Moody's changes outlook on Portugal's banking system to stable

Moody's Investors Service has changed the outlook on Portugal's banking system to stable from negative, reflecting the rating agency's view that improving operating conditions in Portugal will benefit the country's banking system. The outlook on Portugal's banking system had been negative since 2008.

"The country's modest economic recovery will help stabilise Portuguese banks' credit fundamentals, and improving operating conditions are translating into a gradual deceleration in asset quality deterioration ," says Maria Vinuela, an Assistant Vice President at Moody's and author of the report.

Portuguese banks are now better able to absorb potential losses, after they were recapitalised, restructured and have bolstered loan loss provisions in recent years, although their loss-absorption capacity is still weaker than that of banks in other European systems.

"We also forecast that over the next 12-18 months the banking sector will return to profitability, albeit at weak levels, thanks to a reduction in the cost of risk," says Ms Vinuela. However, Moody's expects that the capacity of Portugal's banks to generate recurrent earnings will continue to be constrained by low interest rates, a still substantial amount of non-earning assets and reduced business volumes. Weak recurrent earnings will also continue to inhibit their capacity to generate capital internally.

Portuguese banks' funding and liquidity position has improved on the back of deleveraging and a stable retail deposit base, which has allowed them to continue to reduce their loan-to-deposit ratio and the use of wholesale and central bank funding.

Finally, the European Union's new banking resolution framework is now in place in Portugal, setting rules to guide the resolution of banks and reducing any uncertainty on government support. Moody's now considers that government support will only translate into a meaningful reduction in credit risk for those senior creditors and junior depositors of Portuguese banks considered to be systemically significant. Moody's expectation of lower loss rates in the event of resolution is mitigating the impact on bank ratings of the new resolution framework and the reduction of public support.