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Espirito Santo woes spill over to Angolan banking unit

* Angola central bank says BES's Angola unit needs capital increase

* Says unit needs capital to address 'bad' credit operations

* Portugal central bank says private investors could help BES (Recasts with BES Angola disclosure; adds comment from market regulator, bankers)

By Shrikesh Laxmidas and Andrei Khalip

LISBON, July 18 (Reuters) - Financial problems at Portugal's Espirito Santo business empire spilled further across national borders on Friday, with Angola's central bank saying the local division of Banco Espirito Santo would need a capital increase to deal with bad loans.

Banco Espirito Santo (BES), Portugal's largest-listed lender, is under scrutiny from investors and regulators after disclosures of financial irregularities at companies owned by the Espirito Santo family, the bank's largest shareholder, which have raised the possibility of destabilising losses at the bank, too.

Investors are watching potential liabilities at BES's 12-year-old Angolan unit as a fault line in an escalating affair that has already roiled global markets and forced Portugal's biggest telecoms firm to reduce its role in a planned merger with a Brazilian rival.

Banco Nacional de Angola Governor Jose de Lima Massano broke his government's silence on the matter, saying the BESA Angolan subsidiary had problems with its credit portfolio.

"We have operations in an irregular state, so 'bad' credit operations," Massano said in Thursday statements to the Angolan parliament, which were emailed to Reuters on Friday.

He did not give further details on the type or extent of the bad credit.

Massano said the problems at BESA - which is majority owned by BES and is one of the most active lenders in Africa's second-largest oil producer - would not pose a threat to Angola's overall financial system.

"What is not at stake is either the guarantee of the deposits made with BESA, nor the responsibilities which this bank has with third parties, and much less the stability of our financial system," Massano said.

The government of Angola, a former Portuguese colony, in December guaranteed 4.2 billion euros, or 70 percent of the loan portfolio of BESA, which has links to the ruling elite and family of President Jose Eduardo dos Santos.

However, the guarantee lasts only until mid 2015, and some investors have expressed concern that it could be diluted by Angola's poor credit rating. Portugal's central bank says it is sure BESA would honour its commitments, but Luanda has not commented on the state guarantee.

Analysts say the Angolan state and state-linked companies are most likely to take a larger stake in BES Angola as BES has no capacity to subscribe to any capital increase.

Angola's disclosure comes as Portugal's establishment is trying to assure investors that problems with the Espirito Santo family empire - where at least two holding companies are suffering financial difficulties, imminent bankruptcy proceedings and restructurings - will not have a bearing on the southern European country's financial stability.

Earlier on Friday, the Bank of Portugal reiterated that BES, which raised capital in May, has sufficient capital reserves to make up for any losses and added that the lender would be able to tap private investors should it need a further boost.

"Preliminary contact between BES and international investment banks, as well as interest shown by various entities, investment funds and European banks show that it is very probable that there could be a private solution to reinforcing capital," central bank governor Carlos Costa told a parliamentary committee.

And Portugal's stock market regulator said the exposure of all foreign and local investors registered in Portugal to BES, its units, and the Espirito Santo family companies was minimal - 257 million euros - compared with the 13 billion euros managed by funds registered in the country.

Investors seemed to agree that BES could be a buying opportunity. One banker who has worked with BES said there was a lot of interest in the Portuguese bank.

"This isn't a clean situation by any stretch. But we haven't had any complaints from investors (in the May rights issue).

"Everyone wants a piece of this. A lot of people are fishing around," he said.

Another banker said investors still believed in the broader recovery story of Portugal, which last spring emerged from the international bailout it took during the euro zone debt crisis.


Still, the Espirito Santo clan's troubles have had a major trickle-down effect since they broke into the open. In May, BES told investors that independent auditors had found "irregularities" at Espirito Santo International, or ESI, the holding company at the top of the Portuguese clan's business empire.

It said the problems had left ESI in a "serious financial situation" and that this would trigger "reputational risk" for BES. ESI owns a nearly 50 percent stake in another company, Espirito Santo Financial Group, or ESFG, which in turn owns a 20.1 percent stake in BES.

The potential losses at BES, which has identified its direct exposure to family holdings at 1.15 billion euros, prompted investor panic in equity markets across the world earlier this month.

The bank has said it has 2.1 billion euros in capital above minimum regulatory requirements to deal with any losses. But it has not been able to quantify the potential losses, because it is awaiting a restructuring of the Espirito Santo holding companies to do so. BES shares reversed losses of more than 3 percent to end up 0.24 percent at 0.42 euro after Costa's remarks, but have lost about 60 percent in a month.

Portuguese prosecutors said on Friday they were investigating the family's web of businesses, and a group of investors are preparing to file a lawsuit over the unpaid debt of one of its companies.

Portugal Telecom has also been caught up in the Espirito Santo woes. Earlier this week, the company said another family company, a conglomerate called Rioforte that is 100 percent owned by ESI, had not paid back a 900 million euro loan. The non-payment forced Portugal Telecom to cut back its stake in a planned merger with Brazilian rival OI, and its shares have plummeted to all time lows. Its shares lost 1.76 percent on Friday, and are down about 40 percent since mid June.

Portuguese Telecom executives are now under fire for making the loan in the first place. People familiar with the talks that led to the loan said PT executives knew the Espirito Santo family had financial problems when the telecom firm lent them the money in April.

Rioforte, a Luxembourg-based conglomerate, is expected to file for bankruptcy, according to people with direct knowledge of the situation.

PT also faces a lawsuit by several minority investors, expected to be filed on Friday, over its alleged failure to properly gauge the risks of the debt.

"The executive board had to observe the correct distribution of risks, a precaution that they failed to take, which resulted in a suicidal exposure," Octavio Viana, the head of investor association ATM and a representative of the shareholders, told Reuters.

Portugal Telecom has declined to say why it invested so much of its liquidity in one firm's commercial paper. Its merger partner Oi has sharply criticised the Lisbon-based group for not disclosing the loan earlier. Oi's representatives quit the Portugal Telecom board when told of the debt.

(Reporting by Andrei Khalip, Shrikesh Laxmidas, Sergio Goncalves and Freya Berry; Writing by Alessandra Galloni; Editing by Will Waterman)