Portugal Evades Second Tap of Aid for Bank Needs: Euro Credit

Portugal’s banks are defying a prediction by Moody’s Investors Service that the nation would need to tap bailout funds a second time to refinance lenders.

The government is raising taxes and cutting spending to meet the terms of its 78 billion-euro ($102 billion) rescue by the European Union and the International Monetary Fund. As part of the plan, Portugal injected 5.6 billion euros into banks that aren’t state-owned, helping its financial industry cope with higher capital requirements and a rise in bad loans as the economy shrinks for a third year.

“With recession extending through the middle of 2014 and bad loans peaking later that year or in 2015, the risk of a series of capital increases at banks is very limited,” said Andre Rodrigues, an analyst at Caixa Banco de Investimento.

The Portuguese government forecasts the economy will contract by 2.3 percent this year before growing 0.6 percent in

2014. The jobless rate will climb to 18.2 percent in 2013 and

18.5 percent next year. Portugal’s 10-year borrowing cost dropped to 5.73 percent last week, its lowest level in more than two years, and traded at 5.8 percent at 8:45 a.m. London time, compared with an average of 8.4 percent in the past year. The yield premium to German bunds has narrowed to 462 basis points from 511 at the start of the year.

Bad loans rose to a record 6.7 percent of total loans in February, up from 6.5 percent the previous month, according to Bank of Portugal data, with most of the increase attributable to companies failing to pay their debts.

Moody’s Doubts

“Despite the effort that has been made to improving the capital for banks, amid the deterioration of the economic environment, asset quality and profitability are going to continue to suffer,” Moody’s analyst Pepa Mori said in an interview in Lisbon on April 10. Mori estimates the country’s lenders may need an additional 8 billion euros in capital, with only about 6 billion euros left from the aid package.

Portuguese businesses are among those in the euro area with the largest “debt overhang,” according to the International Monetary Fund’s Global Financial Stability Report published April 17. This may in turn hurt bank’s asset quality, the report showed.

Stress Tests

“Even in a scenario of rising bad loans and sovereign risk, Portuguese banks look resilient compared to peers in the periphery,” analysts at Royal Bank of Scotland Group Plc in London wrote in a note to clients April 19. “Our stress tests show Portuguese banks can manage a rise in bad loans of over 50 percent, and a widening in sovereign spreads.”

Banco Espirito Santo SA, Portugal’s second-biggest non-state bank by assets, would be able to offset a 30 to 40 percent a year increase in bad loans with earnings alone, Lee Tyrell-Hendry, one of the authors of the RBS report, said in a telephone interview.

Portuguese banks had a core tier 1 capital ratio of 11.5 percent at the end of 2012, according to the Bank of Portugal, in line with that of the biggest banks in Europe by market value, according data compiled by Bloomberg.

“In the short time, Portuguese banks’ headline capital ratios in the European context look pretty solid,” said Benjie Creelan-Sandford, an analyst at Macquarie Bank Ltd. in London. “My concern is in the medium term, I think the banks will have a problem in repaying the state for the hybrid instruments.”

Bond Aid

To help refinance lenders, the state subscribed to contingent convertible bonds sold by the banks that convert into equity if a capital ratios drop below pre-defined levels. Banco Comercial Portugues SA plans to repay the state by the end of 2016, while Banco BPI SA targets repayment by mid-2017. BPI CEO Fernando Ulrich said in an April 25 interview that the bank could pay earlier if regulatory capital requirements changed.

“Regulators went too far” in calls for increases in banks’ capital after the 2008 financial crisis, Jose Maria Ricciardi, CEO of Banco Espirito Santo SA’s investment banking unit, said in a Bloomberg Television interview with Guy Johnson April 18. “It’s better to invest more in supervision than asking still more capital for the banks.” Espirito Santo didn’t resort to state aid to increase its capital ratios.

“The Portuguese banks are now very well capitalized and now they are beginning to come back to the markets and liquidity is better than before,” Ricciardi said. “What the banks now need is the improvement of our economy.”

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