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Portuguese banks to benefit from economic uptick in bid to reduce bad loans

Portugal's economy is starting to turn the corner, fueling optimism that local banks will finally be able to reduce their large stock of problem loans, but industry observers warned that the country's financial sector will take time to rid itself of bad debt.

Six years after Portugal's €78 billion bailout and subsequent bank rescues, its lenders remain among the EU's worst performers in terms of nonperforming loans, with banks forced to provision heavily, denting their capital ratios and profitability — a situation that has been exacerbated by the country's protracted recession, as credit demand has failed to take off.

According to data compiled by S&P Global Market Intelligence, Portugal's ratio of nonperforming exposures versus total loans stood at 16.42% at the end of 2016, compared to 4.44% for the EU as a whole. Two years earlier, the respective ratios had been 14.79% and 5.54%, showing that the trend in Portugal has been significantly worse than elsewhere. In neighboring Spain, for instance, the ratio fell to 4.91% from 6.76% over the period after most of its banks vastly reduced their NPLs. In Italy, where the government is propping up banks with a €20 billion rescue fund, it stood at 12.59% at the end of 2016, down from 14.01% two years earlier.

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'A lot of work to be done'

"The major issue for Portuguese banks at the moment is the NPLs," Fincor analyst Albino Oliveira said in an interview. "It's a major problem for banks such as Caixa Geral de Depósitos SA and Novo Banco SA as they have significant exposure to the economy. There's a lot of work to be done."

Yet, Portugal's economy accelerated its recovery in the first quarter, expanding at an annualized 2.8% compared to 2% and 1.7% in the fourth and third quarters of 2016, respectively, and just 1% in the first half of last year.

"If the economy continues to recover at this pace, it will be a great help," Oliveira said.

However, Anna-Joy Kühlwein, a senior investment analyst at Landesbank Baden-Württemberg, cautioned that "it's too early to say that the trend is declining."

Banks such as Caixa Geral, which launched a state-backed €5 billion recapitalization program to turn its finances around, will benefit from the uptick in the economy, but Oliveira warned that the lender "will need time because interest rates are low, its return on equity remains low. They will take time to sell NPLs — it's not something that could happen at the end of the year. It's difficult for it to create capital."

The ratio of gross impaired loans to loans at Caixa Geral was 10.5% at the end of 2016, up from 9.4% two years earlier. Millennium BCP's ratio fell to 10.9% from 13.1% over the period, yet by comparison, many Spanish lenders are in a much better position. For example, at CaixaBank SA, the ratio fell to 6.93% from 8.88% over the two years, while Banco de Sabadell SA's slid to 6.42% from 16.12%.

?Bad bank a potential solution

There is also concern among some analysts that better economic growth alone is not enough for Portuguese banks to reduce their bad loans and that a vehicle for them to park those loans might be required.

Bank of Portugal Governor Carlos Costa was quoted by Reuters recently saying that the country's banks needed a common mechanism that would allow them to off-load bad loans and unprofitable assets. Portuguese Prime Minister António Costa said at the end of May that the government was working with the central bank to establish a platform where banks can coordinate their lending activity, though he ruled out the need for a bad bank.

"A bad bank would be a good idea, but you don't have the money for financing it in Portugal," Kühlwein said.

The success of any vehicle to soak up bad loans would depend on how the entity was constructed, other analysts said.

"At this stage, it is not crystal clear whether a bad bank would be a solution," said Carlos Peixoto, analyst at BPI Online. "It would depend on the terms of it."

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