Catching falling knives – BES

The road to success is littered with stupid decisions. This post is about one of my stupid mistakes and the conclusions taken from it. A true investor won’t see the individual error as more than what it is, and it won’t either see it as a fluke and blame it on others or bad luck. Self-reliance is of greatest importance and shouldn’t be rejected when you feel like it.

By now the financial world knows the story of Banco Espirito Santo’s sudden fall, but as the picturesque historian that I am, I’ll retell it. At the end of the 19th century, José Espirito Santo e Silva started making business in lotteries and exchange houses. From 1884 forward he began creating and managing banking units. By the time of his death, BES as we know it wasn’t yet a reality. It merged with Banco Comercial de Lisboa in 1937 to form the Banco Espirito Santo e Comercial de Lisboa, which was afterwards shortened to Banco Espirito Santo. New tentacles came and they stretched to insurance through Tranquilidade, a company founded by Espirito Santo in 1935. During WW2, BES was able to profit from interest in Portugal’s tungsten, a rare metal used in weaponry.

Then came Revolução dos cravos in 1974 and BES was nationalized. What followed was a true testimony of a family’s ingrained establishment. Although its business was lost in Portugal, Espirito Santo went to Brazil, Switzerland and USA where it made business. When the climate was cooler in Portugal, they came back to start Banco Internacional de Crédito in 1986. Only 3 to 4 years later it recovered the insurance company Tranquilidade and the crown jewel BES. The road was paved to restart the family business in Portugal as nothing ever happened.

Then came 2008 great recession and the Espirito Santo’s businesses came under intense pressure. The family maintained its control of the bank through Espirito Santo Financial Group, which was based in Luxemburg, and they didn’t want to sell BES to tackle down debs. They went another way when ESFG and other family-owned companies borrowed from BES, at advantageous conditions for the Espirito Santo, not so much for BES’ shareholders. Then it all came tumbling down when it was known the magnitude of BES involvement with the family’s debt. Its stock was suspended multiple times during the days leading to it being shut off from the market.

And here comes the little investor who did everything right, except wait. Given that BES was already trading at around 0,8 book value before the crisis, then its subsequent fall to the neighborhood of 0,5€ from about 1,4€ was all the more safe. Like a sensible investor, I reasoned that BES’ bankruptcy was improbable (it was the second biggest lender in Portugal), and even if a bankruptcy happened then I felt safe enough that BES’ assets could be turned over to shareholders.

There were also political and regulator assurances to the public that BES was more than capitalized. Note to self: take every public assurance as useless.

BES stock graph

Actually, the exact opposite happened. BES was chopped off from its good assets (clients, deposits, physical offices, employees) and shareholders were left with the toxic ones (Angola unit, which was doing risky lending, ESFG and family owned companies’ debt).

What was my mistake? Although I made sure of having a margin of safety, I should have waited to know how much toxic debt was BES liable for. No investment decision will ever be completely backed by crystal clear information and it is an investor’s job to seek as much information as possible, given that an unturned rock might hide the snake.

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