DBRS: Novo Banco's Ratings Confirmed at BB (low), Now Under Review Neg; IA Revised Up to B

DBRS Ratings Limited has today confirmed the ratings of Novo Banco, S.A. (NB or the Bank), including its Senior Long-Term Debt & Deposits rating at BB (low) and Short-Term Debt & Deposits rating at R-4. Concurrently, the ratings have been revised to Under Review with Negative Implications (URN) from Under Review with Developing Implications. At the same time, DBRS has revised up the Bank’s intrinsic assessment (IA) to B from B (low).

The Senior Notes issued by BES Finance Ltd. and guaranteed by Novo Banco S.A. have been transferred on July 7, 2015 to a new legal entity named NB Finance Ltd. The ratings for this transferred debt remain at BB (low). DBRS has changed its review status on this rating to URN from Under Review Developing in line with the rating action taken today for NB and its subsidiaries. See a full list of rating actions at the end of this press release.

Today’s rating action concludes the review that was initiated by DBRS on August 5, 2014, where the ratings were placed Under Review with Developing Implications after the creation of NB on August 4, 2014. The Bank’s ratings, however, have been revised to Under Review with Negative Implications, to reflect DBRS’s review of the systemic support assumptions for NB, in line with the rating action taken on a number of European banks initiated on May 20, 2015.

In revising the IA up by one notch to B, DBRS recognizes the progress the Bank has made, including protecting its franchise through a very difficult period that followed the resolution of BES and the creation of the Bank. NB’s franchise strength has been supported by the appointment of new management in September 2014, who appear to have brought strategic and management guidance to the Bank. NB remains a leading bank in Portugal in the small and medium size enterprises (SMEs) and corporate segments with a meaningful market share of 21%. The change in the IA is also supported by DBRS’s view that, given its important role in the Portuguese SME and corporate market, and helped by its recovering franchise, the Bank will be able to continue generating sustainable revenues in the medium-term.

The Bank is making progress in restoring customer confidence, as evidenced by the inflow of new customer deposits and reduction in outflows. Also helped by deleveraging, the Bank has also reduced the usage of ECB funding. Moreover, it has recently regain access to some secured funding sources that were previously closed for NB.

DBRS sees, however, that significant downside risks persist. In spite of improved customer deposit stability, the Bank’s funding and liquidity position is still fragile and highly vulnerable to a change in customer sentiment. Unpledged liquid assets are very low, but improving, and the Bank has not yet been able to access the wholesale markets for unsecured funding. NB has a weak capital position and it has limited ability to improve capital levels by its own means, particularly considering that profitability continues to be under pressure from a high cost of funding, both from regained deposits and its legacy high wholesale funding reliance. Moreover, the economic recovery in Portugal is taking place at a slower pace than initially anticipated. In this context, profitability will continue to be pressured driven by asset quality deterioration. The Bank’s credit risk profile is high, with a larger proportion of real estate risks than peers and a high risk concentration by borrower. Moreover, contingency risks, albeit being reduced, are still present as the Bank of Portugal (BoP) could, in DBRS’s understanding, decide on further reclassifications of assets and liabilities from BES to NB and vice versa.

DBRS expects the NB’s sale process to be concluded within a reasonable timeframe, presumably in 2015. Today’s rating action does not take into account any potential impact on the Bank as a result of a new ownership structure and/or changes in the current management team. DBRS will closely monitor any announcements regarding the sale and evaluate any potential impact on NB’s ratings in due course.

Downward pressure on the IA could arise if DBRS perceives notable franchise deterioration, particularly within NB’s home market of Portugal, which could negatively impact its funding and liquidity position. Continued net losses in excess of expected levels could also pressure the IA, particularly if capital levels are significantly impacted as a result. Positive pressure on the ratings is at present constrained by the lack of disclosure and lack of updated full public information available for the Bank. Upward pressure on the IA could arise from a sustained improvement in its fundamentals. In particular, it could arise from a longer track record of sustained funding stability and rebalance of its funding structure. It could also arise from a significant reinforcement of capital levels together with a substantial reduction of the Bank’s credit risk profile.

NB is the “good” bank created after the application of resolution measures to Banco Espírito Santo, S.A. (BES) by the BoP. The Bank was created with an equity contribution of EUR 4.9 billion fully underwritten by the Portuguese Resolution Fund, which remains the only shareholder of the Bank. According to NB’s by-laws, the Bank is a transitional bank that is required to be sold within the next two years, extendable to five years. DBRS expects that a new shareholder structure might reinforce capital levels and bring more stability to the Bank, but uncertainty remains regarding the final ownership and therefore this is not incorporated into the current rating.

The Bank suffered from a significant outflow in deposits during the first three months after the resolution date, but since then, deposits outflows have slowdown and inflows have been consistently improving. Overall, the Bank’s funding and liquidity position is improving but challenges remain, particularly considering the very low level of unpledged assets and the Bank’s legacy large wholesale refinancing needs. However, DBRS sees that refinancing risks could be partially mitigated by further asset deleveraging.

NB reported a loss of EUR 497.6 million in 2014 mostly affected by significant losses on its loan book and other assets provisions. The Bank remains challenged to improve core profitability which will be dependent on the Bank’s success to correct its balance sheet imbalances, continued progress on the evolution of the franchise and its ability to control asset quality deterioration and to reduce high risk concentration to individual names, which should be translated into lower provisioning requirements. The Bank also faces the challenge to continue generating sufficient recurrent core banking revenues and reduce operating costs.

Asset quality is weak and the credit-at-risk ratio (CaR), calculated as total credit and interest past due, other restructured credit and insolvent/bankrupt credits, was the weakest ratio among Portuguese banks at 16.5% at end-2014. CaR loans were 78% covered by provisions, a level above domestic peers, but nevertheless needed due to the Bank’s high risk profile and significant proportion of unsecured lending (48% of gross loans at end-2014).

DBRS considers NB’s capital levels as still relatively weak in the context of the Bank’s risk profile and its limited ability to generate capital through retained earnings. At end-2014, the Common Equity Tier 1 (CET1) capital ratio (phased-in) was 9.5%. DBRS notes that the CET1 ratio (fully-loaded) ratio has significantly benefitted from the non- deduction of tax credits related to loans and FAs impairments and post-employment or long-term employment benefits.

Currently, DBRS has a support assessment of SA-2 in NB. As a result of the confirmation of the Bank’s senior ratings and the change in the IA, NB’s final ratings now incorporate two notches of uplift for systemic support. NB’s final ratings are Under Review Negative, in line with a number of other European banks, and during the review period DBRS will consider whether to change the support designation from SA-2 to SA-3, which is the category for banks for which DBRS has no expectation of systemic support or is not confident enough that timely systemic support would be forthcoming in times of need to add a notch for systemic support. Such a conclusion would lead to the removal of any uplift and a downgrade of the senior ratings for any affected banks. The review is expected to be completed in September.

Notes:
All figures are in EUR unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2015). Other applicable methodologies include the DBRS Criteria: Support Assessments for Banks and Banking Organisations (March 2015) and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2015).These can be found can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include company reports, the European Central Bank, European Banking Authority, Bank of Portugal and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

This rating is under review. Generally, the conditions that lead to the assignment of reviews are resolved within a 90 day period. DBRS reviews and ratings are under regular surveillance.

For further information on DBRS historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: María Rivas
Rating Committee Chair: Elisabeth Rudman
Initial Rating Date: August 5, 2014
Most Recent Rating Update: May 20, 2015

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