DBRS: BES’s Ratings Unchanged at BBBL After Sovereign Rating Action, Ratings Remain UR-Neg.

DBRS, Inc. (DBRS) has today commented that its ratings of Banco Espírito Santo, S.A. (BES or the Group) remain unchanged following the extension of DBRS’s review of the Portuguese sovereign rating. DBRS rates BES’s Senior Long-Term Debt & Deposits at BBB (low) and Short-Term Debt & Deposits at R-2 (middle). The ratings remain Under Review with Negative Implications, where they were placed on 24 May 2012, following DBRS’s similar action on the Republic of Portugal.

DBRS has recently announced the extension of its review on Portugal’s ratings given the unusually high degree of uncertainty regarding Portugal’s growth outlook, which is essential for debt stabilization. As a result, DBRS will wait for the conclusions of the EU-IMF 5th Program Review, which is expected in September 2012, and the 2013 budget proposal, which must be presented by October 15, 2012, prior to finalising its review. DBRS rates the Republic of Portugal at BBB (low). The Republic of Portugal’s long-term foreign and local currency ratings remain Under Review with Negative Implications, where they were placed on 22 May 2012.

DBRS views the higher systemic risks and challenging environment in Portugal as continuing to pressure the ratings of the Group. The economy remains weak, credit costs remain elevated and further deleveraging has the potential to pressure earnings, though this should have less of an impact than the aggressive deleveraging in 2011. Adding to the headwinds, access to market funding continues to be unavailable to Portuguese banks, pressured by heightened market concerns with the adequacy of liquidity and capitalisation of financial institutions, as well as the position of the Portuguese sovereign. These issues are likely to be exacerbated by the increased uncertainty about the prospects for the economy not only in Portugal, but more broadly in Europe. DBRS notes that potential negative rating action on the Portuguese sovereign would likely impact the ratings of BES.

With 2Q12 results, DBRS views BES as continuing to cope with the adverse environment. BES reported net income of EUR 25.5 million in 1H12, despite still elevated levels of provisioning. The Group generated enough net operating income, or income before provisions and taxes (IBPT), of EUR 632.0 million to absorb net provisions of EUR 426.3 million. This follows a net loss of EUR 108.8 million in 2011, which was driven by one-off items such as the partial transfer of BES’s pension fund liabilities to the Portuguese state and non-core international loan sales, and net income of EUR 556.8 million in 2010.

The advantages of the Group’s geographic diversification are evident in the solid contributions from its international businesses within the Strategic Triangle – Africa, Brazil and Spain. Combined, these three businesses generated EUR 63.7 million in net income in 1H12, contributing to 81% of BES’s international net income. These earnings helped to offset negative net income in BES’s domestic franchise of EUR 52.7 million in 1H12. With a much reduced contribution from domestic banking and investment banking, the importance of international operations as a proportion of consolidated profits has increased. Given the uncertainty around the Portuguese sovereign and weak growth prospects domestically, international expansion has become a crucial component of BES’s ability to generate positive earnings.

The Group continues to bolster capitalization levels without assistance from the Portuguese state. The Group successfully concluded a EUR 1 billion rights issue in 2Q12, helping BES to reach a Core Tier 1 ratio of 10.5% at June 2012, based on Bank of Portugal standards, and 9.9%, based on EBA requirements. BES met its regulatory requirements as of June 2012 and maintains a cushion above minimum regulatory requirements. DBRS also notes that the Group has improved its tangible equity / tangible assets ratio to 8.3% at 2Q12 from 7.1% at the end of 2011.

Notes:
All figures 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 DBRS's rating action on the Republic of Portugal, company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Roger Lister
Approver: Alan G. Reid
Initial Rating Date: 19 April 2011
Most Recent Rating Update: 24 May 2012

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