeting has been scheduled for 31 July). Should the ES family be required to sell down its stake in BES, the shares may come under technical pressure. But today the regulator banned naked short sales of BES shares, which should alleviate the pressure somewhat.
