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Caixa Geral recapitalization shadowed by bad loans, weak economy

Portugal's largest bank by assets is embarking on a major state-funded recapitalization program to shore up its ailing finances, but it could be a case of short-term gain without eradicating the long-term pain.

State-owned Caixa Geral de Depósitos SA said Dec. 12 that it had received permission from the ECB and the Bank of Portugal to proceed with the first stage of its €5 billion recapitalization plan, which the EU and Portugal agreed on at the end of August. The plan includes a €2.7 billion injection of funds, the conversion of €900 million of government-held contingent convertible bonds into equity and a €1 billion issuance of fresh subordinated debt.

"In the short term, it is good news and is another sign of the Portuguese banking sector moving forward," Joao Lampreia, an equity analyst at Banco de Investimento Global in Lisbon, said in an interview. "But it's not 100% crystal clear if it will be enough."

Bad loans, slow growth

Portugal has pumped billions of euros into its banking sector in recent years, including during its 2011 financial crisis and more recently via the rescues of Banco Espírito Santo SA in 2014 and Banif-Banco Internacional do Funchal SA in 2015.

The sector has faced elevated levels of bad loans in the wake of Portugal's long recession. The country was bailed out with €78 billion from the EU and IMF in 2011, and concerns have risen recently that the economy may need another aid package as a new left-wing government rolls back key austerity measures.

Foreign investors have been helping shore up many of the country's privately owned banks. The Portuguese unit of Spain's Banco Santander SA took over the bulk of Banif; China's Fosun Financial Holdings Ltd. has agreed to buy an almost 17% stake in Millennium BCP and could raise it to as much as 30%; Spain's CaixaBank SA is planning to close its takeover of Banco BPI SA by early 2017; and Chinese and U.S. investors are in the fray for Novo Banco SA, the good bank carved out of Banco Espírito Santo.

Portugal had to spend months convincing the EU to allow it to prop up CGD, eventually reaching a deal to structure the transaction so that it would not qualify as state aid and therefore not push up the government's budget deficit.

The bank reported a net loss of €189.3 million for the first nine months of 2016, with provisions and impairments totaling €412 million. In June, the Portuguese government asked for an audit of the bank's finances amid allegations of irregularities in granting loans.

Credit at risk of default totaled 12.2% of gross loans at the end of September, with 63.8% of the credit at risk accounted for by provisions and impairments. The bank's common equity Tier 1 ratio was 10.2% on a phased-in basis and 9.3% on a fully loaded basis.

"Higher capital levels should place the bank in a better position to clean up its balance sheet, including its high stock of nonperforming loans," said Maria Rivas, vice president at rating agency DBRS.

But the plan comes with other major challenges, including the still-sluggish rate of growth in the Portuguese economy. The European Commission is predicting growth of 0.9% in 2016, down from 1.6% in 2015, and the success of the CGD capitalization will depend very much on economic growth, which affects lending.

"We are still going through a long deleveraging in Portugal," Fincor analyst Albino Oliveira said in an interview. "It will continue in 2017 and into 2018 and credit will grow at a slow rate."

The bank is also planning to cut 2,500 jobs by 2020 and close branches in an effort to reduce costs as economic pressures are compounded by low interest rates that are eating away at banks' profits.

"The return to profits going forward will depend upon the bank's ability to offset the pressure in revenues from the low interest environment by reducing costs and benefiting from lower impairments, which seems challenging given the still weak sluggish economic recovery for Portugal, the low interest rate environment and increasing regulatory requirements," Rivas said.

High cost of debt

There is also the issue of how successful the bank is in its sale of subordinated debt, with the first tranche scheduled for early 2017. DBRS, the last significant credit rating agency to class Portugal as investment-grade, maintained its credit rating for the country in October, ensuring the eligibility of Portugal's bonds to be included in the ECB's quantitative easing program.

But the yield on 10-year Portuguese government debt rose over concerns that Portugal could find itself reduced to a junk rating, and yields have remained high and now hover close to 4%, up from less than 3% in mid-August. DBRS on Nov. 29 placed ratings for CGD and its subsidiaries under review with negative implications, citing the range of risks facing the bank.

"It will be a high cost selling this in the market," Oliveira said. "But there is no other way for them to advance in their restructuring."