DBRS: ESFG’s Ratings Confirmed at BBB (low), Trend Remains Negative

DBRS, Inc. (DBRS) has today confirmed its ratings of Espírito Santo Financial Group, S.A. (ESFG, the Parent or the Group). DBRS rates the Group’s Senior Long-Term Debt at BBB (low) and Short-Term Instruments at R-2 (middle). The trend on all ratings is Negative. These ratings were previously confirmed on 5 December 2012 following DBRS’s confirmation of the Republic of Portugal (Portugal) at BBB (low) with a Negative trend. Concurrently, DBRS has confirmed ESFG’s intrinsic assessment (IA) at BBB (low), while maintaining a SA-3 support assessment, indicating no expectation of timely systemic support and no uplift for support.

The confirmation of ESFG’s ratings recognises the impact of the increasingly difficult operating environment in Portugal, where the Group has significant operations, the Group’s resilience in managing the ongoing pressure on profitability, as well as its improved funding and liquidity profile and its enhanced capital position. Reflecting the persistent macroeconomic headwinds that are pressuring performance at ESFG’s principal operating subsidiary, Banco Espírito Santo, S.A. (BES), DBRS lowered BES’s IA from BBB (high) to BBB on 17 April 2013. This narrows the notching between ESFG’s IA to one notch below BES’s IA from two. The reduction in notching balances DBRS’s historical consideration of the risk of a sustained interruption in BES’s dividend flow at a time of stress, against ESFG’s demonstrated ability to generate dividends from its earnings in other subsidiaries to meet interest payments on its debt obligations. This is complemented by the Group’s strengthened balance sheet and liquidity profile, which could be used to provide assistance to other subsidiaries, if needed.

Supporting ESFG’s ratings is its continued profitability on an annual basis on both a consolidated and parent-only basis, which is being helped by the Group’s franchise diversity. In addition to its ownership in BES, which is consolidated in ESFG’s financials, the Group’s franchise is supported by its various banking businesses outside of Portugal, as well as insurance businesses in Portugal. This diversity reflects ESFG’s role as the holding company for the financial businesses of the Espírito Santo Group, which also owns nonfinancial businesses. With just 27.5% of consolidated net income generated from the Group’s ownership of BES in 2012, which is down significantly from 85.7% in 2010, ESFG’s earnings have come under significant pressure as BES’s earnings have declined. Helping ESFG sustain its profitability are its banking businesses outside of BES, which focus on private banking, wealth management, corporate banking and investment banking. These businesses contributed 56.2% of consolidated net income in 2012, while its insurance businesses contributed 16.3% of net income.

DBRS views ESFG’s funding and liquidity profile as having improved with the reduction of the debt burden and increased capital at the Parent company. Having repurchased debt in late 2011 to reduce its overall debt load, interest payments at the Parent declined 33.7% year-over-year (YoY) to EUR 52.7 million in 2012 and are expected to decline further in 2013. These interest payments were met through dividends received from subsidiaries, which amounted to EUR 67.9 million in 2012. While sufficient to meet interest payments at ESFG in 2012, DBRS recognises that dividend income has declined markedly from EUR 141.7 million in 2010, prior to BES reducing dividends in 2011 and halting dividend payments in 2012 in response to requests from the banking regulators. Importantly, however, ESFG has been able to maintain dividends at a level sufficient to meet its interest payments through increased dividends from other subsidiaries within the Group. Looking forward, DBRS views resources available at the Parent company and ESFG’s ability to draw on resources available in its subsidiaries outside of BES as offering an appropriate cushion to meet ESFG’s own liquidity needs and those of its guaranteed funding vehicle, Espírito Santo Financiére S.A. (ESFIL), if needed.

ESFG has also enhanced its capitalisation during a time of unprecedented stress in the markets. At the Parent company, the Group has increased equity from EUR 1.25 billion in 2010 to EUR 2.2 billion in 2012, while debt has been reduced from EUR 1.3 billion to EUR 0.7 billion. On a consolidated basis, capitalisation levels are in excess of regulatory minimums with a Core Tier 1 ratio of 10.1% according to Bank of Portugal and 9.6% according to the European Banking Authority (EBA). Compliance with regulatory minimums was achieved through a EUR 500 million rights issue at ESFG in April 2012, a EUR 1 billion rights issue at BES in 2Q12, and reductions in related party lending. DBRS notes that neither ESFG nor BES has received assistance from the Portuguese state.

ESFG’s ratings could come under pressure if the macro environment significantly deteriorates and the Portuguese sovereign’s position weakens furthers. Additionally, earnings pressure that indicates franchise deterioration or any difficulty in rolling funding would negatively pressure the Group’s ratings. While DBRS views positively the continued deleveraging at the Parent-level, any reversal in the progress that has been made could put downward pressure on the ratings. Further, ESFG operates with a complex group structure; any increased complexity within this structure could have an impact on ratings.

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 company documents, SNL Financial, the European Banking Authority, the Bank of Portugal, and DBRS's rating action on the Republic of Portugal. 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: Lisa Kwasnowski
Rating Committee Chair: Elisabeth Rudman
Initial Rating Date: 20 April 2011
Most Recent Rating Update: 5 December 2012

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