Earning My Money

Moody's Investors Service has taken rating actions on seven Portuguese banks and banking groups. The senior debt and deposit ratings for four banks were downgraded by one notch, aligning their ratings at the same level or one notch below the ratings of the Portuguese government, which was downgraded to Ba3 from Ba2 on 13 February 2012. The debt and deposit ratings of Banco Santander Totta (a subsidiary of Banco Santander S.A.) were lowered by two notches to Ba1. The debt and deposit ratings of Banco Comercial Portugues (BCP) and of Caixa Economica Montepio Geral (Montepio) were confirmed at Ba3. All ratings have a negative outlook.

The downgrades of most of the banks' debt and deposit ratings reflect Moody's downgrades of their standalone bank financial strength ratings (BFSRs), which are driven by the following key factors:

While none of these pressures are new, in Moody's view they continue to mount against the backdrop of the ongoing euro debt crisis. Positively, Moody's recognises the supportive stance toward the Portuguese banking system by its government and the euro area authorities including the ECB. However, as discussed further below, Moody's has concluded that this supportive stance does not fully offset the aforementioned negative drivers.

All of the banks' standalone credit assessments have negative outlooks, reflecting the very challenging operating environment, which will likely continue to exert negative pressure on the banks' operating performance. The negative outlooks on the banks' debt and deposit ratings reflect the negative outlook on their standalone credit assessments and on the Portuguese government's Ba3 bond rating.

Today's rating actions conclude the review for downgrade of Portuguese banks, initiated on 15 February 2012 (see "Moody's Reviews Ratings for European Banks"). That review was part of Moody's wider review of European financial institutions driven in part by (i) the difficult European operating environment caused by the prolonged euro area crisis; and (ii) and the deteriorating creditworthiness of certain euro area sovereigns (including Portugal).

Moody's has also concluded its review of systemic support currently incorporated in the ratings of subordinated debt of Portuguese banks, which was initiated on 29 November 2011, and removed all systemic support from these ratings.

As a result, the subordinated debt (and, where applicable, junior subordinated debt) ratings of two banks (Banco Comercial Portugues and Banco Espirito Santo) have been affected, since the ratings on those securities are now being notched off these banks' adjusted standalone credit assessments, which do not incorporate government support assumptions. This action reflects Moody's view that creditors holding subordinated debt of Portuguese banks are more likely to suffer losses than holders of their senior unsecured debt in the event that the government provides financial support to the banking system.

In Moody's view, the intrinsic credit strength of Portuguese banks is weakening, primarily owing to the three drivers mentioned above and discussed below:

Portugal's increasingly challenging economic prospects will exacerbate the intense pressure on Portuguese banks' already weak profitability and asset quality. Moody's expects loan loss provisions to absorb an increasing portion of banks' pre-tax income. At the same time, margins will be further pressured in light of the expected increase in non-earning assets, higher funding costs (particularly of retail deposits) and continued balance sheet deleveraging.

The Portuguese economy, which Moody's expects to shrink by 3.6% during 2012, is weighed down by the weakening sovereign credit profile (reflected in the recent government bond rating downgrade to Ba3 from Ba2 on 13 February 2012), by the government's austerity programme needed to consolidate the sovereign's debt position and by an increasingly restricted supply of credit, as banks seek to reduce risk assets given the demands on them to deleverage from investors and regulators. The recapitalisations orchestrated (and most likely funded) by the Portuguese government as a means of supporting the solvency of the Portuguese banking system and perhaps ultimately bolstering confidence in it are likely, in the short term, to further inhibit credit creation.

Portuguese banks, like most banks, have substantial exposures to their domestic sovereign. Holdings of government bonds averaged around 80% of core capital as of end-December 2011 for the seven banks covered by today's announcement. This direct exposure, together with exposure via counterparties and customers who are themselves sensitive to the sovereign, means Portuguese banks are highly sensitive to the sovereign's weakening credit profile (see "Moody's adjusts ratings of 9 European sovereigns to capture downside risks" and "How sovereign credit quality may affect other ratings", 13 February 2012).

Portuguese banks face a prolonged loss of access to private sources of wholesale funding. They are, to all intents and purposes, unable to operate on a standalone basis without external funding. Moody's has taken into account the extensive routine and extraordinary financing made available by the Portuguese government and the euro area authorities in preserving the banks' BFSRs and debt and deposit ratings in the 'B' and 'Ba' category. The rating agency also acknowledges the generally supportive stance of the euro area authorities including the supportive effect of recent ECB operations, which have sharply reduced the risk of any bank failing because of illiquidity.

However, this supportive stance does not mitigate Moody's concerns. Such extraordinary support will ultimately buy time, however there is still significant uncertainty about how that time will be used to resolve the underlying problems driving the euro area debt crisis or to enable the Portuguese banks to re-enter the markets. The recent downgrade of the Portuguese sovereign reflects the heightened uncertainties over the government's ability to achieve its debt targets given, for example, the weakening of the Portuguese economy.

In such an environment it is very difficult to see the Portuguese banks re-entering the private markets in the foreseeable future. The longer the banks remain reliant on public sector support, the greater the probability that conditions come to be attached to continued funding and liquidity support, with negative consequences for creditors including bondholders. Moody's has therefore concluded that it should continue to place only limited additional weight on the availability of routine and extraordinary funding and liquidity support arrangements in assessing the banks' standalone strength, and in determining the appropriate uplift factored into debt and deposit ratings. 

By RAZI ANWAR (PGDM 2nd sem)