DBRS: BES Reports 2013 Net Loss, Weak Economic Environment in Portugal Weighs on Performance

Summary:
•Net loss of EUR 517.6 million in 2013, after reporting a net profit in 2012 supported by trading gains.
•The weak economic environment in Portugal continues to weigh on net revenues and drive higher loan loss provisions due to asset quality deterioration.
•Despite focusing on strengthening capitalisation in 2013, through deleveraging and asset disposals, ongoing losses may result in some capital pressure.
•DBRS rates BES’s Senior Long-Term Debt & Deposit at BBB (low) with a Negative trend.

DBRS Ratings Limited (DBRS) considers Banco Espírito Santo’s (BES or the Group) 4Q13 results as highly pressured by the still deteriorating economic environment in Portugal. The Group reported a net loss of EUR 517.6 million in 2013, following a profit of EUR 96 million in 2012 in part supported by gains from financial operations. Net interest income declined by 12% Year-on-Year (YoY), driven by the deleveraging process undertaken by the Group domestically, a record low Euribor which brought net interest margin (NIM) down to 1.51%, a lower contribution from the sovereign bond portfolio and the increased cost associated with elevated non-performing loans (NPLs). Gross operating income was also impacted by lower trading income compared to 2012, reporting a decline of 70%. Loan loss provisions were up 18.6% in 2013 and at EUR 1.4 billion were well in excess of a weak level of income before provisions and taxes (IBPT) of EUR 762 million (down 47% from 2012).

The difficult economic conditions in Portugal contributed to a net loss in domestic operations of EUR 539.5 million in 2013, a decline from a net profit of EUR 8.5 million in 2012. In terms of international activity, profits declined 75% to EUR 22 million from EUR 87.6 million. The geographies that form a core strategic triangle for the Group (Africa, Brazil and Spain), registered a net loss driven mainly by high provisioning requirements in Spain. Wholesale banking activity with sound performance in countries like United Kingdom and Luxembourg resulted in an overall positive contribution from international activity, but insufficient to compensate for the poor domestic results.

BES continued the deleveraging process in 2013, albeit at a slower pace, mainly driven by a reduction in the residential mortgage portfolio. Traditionally the Group maintains a high exposure to the corporate sector (73.4% of the portfolio at 4Q13), with an increase in loans to exporting small- and medium-sized enterprises (SMEs) in 2013 replacing some maturing loans to domestic corporates. Reflecting the difficult economic conditions domestically, asset quality continued to deteriorate, although with lower delinquency entries in the last quarters of the year. The overdue loan ratio for the Group reached 6% at 4Q13, which still compares favourably with domestic peers. BES’s residential mortgage overdue loan ratio was 1% and for corporate lending was 5.2%, below system averages of 2.1% and 10.7%, respectively.

The Bank’s funding and liquidity profile has improved in 2013. The deleverage process coupled with a steady increase in deposits (up 6.7% in 2013) improved the loan-to-deposit ratio which stood at 121% in 4Q13, down from 137% at end-2012. BES continues to be the most active Portuguese bank in the wholesale market; following a senior debt issuance in January 2013 (EUR 500 million for 5 years) the Bank concluded a subordinated debt issuance of EUR 750 million for 10 years (Tier II according to Basel III standards) in November 2013. At the beginning of 2014 the Bank issued a further EUR 750 million in senior debt at pre-crisis levels. This has allowed the Bank to reduce its dependency on European Central Bank (ECB) funding which stood at EUR 5.4 billion in net terms, down significantly from the peak of EUR 13.7 billion at June 2012.

The Group’s regulatory capitalisation has improved marginally to 10.6% (based on Bank of Portugal criteria) with a reduction in risk-weighted assets (RWAs), the reinsurance of part of the BES Vida insurance book, a capital increase at BES Angola and the sale of a stake in EDP (the Portuguese electrical company). BES has shown it has the ability to recapitalize without requiring access to public funds, through its EUR 1 billion rights issue in 2012. However, in DBRS’s view, further sizable losses could put pressure on BES’s capital levels.

BES reported a Basel III Core Tier 1 ratio of 10.1% for the phased in approach and 8.1% on a fully loaded basis. These ratios exclude any potential benefit for deferred taxes assets (DTAs); so far, there has not been any guidance from the Portuguese authorities with regards to the treatment of DTAs by the domestic banks.

DBRS rates BES’s Senior Long-Term Debt & Deposit at BBB (low) with a Negative trend.

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

[Amended on December 23th, 2014 to remove unnecessary disclosures.]