DBRS Lowers Banco Espírito Santo’s Sr Debt to BB (low); Ratings Remain UR-Negative

DBRS, Inc. (DBRS) has today lowered the Senior Long-Term Debt & Deposit rating of Banco Espírito Santo, S.A. (BES or the Bank) to BB (low) from BBB (low) and the Short-Term rating from R-2 (middle) to R-4. The rating of Dated Subordinated Notes issued by BES and its subsidiaries has been downgraded to CC (high) from B (high). The Intrinsic Assessment (IA) of the Bank is now B (low), from BB (high). All ratings remain Under Review with Negative Implications.

In lowering the IA by five notches to B (low), DBRS highlights the severe impact on the Bank from the disclosures in the Bank’s 1H14 results announced on 30 July. The Bank reported a net loss of EUR 3.5 billion, which negatively impacted capital levels to such a degree that the Bank reported a transitional Basel III Common Equity Tier 1 (CET1) ratio of 5%, well below the regulatory minimum requirement of 7%. DBRS view the nature of the losses, which evidence control failures and possible illegal behavior, as well as the fact that there is, in DBRS’ opinion, significant execution risk with regards to the capital plan, as warranting a multi-notch downgrade. DBRS anticipates that these issues could have a significant impact on the customer franchise, including the potential loss of deposits, and that the long-term ramifications for the Bank’s franchise could be significant.

The loss reported in 1H14 was primarily driven by a series of provisions and impairments for extraordinary items related to some previously-reported exposures to Espirito Santo (ES) Group entities, as well as newly reported exposures and provisioning requirements that came to light following a thorough review by a third-party auditor. The unexpected size of the losses and its subsequent impact on capital followed on from earlier assurances by the Bank of Portugal on 11 July that the Bank was sufficiently well capitalized to absorb emerging exposures, and indicates serious concerns regarding risk and compliance controls within BES. It has become apparent that a number of these transactions were undertaken without the proper approvals or without being recorded through the proper channels.

The Bank of Portugal has indicated in its most recent statement of 31 July that a private solution for a capital increase is the most desirable, but that the public recapitalisation line, provided in the Economic and Financial Assistance Programme, remains available to support the banking system. Given BES’s position as Portugal’s second largest banking group by assets, DBRS has maintained 3 notches of systemic support in the Senior Long-Term Debt & Deposit ratings. However, the uplift incorporated in the senior ratings could be reduced if in DBRS’s view, the timeliness of support is prolonged, or if the willingness for support reduces. This could be the case given the nature of the losses and the potential for further irregularities to be uncovered.

As the capital planning process continues, DBRS expects that BES’s liquidity and funding profile will remain challenged, heightened by the continued uncertainty, although the Bank has access to ECB liquidity. DBRS maintains its ratings Under Review with Negative Implications, pending clarity on the capital increase. While near-term events could lead to rating actions, especially if further irregularities were to arise, DBRS does not expect to complete the review prior to the results of the ECB AQR and EBA-EU stress tests. Before concluding on the review DBRS will also require further clarification and details on the capital plan, as well as details of new management’s strategy.

The downgrade of the Bank’s subordinated debt by six notches to CC (high) reflects the increased risk to these instruments pending recapitalisation of the Bank, given the significant deterioration in BES’s capital position. In the current European regulatory environment DBRS notes that accepting state capital is expected to have negative implications for holders of BES subordinated debt and for the strategic flexibility of the Bank. Although the long-term debt and deposit ratings of the Bank continue to incorporate uplift for potential government 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.

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 methodologies used include the DBRS Criteria: Support Assessment for Banks (January 2014) and Banking Organisations and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (December 2013). These can be found can be found at: http://www.dbrs.com/about/methodologies

The primary sources of information used for this rating include company documents, SNL Financial and the Bank of Portugal. 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: 19 April 2011
Most Recent Rating Update: 17 June 2014

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