By Andrei Khalip
LISBON (Reuters) - Two of the big three ratings agencies slashed their credit marks for Portugal's Banco Espirito Santo (LS:BES) and its biggest shareholder on Thursday, warning of an impact on their solvency from the founding family's growing financial problems.
Standard & Poor's cut two notches from its long-term rating - to high-risk "B-" - for BES, following Tuesday's failure by the Espirito Santo family's Rioforte holding company to repay 847 million euros in debt to Portugal Telecom (LS:PTC), which forced the telecom firm to take a cut in its stake of a merger with Brazil's Oi.
S&P said its action reflected "our assessment that BES' capital position has weakened as a result of the higher losses that, according to our expectations, it is likely to face given its direct exposure to the Espirito Santo Financial Group (ESFG), to its subsidiaries, and to Rioforte."
Sources have told Reuters that Rioforte is preparing to file for creditor protection in Luxembourg, where it is registered.
Moody's rating agency - which last week cut BES by three notches to "B3" - downgraded Espirito Santo Financial Group (LS:ESF) by two notches to "Ca", citing "the heightened risk of default for the group, combined with the potential for significant losses for bondholders."
It also said ESFG's financial flexibility was becoming increasingly limited, evidenced by Monday's fire sale of a 4.99 percent stake in BES at a big discount.
Although the Espirito Santo family no longer controls the bank, ESFG is still the largest single shareholder in BES with a 20 percent stake.
BES shares sank 9.9 percent to 0.41 euros by 1106 GMT (12:06 p.m. BST), just above its all-time low of 0.36 euros hit on Tuesday.
"The rating cut is another blow in what has been a very negative news flow about the group, which stokes the uncertainty in the market, not allowing BES to have two straight sessions of gains," said Jose Novo, a trader at Orey iTrade brokers.
Reflecting widespread fear among investors that BES's problems are still far from clear, he added: "The difficulties of the group need to be spelled out."
"SERIOUS SITUATION"
Concerns surrounding the Espirito Santo banking clan, which founded BES more than a century ago, were sparked by an audit of a family holding company that owns Rioforte which found a "serious financial situation" there.
Those jitters spread last week to Europe and beyond, raising new concerns about Portugal generally only two months after it exited an international bailout deal.
The problems at BES initially pushed Portugal's bond yields higher, but in the past few days those yields have fallen again - to 3.70 percent on Wednesday after Tuesday's 3.76 percent.
The BES rating remains on S&P's Creditwatch and could be downgraded again. S&P said it saw "an increased likelihood" of a negative impact on its assessment of BES' solvency, given the magnitude of BES' exposure to these companies.
It said "potential new impairments associated with BES' direct exposure to the ESFG group entities and Rioforte could be of a magnitude at least offsetting the benefit from BES' recently completed capital increase."
BES raised 1.04 billion euros in a capital increase in May-June. It first reported unspecified "material irregularities" at Rioforte's parent company Espirito Santo International in the capital hike prospectus in late May.
Later on Thursday, financa minister Maria Luis Albuquerque will speak to a parliament committee about BES' situation. The government has said the bank is well-capitalised and does not require state aid, but there are still many unanswered questions on its total exposure to the family's troubled companies.
BES's problems wiped out 57 percent of its value in the past month, despite a 20 percent surge on Wednesday that analysts attributed to bargain-hunting and reports the bank's new CEO may bring in new shareholders to reinforce the bank's capital.
Bank of Portugal chief Carlos Costa has also said that although he sees no need for a capital increase at BES, if any additional capital were needed there are shareholders interested in taking part in a BES capital increase.
(Reporting By Andrei Khalip and Filipa Lima; Editing by Sophie Walker)