Portuguese banks well placed to absorb rise in impaired loans, says Fitch

Portuguese banks are generally well positioned at their rating level to withstand a likely increase in impaired loans in 2023 resulting from the economic slowdown, high inflation and rising interest rates, Fitch Ratings says.

“We expect the sector’s impaired loans ratio to increase only modestly, partly due to tighter underwriting guidelines introduced in 2018. Moreover, banks have improved their ability to absorb impaired loans through write-offs and sales in recent years by developing in-house loans restructuring teams. Profitability will benefit from higher interest rates, supporting capacity to absorb higher loan impairment charges”, the rating agency states in a release.

Most major Portuguese banks are entering the economic downturn from more favourable positions than before the pandemic due to the active management of legacy impaired loans (cures, granular sales and write-offs) and Portugal’s swift post-pandemic recovery, the analysts conclude. The sector impaired loans ratio was about 3.4% at end-June 2022, according to Banco de Portugal, compared with a peak of about 18% at end-June 2016.

“Nevertheless, high household indebtedness and a large proportion of variable-rate loans pose a risk to asset quality as interest rates rise. The risk is mitigated by the Bank of Portugal’s 2018 macroprudential recommendations. These set more conservative guidelines for the underwriting of new lending to households, including limits on loan-to-value (LTV) ratios and stress-testing customers’ repayment capacity under a 300bp interest rate rise”, says the same document.

The guidelines quickly led to the near elimination of new residential mortgage lending with LTV ratios above 90%.

By end-2021, 92% of residential mortgages had an LTV ratio of below 80%, which should limit credit losses for banks if home prices fall moderately. Mortgages originated before the 2018 guidelines took effect should not pose a significant risk. Lending volumes before 2018 were low as Portugal was still recovering from the eurozone sovereign debt crisis and private-sector deleveraging. In addition, the loans were originated when interest rates were higher and their LTVs have since reduced.

“Fitch expects banks to closely monitor borrowers’ repayment capacity and to implement early restructuring of loans, consistent with government measures approved in late 2022 to mitigate the impact of rising interest rates on vulnerable borrowers. This should help to prevent a significant rise in Stage 3 loans”.

In the meanwhile, Portuguese banks are well positioned to benefit from rising interest rates. “The positive effects were already evident in 3Q22 and 4Q22 results, and we expect an acceleration in 2023. Most of the banks’ loans are variable-rate, including 90% of residential mortgage loans, and most of their funding is deposits that will reprice more slowly than assets. Pre-impairment profits should also be supported by the reduction of branch networks and cost-saving initiatives in recent years, partly offsetting the impact of inflation on operating costs”, stress these specialists. 

Original Story: Fitch Wire | Press-Release
Photo: BPI Facebook
Edition: Prime Yield