Moody’s maintains negative outlook on Portuguese banks

The negative outlook on the Portuguese banking system is based on the expected continuation of the adverse impact of the weak macroeconomic environment on the country's banks, Moody's Investors Service said in its latest banking System Outlook on Portugal.
"The weak macroeconomic environment, characterised by contracting GDP and rising unemployment, will adversely affect Portuguese banks' asset quality, profitability and capital," said Olga Cerqueira, author of the report and lead analyst for Portuguese banks.
These factors, combined with the persistent structural weaknesses — namely high credit risk concentration exposure to market risk, strong reliance on wholesale funding and corporate governance issues — triggered Moody's downgrade of the ratings of Portuguese banks in September. The weighted average bank financial strength rating (BFSR) of Portuguese banks was downgraded to C- from C, and the weighted average senior debt and deposit rating to A1 from Aa3.
"However, the exceptional level of systemic support from the government led to the banks' senior debt and deposit ratings showing greater stability than BFSRs during the crisis," explained Maria Cabanyes, Senior Vice President in Moody's Financial Institutions Group. The government's support to its banking system was demonstrated by the nationalisation of Banco Portuguκs de Negσcios (rated Baa3/P-3/E+), the liquidity support provided to Banco Privado Portuguκs, as well as the numerous support measures taken in 2008, which included a EUR 20 bln state-guaranteed debt facility among other measures.
The government's demonstrated willingness to support Portuguese banks is a key reason for the strong uplift (of four notches on average) that their debt and deposit ratings receive from their standalone baseline credit assessments (BCAs, which map from their BFSRs). "Given the high concentration in the Portuguese banking system, with the five largest banks accounting for around 75% of the system, Moody's expects systemic support to remain very high for systemically important institutions, even after the crisis," added Cerqueira. However, this may not be the case for smaller institutions if they are unable to strengthen their credit profiles by the time the government reduces its support.
The current dynamic environment has made necessary to complement the analysis of the historical performance of Portuguese banks with forward-looking opinions on expected credit losses and financial performance. The rating agency's current ratings can absorb estimated lifetime credit losses and writedowns on securities of around EUR 12 bln for rated Portuguese financial institutions in its base stress scenario.
Moody's factors these losses into its analysis by assuming that they could materialise over the next six quarters. "Unless the downturn in the economy is significantly worse than anticipated in Moody's base-case scenario, the rating agency does not expect further system-wide BFSR downgrades," said Cerqueira. The evolution of each banks' BFSR will mostly depend on its earnings generation capacity, capital levels and its strategies for addressing its own weaknesses.
However, Moody's cautions that the debt and deposit ratings of several banks could potentially be downgraded if the Portuguese government's rating (currently at Aa2, with a negative outlook) were to be downgraded to Aa3. The government's rating is a key element in determining its ability to support the banking system. Moody's says that a potential downgrade of the government's rating would lead to a maximum one-notch downgrade of Portuguese banks' debt and deposit ratings.