S&P Warns May Downgrade Portugal Again As Early As This Week

Tyler Durden's picture

Just released by Moody's:

  • On March 23, 2011, the Portuguese parliament rejected the government's proposed austerity package. Prime Minister José Sócrates subsequently resigned, which, in our opinion, increases policy uncertainty and heightens Portugal's refinancing risk.
  • We have lowered our long-term sovereign credit rating on Portugal by two notches to 'BBB' from 'A-'. The 'A-2' short-term sovereign credit rating is unchanged. All ratings remain on CreditWatch with negative implications, pending the official announcement about the European Stability Mechanism.
  • We are lowering our long- and short-term counterparty credit ratings on the five Portuguese banks and two related subsidiaries that we rate. The long-term ratings remain on CreditWatch with negative implications.

  • The negative CreditWatch implications reflect the possibility of a further sovereign downgrade, which we expect could take place as early as this week, and its direct and/or indirect impact on our view of Portuguese banks' creditworthiness.

More bad news for Portuguese bonds which just traded at lifetime high yields.

Full report:

Rating Action

On March 28, 2011, Standard & Poor's Ratings Services lowered its long- and short-term ratings on the five Portuguese banks and two related subsidiaries that it rates. At the same time, Standard & Poor's removed all of its short-term ratings on the banks (except for Millennium bcp) from CreditWatch, where they had been placed with negative implications on Dec. 3, 2010. All long-term ratings that were on CreditWatch with negative implications remain on CreditWatch.

Specifically, we lowered our long- and short-term counterparty ratings on:

  • Banco Santander Totta, S.A. (Santander Totta) to 'BBB/A-3' from 'A/A-1'. At the same time, we lowered our ratings on Santander Totta's hybrid instruments to 'BB' from 'BBB'. In addition, we lowered our assessment of Santander Totta's stand-alone credit profile (SACP) to 'bbb' from 'a-'.
  • 100% state-owned Caixa Geral de Depósitos S.A. (CGD) to 'BBB/A-3' from 'A-/A-2'. At the same time, we lowered our ratings on CGD's hybrids to 'BB' from 'BBB-'. In addition, we lowered our assessment of CGD's SACP to 'bbb' from 'a-'.
  • Banco Espirito Santo, S.A. (BES) and its core subsidiary Banco Espirito Santo de Investimento, S.A. (BESI) to 'BBB/A-3' from 'A-/A-2'. At the same time, we lowered our ratings on BES' and BESI's hybrids to 'BB' from 'BBB-'.
  • Banco BPI S.A. (BPI) and its core subsidiary Banco Português de Investimento S.A. to 'BBB/A-3' from 'A-/A-2'. At the same time, we lowered our ratings on BPI's hybrid to 'BB' from 'BBB-'.
  • Banco Comercial Português, S.A. (Millennium bcp) to 'BBB-/A-3' from 'BBB+/A-2'. In Millennium bcp's case, both the long- and short-term ratings remain on CreditWatch with negative implications. We have increased the notching differential between our ratings on Millennium bcp's hybrids and our counterparty credit ratings on the bank to four notches from three. Consequently, we have lowered our ratings on Millennium bcp's hybrid to 'B+' from 'BB+'.

Rationale

Our rating actions today reflect:

  • The direct impact of our two-notch downgrade of the Republic of Portugal (BBB/Watch Neg/A-2) on those Portuguese banks' that we previously rated at the same level or higher than the sovereign, namely Santander Totta, CGD, BES, and BPI; and
  • The deterioration we anticipate of the financial profiles of all of the rated Portuguese banks as a result of what we view as an increasingly difficult economic, financial, and operating environment in Portugal.

We rarely rate financial institutions above the long-term sovereign rating on their home country, since we generally consider it unlikely that these institutions would remain unaffected by developments in their domestic economy. We have decided, with today's rating actions, specifically, to no longer rate Santander Totta higher than the sovereign (previously, our long-term rating on Santander Totta incorporated a one-notch uplift over our assessment of the bank's SACP to reflect the benefit of parent support, and, as a result, its long-term rating was one notch higher than the long-term sovereign rating). Although we believe that having Spanish bank Banco Santander S.A. (AA/Negative/A-1+) as a parent gives Santander Totta greater financial flexibility with respect to its domestic peers, we believe that the parent would have little incentive to provide financial support to Santander Totta if the sovereign were to face meaningful stress. Even if Banco Santander were willing to provide financial assistance to Santander Totta in a stressful scenario, we believe that the magnitude of such support would not be material enough to be reflected in a one-notch differential with the long-term sovereign rating.

The operating environment for Portuguese banks is becoming increasingly challenging, in our opinion. We anticipate that the need to correct fiscal and external imbalances will lead the Portuguese economy back into recession in 2011 and will potentially confine economic growth prospects over a more prolonged period. With the economy contracting, Portuguese banks' domestic asset quality and profitability will, in our view, likely deteriorate further. The sound performance we foresee for most of these banks' international operations should, we believe, help partially offset the impact on consolidated profits, but only to a limited extent.

Increasing policy uncertainty, in turn, will, in our opinion, further undermine the already very weak level of investor confidence, increasing Portuguese banks' funding difficulties. In our view, the wholesale markets will remain closed for the issuance of medium and long-term debt, and temporary strains in the short-term markets cannot be disregarded. Potential risks related to episodes of illiquidity in the short-term markets are, in our opinion, mitigated, however, by our view that Portuguese authorities—in the EU
framework—are supportive of the country's financial system, and that, consequently, Portuguese banks benefit from operating in a regulated and supervised environment, with access to extraordinary liquidity, such as that provided by the European Central Bank (ECB).

To cope with challenging funding markets, Portuguese banks have already articulated strategies to deleverage, including selling and/or not renewing domestic and international loans, reducing the size of their securities portfolios, upstreaming excess funding from international operations to parents, and increasing on-balance-sheet retail deposits. We believe that these strategies, while positive from a funding and liquidity perspective, will likely lead to a credit contraction and will heighten price competition for domestic retail funding. In our opinion, credit contraction, in turn, will put pressure on domestic demand and borrowers' ability to meet their financial obligations. As a result, we believe that funding challenges will magnify the negative effect of Portugal's economic recession on Portuguese banks' domestic asset quality and profitability.

In our view, Portuguese banks' direct exposure to the country's sovereign debt, through their securities portfolio, is not negligible compared to the banks' capital bases (particularly for some institutions). At current rating levels, however, we do not think that public debt holdings expose Portuguese banks to significant credit risk, although they do expose them to market risk.

Lastly, we anticipate that Portuguese banks' capitalization will remain stable, with the likely reduction of risk-weighted assets (RWA) as the deleveraging progresses compensating the banks' weak earnings generation. We see downside risk, however, if weak market performance increases the banks' pension fund deficits, which are partly deducted from regulatory capital ratios. In any event, and as in the past, we do not expect capital to be a supportive rating factor for the Portuguese banks.

In light of the challenges ahead and our actions today on the Portuguese banks we rate, we will shortly review our Banking Industry Country Risk Assessment (BICRA) for the Portuguese financial system (we currently place Portugal in BICRA Group 3 on our scale of 1 to 10, with 1 representing the strongest).

We have lowered our short-term ratings on the Portuguese banks to 'A-3' in the context of what we see as increased vulnerability of their funding profiles to fragile market confidence. The current operating environment magnifies financial institutions' inherently high exposure to liquidity risks, given their highly leveraged balance sheets and the meaningful weight of short-term liabilities (including deposits) in their funding mixes.