DBRS: Millennium bcp Ratings Unchanged After 2011 Results; Intrinsic Assessment Lowered to BBB (low)

DBRS, Inc. (DBRS) has today commented that its ratings of Banco Comercial Português, S.A. (Millennium bcp or BCP, or the Group) remain unchanged after the Group’s 2011 results announcement. DBRS rates the Group’s Senior Long-Term Debt & Deposit at BBB (low) and Short-Term Debt & Deposit at R-2 (mid). The trend on all ratings is Negative. These ratings were downgraded on 31 January 2012 following DBRS’s downgrade of the Republic of Portugal to BBB (low) with a Negative trend.

Following the Group’s 4Q11 results announcement, DBRS is lowering Millennium bcp’s intrinsic assessment (IA) to BBB (low) from BBB. DBRS views the substantial stress in the domestic economy and disrupted financial markets within the Euro zone, which continue to exacerbate the funding and liquidity pressures, as significantly pressuring the Group’s earnings through higher funding costs, the rising cost of credit risk, and the negative impact of deleveraging. Adding to the stress and need for further deleveraging, the Group faces additional capital demands by June 2012, given the new EBA capital requirements that include a sovereign-related capital buffer, which results in BCP needing to bolster capital levels during a time of unprecedented stress in the markets. While BCP continues to adjust to the difficult environment and is benefiting from its international business earnings, DBRS has reflected in the lowering of the IA the weakening in its domestic earnings power, its very constrained access to funding and increased likelihood of rising credit impairments. DBRS maintains its SA-2 support assessment for BCP, which indicates an expectation of timely systemic support in case of need. However, given the sovereign rating of BBB (low), this does not bring any uplift for BCP’s final rating from its IA.

Supporting its IA of BBB (low), BCP has demonstrated its ability to adjust in various ways to the adverse environment. The Group has been fairly successful at maintaining its revenues throughout this prolonged crisis, supported by BCP’s sizeable international presence that has offset weakness domestically. BCP has also been successful at controlling expenses, building up liquid resources and improving its regulatory capital levels. To bolster its regulatory capital, the Group has utilised various resources, including a scrip dividend, debt-for-equity exchanges and a rights issue, in order to boost its core Tier 1 capital ratio from 6.7% at the end of 2010 to 9.4% at the end of 2011. While DBRS views BCP as taking steps to appropriately meet regulatory requirements, these actions have utilised some of BCP’s contingency resources, leaving it with fewer alternatives to boost capital levels to meet more stringent regulatory requirements. DBRS notes that the Group does have high quality assets which can be sold if needed, albeit at depressed prices. DBRS views Millennium bcp’s subsidiary in Poland as an example of a contingency resource that could be sold. While regulatory capital ratios have been improved, the Group’s equity capital base has declined with increased negative fair value and other reserves, as well as the net loss in 2011. DBRS views tangible equity to tangible assets of 4.5% at year-end 2011 as much deteriorated from the same ratio of 6.9% at year-end 2010, prior to restatement.

DBRS notes that in 2011 the Group reported its first annual loss since its incorporation in 1985, despite positive net income in 1Q11 and 2Q11. Driving this net loss of EUR 786.2 million was the partial transfer of BCP’s pension fund liabilities to the Portuguese state (-EUR 117 million, after tax), impairments related to the Special Inspection Programme (SIP) (-EUR 271 million, after tax), writedowns on Portuguese and Greek debt (-EUR 437 million, after tax), and a goodwill writedown related to Greece (-EUR 147 million). Excluding these items, BCP would have reported positive net income of EUR 186 million in 2011. DBRS notes that this transfer of BCP’s pension fund liabilities will negatively affect core capital in 1H12 further pressuring the Group’s regulatory ratios in a time of stress. BCP’s domestic revenues are supported by its significant nationwide franchise with strength in corporate and mortgage lending, enabling Millennium bcp to defend its margins. The advantages of the Group’s geographic diversification were evident in the positive net income of EUR 123 million generated in BCP’s international businesses, with the international components of its core franchises – Poland, Mozambique and Angola – contributing EUR 236 million in net income before minority interests. DBRS views BCP’s success in building out its international franchises as supporting the Group’s intrinsic strength, given that the contribution is helping to compensate for the pressure on its domestic businesses. At the same time, DBRS views non-core franchises, such as Greece and Romania, as negatively pressuring the Group’s risk profile during this sustained period of stress.

With the Portuguese economy weakening, deteriorating credit quality is taking its toll on the Group’s results. Provisions of EUR 1.3 billion in 2011 were up 87% YoY and significantly exceeded net operating income of EUR 935 million. In 2Q11, BCP reinforced provisions with an additional charge based on expected asset quality deterioration and, in 4Q11, the Group boosted provisions based on the results of the SIP inspection. DBRS views elevated credit costs as absorbing a substantial portion of recurring earnings and reducing significantly the resources to grow capital through retained earnings. Given the outlook for the economy, a reduction in provisioning does not appear likely in the near-term. BCP’s ratio of overdue loans by more than 90 days is trending upward, reaching 4.5% at the end of 2011. Given the current macroeconomic outlook for Portugal, further asset quality deterioration is likely.

DBRS views BCP as appropriately reducing wholesale funding needs through its deleverage plan, which has helped the Group to reduce its loan-to-deposit ratio to 145% at year-end 2011, down from 164% a year ago. Despite reducing its commercial gap significantly, BCP remains reliant on wholesale funding. With no access to the wholesale markets, BCP’s usage of the ECB as its primary source of funding remains elevated at EUR 12.7 billion at year-end 2011, or 13.6% of total assets, though this is down from EUR 15.3 billion at 3Q11. At the end of 2011, the Group had approximately EUR 3.6 billion of collateral available to pledge for central bank funding, which enabled the Group to refinance EUR 3.0 billion of debt in early 2012, leaving only EUR 0.9 billion of debt to be refinanced later in the year. While DBRS views the Group as taking the appropriate steps to maintain a comfortable liquidity buffer, continued inability to access the wholesale markets negatively pressures the Group’s funding and liquidity profile and adds negative pressure on Millennium bcp’s intrinsic strength.

Notes:
All figures are in Euros (EUR) unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents, DBRS’s rating for the Republic of Portugal, and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This commentary was disclosed to the issuer and no amendments were made following that disclosure.

This credit rating has been issued outside the European Union (EU) and may be used for regulatory purposes by financial institutions in the EU.

Lead Analyst: Roger Lister
Approver: Alan G. Reid
Initial Rating Date: 10 June 2011
Most Recent Rating Update: 31 January 2012

For additional information on this rating, please refer to the linking document under Related Research.