Portugal’s weakening sovereign fundamentals challenge banks ratings

The recent weakening in Portugal's sovereign credit fundamentals, which is reflected in the negative outlook on the Aa2 government debt rating, and the challenges ahead for the domestic economy raise questions about the potential impact these developments may have on the credit profiles of Portuguese banks, Moody's Investors Service said in a new Special Comment. However, Moody's bank financial strength ratings (BFSRs) for Portuguese institutions already incorporate its anticipation of a further deterioration in their financial fundamentals in light of the expected low trend growth rate of the Portuguese economy and the potential negative impact of fiscal consolidation on households and corporates.
By contrast, Moody's cautions that the debt and deposit ratings of Portuguese banks could come under downward pressure because these ratings take into account not only the banks' intrinsic creditworthiness but also their potential external sources of support, including support from the Portuguese government.
The weighted average BFSR of Portuguese banks is now C- versus C+ at the beginning of 2008.
As a result, Portuguese banks' current BFSRs incorporate an anticipated deterioration in their financial fundamentals. In addition, the negative outlook on most of these BFSRs indicates that there could be downward pressure on these ratings if loss assumptions were to increase significantly above Moody's current expectations or if the banks' risk absorption capacity were to deteriorate beyond Moody's expectations in its base case scenario. This would allow a further deterioration in bank's asset quality and ensuing provisioning requirements of up to EUR 4.5 bln on top of the system's Q3/09 provisions of EUR 7.5 bln.
Moody's considers that both the ability and willingness of the Portuguese government to support the country's banking system remain very strong but they may be decreasing, albeit marginally.
As a result, the debt and deposit ratings of Portuguese banks are at risk not only from a potential downgrade of the sovereign rating but also from an assessment of the government's decreasing ability and, potentially, willingness to support the country's banking system.