DBRS Upgrades Novo Banco’s Issuer Rating to B, Positive Trend

DBRS Ratings Limited (DBRS) has upgraded Novo Banco, S.A.’s (NB or the Bank) Long-Term Issuer Rating to B from CCC (high), its Short-Term Issuer rating to R-4 from R-5 and its Long Term Critical Obligations Ratings (COR) to BB. The trend on the long-term ratings is now Positive while the trend on the short-term ratings is Stable. At the same time, DBRS has confirmed the Short-Term COR at R-4 with a Stable trend. The Bank’s Intrinsic Assessment (IA) has been upgraded to B and the Support Assessment remains at SA3. See the full list of ratings in the table at the end of this press release. This rating action concludes the review on the ratings that was initiated on October 17, 2017 and extended on January 17, 2018.

KEY RATING CONSIDERATIONS
The upgrade of NB’s Long-Term Issuer Rating to B takes into consideration the Bank’s strengthened capital and improved funding and liquidity position. It also considers the improvement in its risk profile, particularly in terms of the acceleration of the reduction in non- performing loans (NPLs) and the reinforced coverage levels on these assets. The ratings, however, continue to recognise the challenges the bank faces, particularly in relation to asset quality and profitability. These include its very weak asset quality with a very high NPL ratio, which albeit improving, remains considerably weaker than most European banks.

The positive trend on NB’s Long-Term Issuer Rating reflects DBRS’s expectations that, helped by the new ownership by Lone Star, and the contingent capital agreement available for NB from the Resolution Fund on a certain pool of assets, the bank is in a better position to accelerate its balance sheet clean-up, reduce NPLs, improve efficiency and strengthen its franchise position in Portugal, where it continues to have a leading position in small and medium size enterprises (SMEs) and corporate segments.

The upgrade of NB’s COR to BB, with a Positive Trend, reflects that given the Bank’s improved capital and funding position as well as potential support from its new private shareholder, DBRS considers the risk of applying further resolution measures to NB has reduced and therefore the risk of default on these instruments has also reduced.

RATING DRIVERS
Positive rating pressure on the long-term ratings could arise if the Bank continues to improve its risk profile, primarily through a further reduction in Non-performing loans. Positive rating pressure would also require progress in core profitability and further evidence that its deposit base has stabilised.

Downward rating pressure to the long-term ratings, although unlikely considering its current trend, could arise from a weakening of the Bank’s funding and liquidity position as well as a material deterioration of the Bank’s asset quality, also negatively impacting capital.

DBRS anticipates that as the Bank’s credit profile and IA improves further, the COR could be upgraded further.

RATING RATIONALE
Since its inception NB has reported annual losses primarily as a result of its weak risk profile and asset quality. In 2017 NB reported a net loss of EUR 1.4 billion. DBRS notes however, that commissions grew strongly, helping to partly offset the continued pressure on net interest income (NII) from the low interest rate environment. Impairment charges for loans and other assets were up nearly 50% Year-on-Year (YoY) totaling EUR 2.1 billion, largely from loans. These impairments were, however, partly offset by EUR 792 million compensation paid to Novo Banco from the Portuguese Resolution Fund related to the Contingent Capital Agreement agreed upon conditions of the sale to Lone Star. According to this, the Resolution Fund will compensate NB, up to a limit of EUR 3.89 billion for losses that may be recognised in some of its problematic assets, in the event that its capital ratios decrease below a predefined threshold.

NB’s asset quality remains weak but DBRS recognises that the Bank has successfully reduced NPLs at a good pace, as evidenced by the 15% reduction YoY in 2017. Nevertheless, the Bank’s NPL ratio (as defined by the European Banking Authority, EBA) remains elevated at 30.5% at end-2017, much higher than the average of its domestic peers and most European banks. However, helped by the capital increase, NPL coverage levels materially improved to 59% at end-2017, from 49% a year earlier. Whilst these coverage levels are above most domestic peers’ levels, DBRS considers them essential to cover for NB’s larger than peers’ proportion of uncollateralised exposures.

NB’s funding and liquidity position improved in 2017, helped by the capital increase, good growth of customer deposits and a reduction of net funding from the European Central Bank (ECB). Despite the improvement, DBRS considers NB’s funding and liquidity as still vulnerable to deposit and investor confidence and this is a key consideration for the ratings. Total customer deposits were up 16% in 2017 or EUR 4.1 billion, supported by both organic growth and the bondholders’ acceptance of the commercial offer of deposits following the completion of the liability management exercise (LME), completed in October 2017. Helped by asset deleveraging, capital injections and the results of the LME the Bank continued to reduce its net usage of ECB funds in 2017 to EUR 2.8 billion, compared to EUR 5.1 billion at end-2016.

NB’s capital position materially improved with the capital injection in 4Q17 and the Bank’s CET1 (phased-in) ratio improved to 12.8% and the CET1 (fully-loaded) ratio to 12.0% at end-2017. However, DBRS continues to see NB’s capitalisation as weak in the context of the Bank’s large stock of unreserved NPLs and ongoing operating losses. The unreserved NPL ratio/ CET1 (phased-in) was a high 97.9% at end-2017, although much improved from a 141% at end-2016.

The Grid Summary Grades for Novo Banco S.A. are as follows: Franchise Strength – Good/Moderate; Earnings – Weak; Risk Profile – Very Weak; Funding & Liquidity – Weak; Capitalisation – Weak.

Notes:

All figures are in Euros unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (May 2017) and DBRS Criteria: Guarantees and Other Forms of Support (January 2018). These can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include SNL Financial, company disclosures, the Bank of Portugal and European Banking Authority (EBA). DBRS considers the information available to it for the purposes of providing this rating to be 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.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“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 and US regulations only.

Lead Analyst: Maria Rivas, Vice President, Global FIG
Rating Committee Chair: Elisabeth Rudman, Managing Director, Head of EU FIG
Initial Rating Date: August 5, 2014
Most Recent Rating Update: January 17, 2018

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