DBRS Lowers Banco Espírito Santo’s Sub Debt to B (high); Senior BBB (low) Ratings Remain UR-Negative

DBRS, Inc. (DBRS) has today lowered the Intrinsic Assessment (IA) of Banco Espírito Santo, S.A. (BES or the Bank) by one notch to BB (high) from BBB (low). At the same time, the rating of BES’s Dated Subordinated Notes has been downgraded by three notches to B (high) from BB (high). BES’s Senior Long-Term Debt & Deposit rating of BBB (low) and Short-Term Debt & Deposit rating of R-2 (middle) remain unchanged. All ratings remain Under Review with Negative Implications.

In lowering the IA by one notch to BB (high), DBRS recognizes the pressure that the Bank is facing on its fundamentals given increased concerns regarding the financial soundness of BES’s largest counterparties, which include Espírito Santo Group (ES Group) entities. DBRS views BES as being vulnerable to the deteriorating financial position of ES Group entities and sees this intercompany exposure as having the potential to have a negative impact on BES’s capital base. While Basel III Transitional Common Equity Tier 1 Capital is approximately EUR 7 billion, the Bank’s buffer of EUR 2.1 billion over regulatory minimums provides a limited cushion over potential risks, including direct intercompany exposures of EUR 1.2 billion (including guarantees). Furthermore, BES has indirect intercompany exposures through commercial paper of ES Group entities sold to BES retail customers. Although Espírito Santo Financial Group has set aside a provision for some of these exposures, DBRS still believes there is a possibility these exposures could require the support of BES if any of these ES Group entities were to skip or delay payment.

In addition, the quality of BES’s exposure in Banco Espírito Santo Angola (BESA) remains uncertain. BESA may require higher provisioning for its loan portfolio due in part to the European Central Bank (ECB) Asset Quality Review (AQR). BES owns 55% of BESA, which had EUR 8.5 billion in assets and equity of EUR 1.2 billion at the end of 1Q14. BES has extended funding to BESA of approximately EUR 3 billion. At the end of June 2014, BES reported that, reflecting certain difficulties in BESA’s loan book, BESA has a guarantee from the Republic of Angola on EUR 4.2 billion out of its loan book of EUR 6.05 billion; this guarantee applies to exposures that are related to the government development plan, but has not yet been utilised. While difficulties at BESA would likely be manageable in isolation, it adds to the uncertainty surrounding BES’s financial position and constrains its financial flexibility.

Reflecting BES’s position as Portugal’s second largest banking group by assets, DBRS maintains its SA-2 support assessment for the Group. DBRS anticipates that BES would likely receive some form of timely systemic support in a highly stressed scenario, resulting in one notch of uplift from the IA for the final senior debt rating. DBRS also takes comfort in BES’s access to the ECB for liquidity, if needed, though at present the Bank’s liquidity position appears solid.

The downgrade of the Bank’s subordinated debt to B (high) reflects the increased risk to these instruments due to adverse government actions, if a significant deterioration in the Bank’s capital position were to develop. In the current European regulatory environment DBRS notes that accepting state capital would be likely to have negative implications for holders of BES subordinated debt and for the strategic flexibility of the Group. Although the long-term debt and deposit ratings of the Bank continue to incorporate one notch of uplift for potential external support DBRS would not expect this to be forthcoming for more junior instruments and therefore, given the potential pressure on BES’s capital position, the notching of these instruments from the IA has been widened.

DBRS will look for further clarification over the coming weeks on the aforementioned exposures, as new management transitions into the organization and the strategy of the new management team is made clear. The continued strength of BES’s franchise and earnings power remain important elements for its intrinsic strength, such that any significant weakening in these characteristics could add to negative pressure on the ratings. DBRS’s review will continue to focus on the concerns regarding BES’s intercompany lending, risk management processes/procedures, as well as the quality and independence of senior management. While near-term events could lead to rating actions, DBRS does not expect to complete the review prior to the results of the ECB AQR and EBA EU-wide 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: July 11, 2014

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