DBRS Places Banco Espírito Santo’s BBB (low) Ratings Under Review with Negative Implications

DBRS, Inc. (DBRS) has today placed the ratings of Banco Espírito Santo, S.A. (BES or the Bank) Under Review with Negative Implications, including its Senior Long-Term Debt & Deposit rating of BBB (low) and Short-Term Debt & Deposit rating of R-2 (middle).

In placing the ratings Under Review with Negative Implications, DBRS recognizes the pressure that the Bank is facing on its fundamentals. One source of pressure is the review by the Bank of Portugal into certain dealings of the Espírito Santo Group (ES Group), which highlighted issues at Espírito Santo International (ESI), the holding company at the top of the ES Group. Changes in senior management at BES are also being implemented. This has elevated DBRS’s concerns regarding BES’s inter-company lending, risk management processes/procedures, as well as the quality and independence of senior management. DBRS also has concerns regarding BES’s subsidiary in Angola, Banco Espirito Santo Angola (BESA), which has potential problems in its EUR 6 billion loan portfolio that required a guarantee from the Angolan government in December 2013.

During the review period, DBRS will focus on these concerns and any impact on investor and client confidence. BES has a strong franchise in its home market, with a leading market share for corporate customers, and an international presence that has provided an important contribution to the Bank’s earnings. DBRS would views any franchise weakening, particularly within BES’s home market of Portugal, as having the potential to impact the rating. Also during the review, DBRS will take an initial assessment of the quality and competency of new management, with changes announced at both the CEO and CFO levels, as well as new appointments to the Board of Directors. The impact of senior management changes can take some time to permeate throughout the organization, but DBRS will look for a clear statement on the Bank’s strategy and focus from the new management team.

Moreover, DBRS will look for further clarification on contingent exposures or other linkages to ES Group entities. Given the high level of intercompany exposures that have been reported, DBRS views BES as being vulnerable to the deteriorating financial position of ES Group entities. DBRS’s concern is that these exposures significantly impact BES’s financial profile and capital position, which could have consequences for its rating especially if accompanied by significant franchise deterioration.

DBRS will assess any impact on BES’s intrinsic assessment (IA), if there is any deterioration in the fundamentals of the Bank. Reflecting BES’s position as Portugal’s third largest banking group by assets, DBRS maintains its SA-2 support assessment for the Bank. DBRS anticipates that BES would likely receive some form of timely systemic support in a highly stressed scenario, although DBRS notes that accepting state capital would be likely to have negative implications for subordinated debt holders and for the strategic flexibility of the Bank. DBRS also takes comfort in BES’s access to the European Central Bank for liquidity, if needed, though at present the Bank’s liquidity position appears solid.

DBRS notes that the added pressures in recent weeks have happened while the economic recovery in Portugal is still struggling to take hold. BES continues to be pressured by the sustained deterioration in asset quality, which has compressed domestic earnings. Reduced international earnings limits the Bank’s ability to offset domestic pressures. Overall, the lower levels of income before provisions and taxes are not sufficient to absorb the elevated cost of risk which, if it continues at its current level, will continue to pressure BES’s capital generation capability.

DBRS would view any perceived weakening of ES Group entities as having the potential to negatively impact BES’s ratings, as these entities carry the Espírito Santo name and have implied linkages. While near-term events could lead to rating actions, DBRS does not expect to complete the review prior to the results of the European Union/European Banking Authority Asset Quality Review (AQR) and stress tests.

Notes:
All figures are in 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 primary 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 19, 2011
Most Recent Rating Update: April 30, 2014

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