DBRS: Espírito Santo Financial Group’s Ratings Downgraded to B, Placed Under Review – Negative

DBRS, Inc. (DBRS) has today downgraded its ratings of Espírito Santo Financial Group, S.A. (ESFG or the Group), including the Group’s Senior Long-Term Debt rating to B from BBB (low) and Short-Term Instruments rating to R-5 from R-2 (middle). At the same time, DBRS has placed all ratings Under Review with Negative Implications. Concurrently, DBRS has lowered ESFG’s intrinsic assessment (IA) to B from BBB (low), while maintaining a SA-3 support assessment, indicating no expectation of timely systemic support and no uplift for support.

In lowering ESFG’s IA to B, DBRS highlights its significant concerns regarding the deterioration in the Group’s financial position combined with a high level of uncertainty around the extent of intercompany exposures and linkages to other Espírito Santo Group (ES Group) entities. DBRS views ESFG as being vulnerable to the deteriorating financial position of ES Group entities. The market has clear concerns regarding ES Group entities and the pace of events is moving very quickly. DBRS views ESFG’s access to the wholesale markets as pressured, making future debt issuances expensive and potential capital raises challenging.

Furthermore, the lowering of the IA recognises that, as of July 31, 2014, ESFG will be no longer regulated by the Bank of Portugal. The Bank of Portugal will supervise ESFG’s principal operating subsidiary, Banco Espírito Santo, S.A. (BES), directly. With ESFG excluded from the Bank of Portugal’s supervisory control, the Group will no longer be subject to increased regulatory requirements or benefit from regulatory oversight.

Moreover, the IA of B reflects the continued difficult operating environment in Portugal, where the Group has significant operations, and the ongoing pressure on profitability. The fundamentals at BES, one of ESFG’s major operating subsidiaries, remain under pressure due to the prolonged stressed economic environment in its home market. BES reported a sizable net loss in 2013 and this trend continued in 1Q14 with a net loss of EUR -89 million. This intimates that there will be a continued interruption in BES’s dividend flow over the medium-term, which has in the past been ESFG’s main source of cash flow. Historically, DBRS had balanced this risk against ESFG’s demonstrated ability to generate dividends from its earnings in other subsidiaries to meet interest payments on its debt obligations. At present, DBRS is concerned about the reliability of dividends from other subsidiaries, combined with the potential sale of certain businesses, as limiting the Group’s earnings streams outside of BES. ESFG itself has faced significant pressure on its financials since being obliged to make a EUR 700 million provision for Espírito Santo International (ESI) debt securities sold to ES Group (BES and Banque Privee Espírito Santo) customers and reported a loss of EUR 864 million in its 2013 financial statements published on April 29, 2014.

In placing the rating Under Review with Negative Implications, DBRS recognises the pressure that ESFG is facing on its fundamentals as a result of reviews into certain dealings of the ES Group. The results of a Bank of Portugal review highlighted issues at ESFG’s largest shareholder, Espírito Santo International, and increased market concerns regarding ESFG’s inter-company lending, risk management processes/procedures, as well as the quality and independence of senior management.

During DBRS’s review of the ratings, DBRS will focus on ESFG’s financial position and on the impact on investor and client confidence during this transition period, which is expected to include changes to senior management and a change in composition of the Board of Directors. DBRS will take further steps to understand ESFG’s liquidity position and inter-company exposures, which are the main drivers of the negative market perception. DBRS will also look for clarification on the restructuring and strategy of ES Group, which could provide further insight into the financial resources of other ES Group entities.

DBRS would view any franchise weakening at BES as having the potential to impact the ratings of ESFG, given its importance to ESFG from a cash flow perspective. Additionally, any perceived weakening of ES Group entities could further negatively pressure ratings as these entities carry the Espírito Santo name and have implied linkages.

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

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2014). Other applicable methodologies include the DBRS Criteria – Support Assessments for Banks and Banking Organisations (January 2014) and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (December 2013). These can be found at: http://www.dbrs.com/about/methodologies.

The sources of information used for this rating include 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: Elisabeth Rudman
Initial Rating Date: April 20, 2011
Most Recent Rating Update: May 7, 2013

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