DBRS Morningstar Confirms Novo Banco’s Long-Term Issuer Rating at B (high), Trend Remains 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 remains Negative, while the trend on the Short-Term Issuer and Deposit ratings is Stable. The BB (high)/R-3 Critical Obligations Ratings were confirmed with Stable trend. 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 confirmation of the ratings reflects the Bank’s continued progress in reducing its Non-Performing Loans (NPLs) and other non-core assets, the expected further capital support through the Contingent Capital Agreement (CCA) from the Portuguese Resolution Fund, as well as the Bank’s relatively stable franchise as the fourth largest Corporate bank in Portugal. 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 8.9% at FY20, from 11.8% at FY19, remains 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 2020, NB posted a net loss of EUR 1.3 billion, following a negative result of EUR 1.1 billion in 2019.

The Negative trend on NB’s long-term ratings considers the risks for the Bank’s financial position and its restructuring plan stemming from the ongoing economic disruption caused by the COVID-19 pandemic. For the time being, policy support measures including furlough schemes, loan moratoria and state guaranteed loans have helped to mitigate the impact. However, in our view, risks for asset quality will be more pronounced when these measures are withdrawn. At YE 2020, NB had EUR 6.9 billion of loans under moratoria, accounting to around 27% of the its loan book, and the bulk of it will expire in Q3 2021.

In addition, we also consider the weaking of the Bank’s capital ratios at YE 2020, as well as the increased uncertainty surrounding the expected capital injection under the CCA. This follows on from the decision of the Portuguese parliament to block the inclusion of new funds in the 2021 state budget.

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, however, the Trend could revert to Stable if the capital uncertainty decreases and the Bank improves its capital ratios. In addition, the Bank will need to demonstrate its ability to restore profitability.

A downgrade could arise from a deterioration in the Bank’s capital position or a further deterioration in asset quality.

RATING RATIONALE

The CCA is a key part of the process which led to the European Commission's (EC) approval, under EU State Aid rules, for Portuguese aid in the sale of Novo Banco in 2017. As of end-2019, NB has received CCA compensation totaling EUR 2.98 billion. The amount still available for NB under the CCA is up to around EUR 900 million, of which around EUR 600 million was requested by the Bank for the loss incurred in 2020. Up until now the support from CCA has been timely and predictable. Despite the current political uncertainty, we believe that a solution will be found given the Prime Minister and Finance Minister have publicly said that the Portuguese authorities will keep their commitments under the CCA, supporting our view that additional capital will be provided to NB in Q2 2021.

The CCA has proved effective in supporting the Bank’s restructuring plan and de-risking process agreed with the DG comp. In 2020, NB continued to reduce its NPLs and real-estate assets and, as part of its strategic refocus on the core business in Portugal, the Bank announced the sale of its Spanish operations.

NB’s gross NPL stock decreased by 27% to EUR 2.5 billion at end-2020, while the gross NPL ratio fell to 8.9% from 11.8% at end-2019, thanks to a combination of cures, write-offs and disposals covered by the CCA. Despite this reduction, 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.

However, the ongoing economic disruption due to COVID-19 is likely to contribute to the formation of new NPLs and increase the execution risk for the Bank’s NPL reduction plan, when the policy support measures are withdrawn. At end-2020, NB had EUR 6.9 billion of loans under moratoria which represent a sizeable 27% of the gross loan book. This portion is much higher than its domestic and international peers.

In addition to legacy issues, the economic impact from COVID-19 led to higher provisions and revenues pressure in 2020. Total impairment charges and provisions amounted to EUR 1.2 billion in 2020, of which EUR 269 million were for COVID-19 following the revision of the risk models and the update of macro assumptions, EUR 524 million for credit impairments on legacy assets, and EUR 166 million for the discontinuation of the Spanish operations. The lockdown measures have also led to lower fees from payment systems and lending products, while net income stayed largely flat on the back of higher loan volumes in the corporate and SME sectors, support from TLTRO funds as well as lower funding costs helped by re-pricing actions.

The Bank’s deposits largely remained flat in 2020 at EUR 26 billion (pro-forma excluding the Spanish operations) and accounted for 59% of total assets at 2020. Funding and liquidity conditions also benefited from the measures announced by the ECB to counter the impact of the pandemic. The provision of TLRO III funds contributed to the extension of the maturity profile and an increase in Novo Banco’s NSFR to 113% from 101% at end-2019.

NB’s capital ratios weakened in 2020, as the loss for the year was higher than the CCA amount expected to be paid in Q2 2021. The Bank reported phased-in CET1 and total capital ratios at 11.3% and 13.3%, including the CCA call for 2020, respectively, down from 13.5% and 15.1% at end-2019. Capital support under the CCA will end with the run-down of the legacy portfolio presumably in 2021-2022, and the Bank will need to demonstrate its ability to generate earnings to build capital.

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/373262

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/Very Weak.

Notes:
All figures are in EUR unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (8 June 2020), https://www.dbrsmorningstar.com/research/362170/global-methodology-for-rating-banks-and-banking-organisations Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (3 February 2021) https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings
And the DBRS Morningstar Criteria: Guarantees and Other Forms of Support (14 January 2021), https://www.dbrsmorningstar.com/research/372344/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 Company Documents, Novo Banco’s H1 2020 Report, Novo Banco FY20 Results Press Release, Novo Banco’s FY20 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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/376937

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Nicola De Caro, Senior Vice President, Global FIG
Rating Committee Chair: Elisabeth Rudman, Managing Director, Global FIG
Initial Rating Date: August 5, 2014
Last Rating Date: April 9, 2020

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