DBRS Upgrades Novo Banco’s Issuer Rating to B (High); Trend Remains Positive

DBRS Ratings GmbH (DBRS) upgraded Novo Banco, S.A.’s (NB or the Bank) Long-Term Issuer Rating to B (high) from B. The Bank’s Short-Term Issuer Rating was confirmed at R-4. The Trend remains Positive for the Long-Term Issuer Rating and Stable for the Short-Term Issuer Rating. The Bank’s Intrinsic Assessment (IA) was raised to 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 upgrade of NB’s Long-Term Issuer Rating to B (high) takes into consideration the improvement in the Bank’s risk profile, particularly in terms of the reduction in Non-Performing Loans (NPLs), the divestment of non-core assets and the further rationalisation of the organisational structure. The ratings, however, also continue to reflect the Bank’s weak profitability and its large stock of legacy problem assets. Albeit improving, NB’s gross NPL ratio, which stood at 22% at FY18, remains considerably weaker than most European banks.

The Positive Trend reflects DBRS’s expectation that, with the continued support from the contingent capital agreement (CCA) available for NB from the Portuguese Resolution Fund, and the still favourable economic conditions in Portugal, NB will make further progress with the clean-up of its balance sheet and maintain adequate capital buffers. The Bank’s liquidity position, which began to stabilise in 2018, is also expected to remain adequate.

The upgrade of NB’s COR to BB (high), with a Positive Trend, reflects DBRS’s view that the risk of applying resolution measures to NB has receded even further given the Bank’s improved risk profile and expected capital support from the CCA. At present, the COR of NB is still positioned three notches above the Bank’s IA. However, DBRS would expect this to narrow to a more typical 2 notches above the IA upon reaching investment grade.

RATING DRIVERS

A rating upgrade would require a further significant reduction in NPLs and improvements in core profitability. The Bank will also need to demonstrate a longer track record of stability in its deposit funding base and improved access to wholesale funding. Downward rating pressure could arise from a weakening of the liquidity position as well as a material deterioration in the Bank’s reputation and customer franchise. Negative implications could also emerge should the Bank face challenges in executing its restructuring plan.

RATING RATIONALE

NB is Portugal’s 4th largest bank by total assets with solid market shares in the Corporate and SME sectors. The Bank is currently implementing a restructuring plan following its sale to Lone Star and the European Commission’s approval under EU State Aid rules. Notable achievements in 2018 included large sales of NPLs and real estate assets. In addition, as part of the strategic re-focus on the core business in Iberia, the Bank completed the disposal of several international operations. The Bank has also continued to streamline its branch network.

In 2018, the Bank accelerated its NPL reduction, mainly through disposals. The gross NPL stock decreased by 34% to EUR 6.7 billion at FY18, from EUR 10.1 billion at FY17. The gross NPL ratio (based on the definition of the European Banking Authority, or EBA, and including exposures to central banks and credit institutions) improved to 22% at FY18 from 28% at FY17, however, this remains high. The bulk of NB’s problem assets relates to Corporate and SME loans. Total provisioning coverage strengthened to 60% from 56% in FY18, but the portion of uncollateralised loans remains high.

DBRS expects the NPL reduction to continue in 2019. Under the CCA, the Portuguese Resolution Fund will compensate NB, up to a limit of EUR 3.89 billion, for losses that may be recognised with respect to some of its problem assets, in the event that its capital ratios decrease below a predefined threshold.

The total assets covered by the CCA amounted to EUR 7.5 billion in FY18 (or EUR 4 billion, net book value). At FY18, NB had requested compensation for a total amount of EUR 1.9 billion, of which EUR 1.1 billion was for 2018. This amount is expected to be paid by the Resolution Fund in May 2019. After this payment, the CCA amount still available for NB is equal to approximately EUR 1.9 billion.

The losses from the CCA assets and other impairments contributed to a net loss of EUR 1.4 billion in 2018. Provisioning levels are also expected to remain elevated in 2019 in connection with the ongoing de-risking plan. Concurrently, DBRS expects the Banks pre-provision income to benefit from several initiatives being implemented which are aimed at recovering core revenue and improving efficiency levels.

NB’s phased-in common equity tier 1 (CET1) capital ratio remained stable at 12.8% at FY18, including the capital support from the CCA. The total capital ratio increased to 14.5% with the issuance of subordinated Tier 2 bonds, providing a small cushion over the total minimum requirement of 14% set under the ECB SREP.

NB’s funding and liquidity positions began to stabilise in 2018 after a prolonged period of uncertainty linked to the Bank’s complex recapitalisation process. The return to the bond market, with a Tier 2 issuance in June 2018, represented a positive development for NB’s restructuring plan. However, in DBRS’s view, the Bank’s access to the capital markets has not yet normalised and it remains vulnerable to a potential weakening in reputation or challenging market conditions.

The Bank’s current funding structure depends largely on deposits and ECB funding. Total deposits accounted for 59% of total funds at FY18, and the bulk of it is composed by sights deposits and term deposits (up to 1 year) with retail customers. In 2018, the stock of deposits decreased by EUR 1.3 billion led by several initiatives on deposit re-pricing with the aim of reducing funding costs. The Bank also has a significant exposure to the ECB with EUR 6.4 billion in TLTRO 2 funds.

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 Euros unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (July 2018) and DBRS Criteria: Guarantees and Other Forms of Support (January 2019). This can be found can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include company documentation and financials, and SNL Financial. 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 GmbH are subject to EU and US regulations only.

Lead Analyst: Nicola De Caro, Senior Vice President, Global FIG
Rating Committee Chair: Elisabeth Rudman, Managing Director, Head of European FIG - Global FIG
Initial Rating Date: August 05, 2014
Most Recent Rating March 28, 2019

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