DBRS Morningstar Confirms Novo Banco’s Long-Term Issuer Rating at B (high), Trend Now Negative

DBRS Ratings GmbH (DBRS Morningstar) confirmed the ratings of Novo Banco, S.A. (NB or the Bank), including the Long-Term Issuer Rating of B (high) and the Short-Term Issuer rating of R-4. The Bank’s Deposit ratings were confirmed at BB (low)/R-4, one notch above the IA, reflecting the legal framework in place in Portugal which provides full depositor preference in bank insolvency and resolution proceedings. At the same time, the Trend on the Bank’s long-term ratings was revised to Negative from Positive, while the Trend on the Short-Term Issuer and Deposit ratings remained Stable. The BB (high)/R-3 Critical Obligations Ratings were confirmed while the trend was revised to Stable from Positive. The Bank’s Intrinsic Assessment (IA) was maintained at B (high) and the Support Assessment remains unchanged at SA3. A full list of rating actions is included at the end of this press release.

KEY RATING CONSIDERATIONS

The change of the Trend to Negative on NB’s long-term ratings reflects our expectation that, although the bank has made considerable progress in reducing its legacy problem assets, the wide and growing scale of economic and market disruption resulting from the coronavirus (COVID-19) pandemic will add new challenges and higher execution risk for the Bank’s restructuring plan. In our view, the deteriorating operating environment in Portugal will likely affect the Bank’s revenues, cost of risk and balance sheet. While the impact will likely emerge in the coming quarters, the implications for the Bank will depend on the evolution of the outbreak, the length of the economic shutdown in Portugal and in other countries, as well as the strength of any recovery.

The confirmation of the ratings reflects the progress made in reducing its Non-Performing Loans (NPLs) and other non-core assets, the support provided by the Contingent Capital Agreement (CCA) from the Portuguese Resolution Fund, and the Bank’s stable franchise and stable liquidity position. Nonetheless, the ratings continue to reflect the Bank’s still large stock of problem assets and its weak profitability. Albeit improving, NB’s gross NPL ratio, which stood at 11.8% at FY19, remains significantly higher than the European average and the large stock of legacy problem assets continues to be a drag on the Bank’s results. For FY 2019, NB posted a net loss of EUR 1.1 billion, following a negative result of EUR 1.4 billion in 2018.

NB’s BB (high) / R-3 Critical Obligations Ratings were confirmed with a Stable Trend. This reflects DBRS’ expectation that, in the event of a resolution of the Bank, certain liabilities (such as payment and collection services, obligations under a covered bond program, payment and collection services, etc.) have a greater probability of avoiding being bailed-in and are likely to be included in a going-concern entity.

RATING DRIVERS

A rating upgrade is unlikely given the Negative Trend. The trend could revert back to Stable if the impact of the coronavirus on NB’s earnings and credit quality metrics is manageable.

A downgrade could arise from a material deterioration in the Bank’s asset quality and capital, potentially as a result of the current coronavirus global pandemic.

RATING RATIONALE

The Bank is in the midst of its restructuring plan agreed with European Commission following its sale to Lone Star. In 2019, NB continued to reduce its NPLs and real estate assets and, as part of the strategic re-focus on the core business in Iberia, the Bank downsized its international operations and non-core assets. Further progress was made in terms of simplification of the branch network and investments in digitalisation, and DBRS Morningstar notes that total customer lending from the recurrent activities increased by roughly 6% YoY on the back of higher volumes in residential mortgages, consumer finance and corporate loans.

NB’s gross NPL stock decreased by 49% to EUR 3.4 billion at FY 2019, with the gross NPL ratio improving to 11.8%, down from 22.4% at FY18, mainly as a result of write-offs and disposals covered by the CCA. At FY 2019, the CCA compensations totalled EUR 2.98 billion, including EUR 1 billion for 2019. After this payment, the CCA amount still available for NB is approximately EUR 900 million.

Despite the reduction in NPLs and non-core assets, the Group’s risk profile is still affected by the large stock of impaired assets, especially in the SME and corporate sectors, and its NPL ratios continue to compare unfavourably with domestic and international peers. In addition, we believe that the ongoing economic disruption resulting from the COVID-19 global pandemic could contribute to the formation of new NPLs and rising cost of risk as well as delay the Bank’s NPL plan. Several key SME sectors of the Portuguese economy are currently experiencing a significant disruption, in particular tourism & hospitality, automotive, textile and other manufacturers, and this could impact NB given its significant exposure to SMEs and Corporates which accounted for 53% of total customer loans at YE 2019, excluding legacy assets. DBRS Morningstar does note, however, the recent support measures announced by the Portuguese government which may mitigate some of the impact on the Bank.

In our view, the ongoing economic slowdown and uncertainty will also weigh on NB’s revenues. The hit will likely result from a combination of low rates and weak business volumes although we expect an increase in credit facilities to support the liquidity of companies. Payment fees are also expected to decrease on the back of lower transaction volumes, while the worsening market conditions will likely weigh on capital market revenues and fees from asset management. A negative impact might also be expected on the Bank’s capital reserves given the large exposure to securities classified at fair value. At YE 2019, NB reported a fully loaded common equity tier 1 (CET1) ratio of 12.8% and total capital ratio at 14.4%, including the CCA compensation for 2019 which is expected to be paid in the first-half of 2020.

In 2019, the Bank maintained a sizable stock of liquid assets and a stable funding profile. Customer deposits, of which a significant portion is composed by corporate clients, are the main sources of funding. Access to the wholesale markets remains generally more difficult compared to domestic peers, although this is likely to be mitigated to a certain degree by the support from the ECB.

ESG CONSIDERATIONS

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792

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

Notes:
All figures are in EUR unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (11 June 2019), https://www.dbrsmorningstar.com/research/346375/global-methodology-for-rating-banks-and-banking-organisations
DBRS Morningstar Criteria: Guarantees and Other Forms of Support (22 January 2020) was also used, https://www.dbrsmorningstar.com/research/355780/dbrs-morningstar-criteria-guarantees-and-other-forms-of-support

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883

The sources of information used for this rating include Novo Banco’s H1 2019 Report, Novo Banco FY19 Results Press Release, Novo Banco’s FY19 Results Presentation, and S&P Global Market Intelligence. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

DBRS Morningstar 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 12-month period. DBRS Morningstar's outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar 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

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/359498

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.
Lead Analyst: Nicola De Caro, Senior Vice President, Global FIG
Rating Committee Chair: Ross Abercromby, Managing Director, Global FIG
Initial Rating Date: August 05, 2014
Last Rating Date: April 17, 2019

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