DBRS: BCP’s Ratings Confirmed at BBBL, Negative Trend; Intrinsic Assessment Lowered to BBH

DBRS, Inc. (DBRS) has today confirmed the ratings of Banco Comercial Português, S.A. (BCP or the Group) and associated entities, including BCP’s Senior Long-Term Debt & Deposits at BBB (low) and Short-Term Debt & Deposits 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. At the same time, DBRS has lowered BCP’s intrinsic assessment (IA) to BB (high) from BBB (low).

DBRS views BCP as a Systemically Important Bank (SIB) in Portugal. As the country’s second largest banking group, a major provider of financial services to the business and financial sector and a key participant in the financial markets, significant distress for Millennium bcp, if not addressed promptly, could materially affect Portugal’s financial system and the country’s payment mechanisms. DBRS maintains its SA-2 support assessment for BCP, which indicates an expectation of timely systemic support, if needed. Explicit support has been provided to the Group through BCP’s issuance of core tier 1 eligible hybrid instruments that were fully subscribed by the State. DBRS views the ability of the government to provide support as having been enhanced by the agreement with the EU/IMF, which provided EUR 12 billion of resources to strengthen the capital base of Portuguese banks, of which approximately half of these resources have been utilised. The SA-2 designation results in a one-notch uplift from BCP’s IA of BB (high) to the final rating of BBB (low), which is at the same level as the long-term debt rating of Portugal.

In lowering BCP’s IA by one notch to BB (high), DBRS factors in the increasingly difficult domestic operating environment; which is significantly pressuring BCP’s domestic earnings through lower net interest income, deleveraging, and elevated credit costs. Given the continued weakness in the Portuguese economy, DBRS expects BCP’s domestic earnings to remain under significant pressure at least through the rest of 2013. The interest rate environment is having a sustained adverse impact on earnings. Lower Euribor rates have reduced yields on adjustable rate loans, especially mortgages, but interest expense has not fallen as much due to pressures on funding in Portugal. The Group has been successful in its international businesses in Portuguese affinity markets and Poland, but its non-core international businesses have been a significant drag on earnings. The Group has raised additional capital and bolstered its capitalisation in combination with the support provided by the State. Although important for meeting regulatory capital requirements, these capital instruments materially increase BCP’s funding expense. While the Group has committed to a repayment schedule beginning in 2014, DBRS views this schedule as ambitious given the pressure on earnings. Progress in reducing risk-weighted assets (RWAs) will facilitate meeting capital requirements, which will be positive especially if earnings are maintained during this deleveraging.

Supporting the IA of BB (high) is BCP’s major presence in Portugal through its 802 branches The Group has significant market shares domestically, with 19.1% in customer loans and 18.1% in customer deposits, in Portugal’s concentrated banking market. In addition to lending to businesses and individuals, BCP is an important player in complementary businesses such as corporate and investment banking, private banking, asset management and insurance.

Despite BCP’s well-established franchise, earnings have weakened with negative bottom line results in recent years. BCP is being challenged by the sustained stress in Portugal. While the Group’s core international franchises (Poland, Mozambique and Angola) are making important contributions to earnings, the international operations in Greece and Romania have had a negative impact on results. BCP reported negative net income of EUR 849 million in 2011, which was impacted by provisioning related to the one-time transfer of certain pension fund liabilities to the State, and negative net income of EUR 1.2 billion in 2012, which was impacted deterioration in Portugal combined with significant provisioning for BCP’s Greek subsidiary, Millennium Bank (Greece) (MBG). In 1Q13, BCP reported negative net income of EUR 152 million.

Revenues are being pressured by the impact of lower interest rates on net interest income. Lower Euribor rates have reduced loan yields, particularly on mortgages where there are limited opportunities to reprice, while interest expense has not declined as much due to competition for deposits and sovereign funding costs. The Group’s NIM narrowed to 0.96% for 1Q13 from 1.20% for 2012 and 1.73% for 2011. To offset this, BCP has implemented a restructuring programme to reduce operating expenses (down 11% between 2011 and 2012). Despite these actions, income before provisions and taxes (IBPT) has been trending downward from EUR 935 million in 2011 to EUR 722 million in 2012. Furthermore, deteriorating credit quality is taking its toll on the Group’s results. In 2012, provisions for loan impairments of EUR 1.7 billion exceeded IBPT. Given the macroeconomic dynamics in Portugal, DBRS expects elevated provisioning to continue pressuring results at BCP.

Given the scope of losses from its Greek operation (EUR -266 million in 2012), DBRS views positively the recent sale of this subsidiary, MBG, to Piraeus Bank. Prior to the sale, BCP recapitalized MBG by EUR 413 million which was fully covered by provisioning provided for in 2012. BCP has also invested EUR 400 million in the upcoming rights issue of Piraeus Bank. Positively, the sale will result in the deconsolidation of a loss-making subsidiary in Greece and will result in the repayment of EUR 900 million of intercompany loans. At the same time, BCP will continue to have exposure to Greece through its investment in Piraeus Bank, which will be accounted for by the equity method.

Credit quality continues to weaken, indicating that provisions are likely to remain elevated into 2014. The Group’s overdue and doubtful loan ratio increased to 8.8% at 1Q13, up from. 8.1% at year-end 2012 and 6.2% at year-end 2011, driven by sustained weakness in BCP’s corporate and consumer lending books. Positively, credit performance in BCP’s mortgage book remains resilient, with an overdue loan (greater than 90 days) ratio of 1.0% at 1Q13.DBRS notes that overdue loan ratios include only the portion of the loan which is non-performing. The broader credit-at-risk ratio, which includes total credit and interest past due, other restructured credit and insolvent/bankrupt credits, was 13.8% at 1Q13, up from 13.1% at the end of 2012 and 10.1% at the end of 2011. This remains well above the Portuguese banking system average of 7.7% for 2011 and 9.8% for 2012.

DBRS views BCP as maintaining a passable liquidity and funding position given the current environment. The Group’s position is improved, but still shows the stress of the current environment and the potential for increased pressure, if financial markets become more stressed, given its still limited access to wholesale funding. While BCP is appropriately reducing its wholesale funding through deleveraging, this adds to earnings pressure. The Group reduced its loan-to-deposit (LTD) ratio to 121% at 31 March 2013 (vs. 129% at the end of 2012 and 143% at the end of 2011). BCP maintains a liquidity buffer that allows it to access the ECB to refinance wholesale funding maturities which DBRS considers to be adequate given the stability of deposits at the Group.

While regulatory capitalisation has improved, this was achieved not only through capital raising but also through the support of the State. At 1Q13, the Group’s Core Tier 1 capital ratio was 12.1%, based on Bank of Portugal standards and 9.6% according to the EBA standards. While regulatory capital ratios have improved with the issuance of contingent capital instruments, which qualifies as core capital, the Group’s equity base remains relatively low. At 31 March 2013, BCP had tangible equity capital of EUR 3.6 billion, or 4.0% of tangible assets, which is down from 4.2% at year-end 2012 and 4.4% at year-end 2011. In light of the still uncertain outlook for important elements in the global economy, DBRS would view further growth in the Group’s equity capital base positively, as it will improve the Bank’s risk absorption capacity.

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 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: Lisa Kwasnowski
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 10 June 2011
Most Recent Rating Update: 5 December 2012

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/

The conditions that lead to the assignment of a Negative or Positive Trend are generally resolved within a twelve month period. DBRS’s trends and ratings are constantly under surveillance

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