Moody's: Stable outlook on Portugal's banking system amid rising growth but still-weak asset quality and capital

Moody's Investors Service has maintained its stable outlook on the Portuguese banking system, reflecting the rating agency's view that, although GDP growth will accelerate, asset quality and capital will be stable but weak. The outlook expresses Moody's expectation of how bank creditworthiness will evolve in Portugal over the next 12-18 months.

Moody's report, entitled "Banking System Outlook - Portugal; Outlook stable as GDP growth accelerates; asset quality and capital weak but stable," is available on www.moodys.com. Moody's subscribers can access this report via the link provided at the end of this press release.

"The stable outlook on Portugal's banking system reflects our view that while sustained economic growth will lead to a mild decline in banks' problem loans, their stock of non-performing assets will remain high," says Maria Vinuela, Assistant Vice President at Moody's.

As noted in September 2017, Moody's expects the operating environment for Portuguese banks to improve over the outlook period as increased investment and exports drive sustained GDP growth, accompanied by falling unemployment.

But while Portuguese banks' stock of problem loans will fall modestly, they will remain high by European standards. At end-June 2017, the banking system's nonperforming loan (NPL) ratio, as defined by the European Banking Authority (EBA), stood at 17.5%, down from 20.1% a year earlier, but well above the European Union (EU) average of 4.5%.

Similarly, banks' capital will remain weaker than the euro area average, held back by low internal capital generation, and high dependence on deferred tax assets. Their average fully-loaded common equity tier 1 (CET1) ratio stood at 11.5% at end-June 2017, below the 14.0% average for the EU.

More positively, Portuguese lenders have improved their funding and liquidity positions in recent years, helped by bank deleveraging, a resilient deposit base, and weaker loan demand. Moody's foresees no pick-up in demand for new credit in 2018, and expects continued deleveraging to deliver further improvements in banks' funding positions.

Profitability, too, will be stable over the outlook period. Although banks' cost of risk will decline as more favourable economic conditions reduce new problem loan formation, this will be largely offset by weaker top-line earnings due to subdued business volumes and low interest rates.

Finally, Moody's assumptions regarding the degree of support the Portuguese government would provide to failing banks are unchanged -- specifically that the introduction of the EU's Bank Recovery and Resolution Directive (BRRD) in 2015 significantly reduced the previous expectation of government support.