DBRS: BES’s Ratings Confirmed at BBB (low), Negative Trend, After Sovereign Rating Action

DBRS, Inc. (DBRS) has today confirmed Banco Espírito Santo, S.A. (BES or the Group)’s Senior Long-Term Debt & Deposit rating at BBB (low), and the Short-Term Debt & Deposit rating at R-2 (middle). The trend on all ratings is Negative. These ratings have been removed from Under Review with Negative Implications, where they were placed on 24 May 2012. This rating action follows DBRS’s confirmation of the BBB (low) rating of the Republic of Portugal with Negative trend on 30 November 2012.

The confirmation of the sovereign ratings reflects DBRS’s assessment that, despite an unfavourable external environment, Portugal has made significant progress consolidating public finances, unwinding external imbalances and implementing structural reforms. The statement from Euro area countries that additional financing would be available to Portugal, if necessary, as long as there is strict policy implementation in the context of the EU-IMF programme, provides additional support to the ratings. The Negative trend, however, recognises that there is substantial uncertainty regarding Portugal’s growth outlook with downside risks emanating from external demand, stressed economy-wide funding conditions and adverse effects from the fiscal consolidation effort.

BES’s intrinsic assessment (IA) of BBB (high) remains unchanged. However, in light of the continued difficult environment, DBRS will continue to evaluate the IA of the Group. Additionally, DBRS maintains its SA-2 support assessment for BES, which indicates an expectation of timely systemic support in case of need. However, with the current rating for the Portuguese sovereign below the BBB (high) intrinsic assessment for BES, there is currently no uplift to the Group’s ratings.

As reflected in the 3Q12 results, DBRS views BES as continuing to cope with the adverse environment. BES reported net income of EUR 64.9 million in 3Q12, up from EUR 13.9 million in 2Q12, and EUR 11.6 million in 1Q12, despite still elevated levels of provisioning. Overall, the Group generated enough net operating income, or income before provisions and taxes (IBPT), of EUR 1,029.6 million in the first nine months to absorb net provisions of EUR 752.3 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. DBRS sees BES as having some success in sustaining its net interest margin (NIM) in a stressed environment at 1.75% in 9M12, an improvement from 1.68% in 2011 and 1.61% 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 73.1 million in net income in 9M12, contributing to about 80% of BES’s international net income. These earnings helped to offset small negative net income in BES’s domestic franchise of EUR 1.4 million in 9M12. With a reduced contribution from 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.

Indicative of the Group’s resiliency in this uncertain environment, BES completed a 3-year EUR 750 million unsecured debt issue in October 2012. It continues to reduce its wholesale funding needs through its deleveraging plan. The Group maintains solid capitalization levels under the latest regulatory requirements, in particular under the EBA criteria that include a buffer for sovereign debt, without assistance from the Portuguese state. Besides retained earnings and reductions in RWA, the Group successfully concluded a EUR 1 billion rights issue in 2Q12, helping BES to reach a Core Tier 1 ratio of 10.7% at September 2012, based on Bank of Portugal standards, and 10.0%, based on EBA requirements (above the 9% required). DBRS also notes that the Group has improved its tangible equity / tangible assets ratio to 8.9% at 3Q12 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 and the Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments. All can be found on the DBRS website under Methodologies.. 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: William Schwartz
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.